Course Code and Title: BACR2 Basic Microeconomics

Lesson Number: 13

Topic: Oligopoly

Oligopoly is a market structure characterized by the presence of a relatively small number

of firms and a great deal of mutual interdependence among them. The dominant feature is
mutual interdependence among the sellers. Each oligopolist formulates policies with a wait
and sees attitude. An oligopolist realizes that any change in its price, output advertising
technique, and other strategies will elicit changes in the policies of rival firms. As a result,
the oligopolist has to develop an aggressive as well as a defensive stand

Oligopolies in history include steel manufacturers, oil companies, railroads, tire

manufacturing, grocery store chains, and wireless carriers. The economic and legal
concern is that an oligopoly can block new entrants, slow innovation, and increase prices,
all of which harm consumers. Firms in an oligopoly set prices, whether collectively – in a
cartel – or under the leadership of one firm, rather than taking prices from the market.
Profit margins are thus higher than they would be in a more competitive market.

Learning Objectives:

At the end of the lesson, the students will be able to:

1. Discuss oligopoly as a market structure.

2. Repeat the characteristics of oligopoly; pure oligopoly from differentiated

oligopoly.

3. Question the ideas of collusion and kinked demand curve.

The characteristics of oligopoly are the following:

1. There are only a few sellers.

2. There is mutual interdependence among the few sellers. Oligopolist’s market behavior is
interdependent action of sellers. An oligopolist considers what its rivals will and will not do.

3. There is a rigid price. Price tends to be sticky and there is uniform pricing of the product.

4. Products sold may be homogeneous. But if it is differentiated the products are said to be
differentiated, too.

5. There may be a price leader. A dominants firm may arise and price-setting role may be
performed by it

6. There are some barriers to entry into the market. Some restrictions prevent a firm from
entering the industry. Some examples are economies of scale, franchises, and patents, or
ownership of important resources.

7. There is a non-price competition. This is usually manifested through product

promotion. Example 1

In the Philippines, there is a growing number of industries which started as monopolists but
are now considered as oligopolists. We have the beer industry, cellular phone industry, and
the Philippines airlines (PAL), to name a few. For so many years, the PAL was the only flag
carrier of our country when it comes to air transportation, particularly domestic flights. But
not anymore. If we want to travel to Cebu or Baguio City, we have now several airlines to
choose from. We have Grand Air, Asian Spirit, Cebu Pacific, and so on.

Another example is the cellular phone industry. In the eighties when it was introduced in the
Philippines, it was only PHILTEL. Which offered the units and the line. It was the most
modern way of communicating with other people so there was a very high demand for it.
Other firms followed suit, so we now have smart, Extelcom, Globe Telecom, Islam, etc.
competition became prevalent. For a firm to maintain its market share, they have to
advertise, give a discount and continuously improve the quality of the product.

There two classification of oligopoly:

1. Pure Oligopoly. Under pure oligopoly the products sold are identical or homogeneous
sellers charge a price which may be more or less the same as what the others charge.
Examples are the cement and steel industry.
2. Differentiated Oligopoly. In differentiated oligopoly, firms sell products which are not
homogeneous. Products are sold at the different prices. Examples are automobile industry
and appliances.
Collusion is a secret agreement entered into by firms who decide to act together all firms in
the industry agree to establish price levels which are most profitable for the industry as a
whole rather than to set their prices as individual units. The advantages derived are:

1. Increased Profits. If firms act jointly or with concerted efforts, competition is minimized
and joint profit can be maximized.

2. Decreased Uncertainty. Firms that agreed among themselves would not do actions that
will be detrimental to their interest.

3. Better opportunity to block entry of new firms. The presence of artificial restrictions
would make an entry for firms difficult.

When the collusive arrangement is openly accomplished through a formal agreement, then it
is said to be a cartel. A cartel is a formal organization of firms in the industry which seeks to
maximize profit through price and output regulation. Decision-making is entrusted to the
central organization which is responsible to its members.

Example 2.

Examples of the cartel are the IATA and OPEC. Most airlines flying transatlantic routes are
members of the IATA (International Air Transport Association). This is a voluntary
organization that permits members to agree on uniform tariffs for transatlantic flights. If the
IATA members unanimously agree in the tariff schedule approved by their respective
governments, then this set of tariffs become binding upon the airlines.

Kinked Demand Curve

The kinked demand curve describes the behavior of the business firms such that they do
not have any incentive to increase nor lower the price. The firm’s attitude rests on an
estimate of what their rivals will and what they will do. Suppose an oligopolist cuts his selling
price, his rivals would match the same price reduction. However, if he were to increase the
price, his rivals would not change their prices.

Example 3.

In this illustration in Figure 1, there are two demand curves, d’1 and D’. If a seller increases
the price, others will not follow so the relevant portion is C. However if a firm lowers the
price, others will follow so the relevant portion of the demand curve is ED’. Because of a
change in the degree of elasticity from elastic demand ('d C) to inelastic demand (CD’)
there will be a kink or twist represented by point C. The price to be charged will be OP and
the quantity is OQ

Figure 1.
Derivation of the kinked Demand Curve

Kinked Demand Curve Model

Generalization:
Oligopoly is a market structure with a small number of firms, none of which can keep the
others from having significant influence. The concentration ratio measures the market share
of the largest firms. A monopoly is one firm, the duopoly is two firms and oligopoly is two or
more firms. There is no precise upper limit to the number of firms in an oligopoly, but the
number must be low enough that the actions of one firm significantly influence the others.

∙ Oligopoly is when a small number of firms collude, either explicitly or tacitly, to restrict
output and/or fix prices, to achieve above normal market returns.
∙ Economic, legal, and technological factors can contribute to the formation and
maintenance, or dissolution, of oligopolies.
∙ The major difficulty that oligopolies face is the prisoner's dilemma that each member
faces, which encourages each member to cheat.
∙ Government policy can discourage or encourage oligopolistic behavior, and firms in
mixed economies often seek government blessing for ways to limit competition. Volume 75%

References:

https://www.youtube.com/watch?v=JMq059SAQXM&t=302s

https://www.slideshare.net/dgwessler/monopolistic-competition-and-oligopoly-44759115