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Definition: Oligopoly is defined as a market structure in which there are a few sellers selling homogeneous or differentiated products. Where oligopoly firms sell a homogeneous product, it is called pure homogeneous oligopoly. For example, industries producing bread, cement, steel, petrol, cooking gas, chemicals, aluminium and sugar are industries characterized by homogeneous oligopoly. And, where firms of an oligopoly industry sell differentiated products, it is called differentiated or heterogeneous oligopoly. Automobiles , television sets, soaps and detergents, refrigerators, soft drinks, computers, cigarettes, etc. are some examples of industries characterized by differentiated heterogeneous oligopoly. Be it pure or differentiated, "Oligopoly is the most prevalent form of market organization in the manufacturing sector of the industrial nations. In non-industrial nations like India also, a majority of big and small industries have acquired the features of oligopoly market. The market share of 4 to 10 firms in 84 big and small industries of India is given below. Market share (%) 1 - 24.9 25 - 49.9 50 – 74.9 75 - 100 Total No. of industries 8 11 15 50 84
As the data presented above shows, in India, in 50 out of 84 selected industries, ie., in about 60 per cent industries, 4 to 10 firms have a 75 per cent or more market share which gives a concentration ratio of 0.500 above. All such industries can classified under oligopoly. The factors that give rise to oligopoly are broadly the same as those for monopoly. The main sources of oligopoly are described here briefly. 1. Huge capital investment. Some industries are by nature capital-intensive, e.g., manufacturing automobiles, aircraft, ships, TV sets, computers, mobile phones, refrigerators, steel and aluminium goods, etc. Such industries require huge initial investment. Therefore, only those firms which can make huge investment can enter these kinds of industries. In fact, a huge investment requirement works as a natural barrier to entry to the oligopolistic industries. 2. Economies of scale. By virtue of huge investment and large scale production,the large units enjoy absolute cost advantage to economies of scale in production, purchase of industrial inputs, market financing, and sales organization. This gives the existing firms a comparative advantage over new firms in price competition. This also works as a deterrent for the entry of new firms. 3. Patent rights. In case of differentiated oligopoly, firms get their differentiated product patented which gives them an exclusive right to produce and market the patented commodity. This prevents other firms from producing the patented commodity. Therefore, unless new firms have something new to offer and can match the existing products in respect of quality and cost, they cannot enter the industry.
4. pulp & conc. Some examples of oligopoly industries in India and market share of the dominant firms in 1997-98 is given below.95 99. Meyer. they control the entire input supply. new firms find it extremely difficult to enter the industry. Small number of sellers. Let us now look at the important characteristics of oligopolistic industries. This is called interdependence of oligopoly firms. An illuminating example of strategic manoeuvering is cited by Robert A. Merger of rival firms or takeover of rival firms by the bigger ones with a view to protecting their joint market share or to put an end to waste of competition is working. What is equally important is that firms initiating a new business strategy anticipate and take into account the possible counter-action by the rival firms. Conceptually. The most striking feature of an oligopolistic market structure is the interdependence of oligopoly firms in their decision-making. Merger and takeover. Fluorescent lamps No. if a few firms acquire the right from the government to import certain raw materials. For example. 2. as an important factor that gives rise to oligopolies and strengthens the oligopolistic tendency in modem industries. of firms 4 2 6 5 5 4 10 3 Total market share (%) 100. one of the US car manufacturing companies announced in one . the business strategy of each firm in respect of pricing. For example. Mergers and takeovers have been one of the main features of recent trend in Indian industries. Where a few firms acquire control over almost the entire supply of important inputs required to produce a certain commodity. however.90 98.This keeps the number of firms limited.00 99.34 99.95 94. Industry Ice-cream Bread Infant Milk food Motorcycles Passenger cars Cigarettes Fruit Juice. How small is the number of sellers in oligopoly markets is difficult to specify precisely for it depends largely on the size of the market. They have introduced new model in competition with one another. The competition between the firms takes the form of action. car companies have changed their prices following the change in price made by one of the companies.21 91. 5. Interdependence of decision-making. in modem times. 1. As already mentioned. The characteristic fewness of firms under oligopoly brings the firms in keen competition with each other. reaction and counter-action in the absence of collusion between the firms. Industries and Market Share. The number may vary from industry to industry. advertising and product modification is closely watched by the rival firms and it evokes imitation and retaliation. the number of sellers is so small that the market share of each firm is large for a single firm to influence the market price and the business strategy of its rival firms.84 91.00 100. there is a small number of sellers oligopoly. 1999.37 Automobile tyres 8 Source: CMIE. To quote the example. Control over certain raw materials. Since the number of firms in the industry is small.
However. price and output are said to be indeterminate. when Maruti Udyog Limited (MUL). The characteristic fewness and interdependence of oligopoly firms makes derivation of the demand curve a difficult proposition. Neumann and Margenstern Game Theory model (1944) and Baumol's sales maximization model (1959).year in the month of September an increase $ 180 in the price list of its car model. at the other extreme. the new entrants that can cross these barriers can and do enter the industry. None of these models. not deterred the economists from their efforts to find an agreeable solution to the problem. The first company made a counter move: it announced a reduction the enhancement in the list price from $ 180 to $ 71. provides a universally acceptable analysis of oligopoly. vigorous advertising and provision of survive. though only a few. (iii) strong consumer loyalty to the products of the established firms based on their quality and service and (iv) preventing entry of new firms by the established firms through price cutting. that too mostly the branches of MNCs survive. "Under [these] circumstances. The Oligopoly Models: An Overview As already mentioned. reactions and counter-actions showing a variety of behavioural patterns. hbwever. collusion may last or it may break down. of the oligopolistic market structure is the indeterminateness of price and output. The analytical models discussed here are selected on the basis of how price and output are determined under price competition. In India. a few days later a second company announced an increase of $ 80 only and a third announced an increase of $ 91.”The economists have.. other companies followed suit.000 to Rs. Sweezy's kinked demand curve model (1939). price competition is not the major form of competition among the oligopoly firms as price war destroys the profits. Another important feature. announced a price cut of Rs. it may last or it may break down. we discuss here . The widely quoted oligopoly models include Cournot's duoply model (1838).. under oligopolistic conditions. In accordance with the a wide variety of behavioural patterns. the economists have developed a variety of analytical models based on different behavioural assumptions. rival firms indulge in an intricate pattern of actions. or. Stackelberg's model (1933). Edgeworth's duoply model (1897). if price is once determined. However. though a controversial one. In this section. Specifically. 4. we discuss some selected oligopoly models with the purpose of showing the behaviour of oligopoly firms and working of the oligopolistic markets. Indeterminate price and output. Following it. Bertrand's leadership model (1880). price and output are said to be determinate under collusive oligopoly. it tends to stabilize. there too. cartel system and the dilemma that oligopoly firms face in their price and output decisions. As Baumol puts it. A more common form of competition is non-price competition the basis of product differentiation. Even if they enter an agreement. therefore. may try to fight each other to the death.000 in early 2005 on its passenger cars. An opposite view is that price under oligopoly sticky. though . Rivals may decide to get together and cooperate in the pursuit of their objectives. Barriers to entry. Barriers to entry to an oligopolistic industry arise due to such market conditions as (i) huge investment requirement to match the production capacity of the existing ones. (ii) economies of scale and absolute cost advantage enjoyed by the existing firms. This has. This is a pertinent example of interdependence of firms in business decisions under oligopolistic market structure. found it extremely difficult to make a systematic analysis of price and output determination under oligopoly. 24.. a very wide variety of behaviour pattern becomes possible.. Therefore. however. 3.these models do provide an insight into oligopolistic behaviour. But. ie. However. 36.
Its total profit is OP 2PQ. PN. A assumes that B will continue to supply 1/4 of the market. B can sell its product in the remaining half of the market. is the maximum profit seller A can make given the demand curve. To begin with. A assumes that it has 3/4 (= 1 . When B draws its MR curve.1/4) of the market available to it. the market available to firm B is QM and the relevant part of the demand curve is PM.the following oligopoly models. With the entry of B. Faced with this situation. To maximize its profit. was the first to develop a formal oligopoly model in 1838 in the form of a duopoly model. In order to maximize its revenue. A's expected profit falls to OP1RQ. falls to OP1.. ie. By assumption. . Cournot's duopoly model is illustrated in Fig. each owning an artesian mineral water well. (b) both the firms operate their wells at zero cost. ii)Sweezy's kinked demand curve model. Due to fall in price. which merits a detailed discussion. Thus. The demand curve for mineral water is given by the AR curve and MR the MR curve. Note that B supplies only QN = (1/2)/2 = 1/4 of the market. Following the profit maximizing rule. (iii) Price leadership models: (a) Price leadership by low-cost firm. On the basis of this model. (d) each seller acts on the assumption that his competitor will not react to his decision to change his output and price. that is. B assumes that A will continue to sell OQ prices OP2. That is. B sells QN at price OP1 = P'N. (b) leadership by dominant firm and (c) leadership by barometric firm. it bisects QM at point N where QN = NM. Coumot made the following assumptions: (a) there are two firms. a French economist. A assumes that B will not change its output QN price OP1 as it is making maximum profit. (i) Cournot's duopoly model. This is Coumot's behavioural assumption. let us suppose that firm A the only seller of mineral water in the market. B assumes that A will not change its price and output because A is making maximum profit. To illustrate his model. A supplies 1/2 of the remaining 3/4 of the market. Thus. Accordingly. it sells quantity OQ its MC = 0 = MR. price OP2 . and (vi) 's Dilemma Baumol's sales revenue maximization model. firm A adjusts its price and output to the changed conditions. Price falls because A's will also now pay the same price as charged by B. 1/2 x 3/4 = 3/8 of the . Its total revenue is maximum at QRP'N which equals its total profit. (c) both of them face a demand curve with constant negative slope. iv)Collusive model: The Cartel Arrangement. And. Cournot has concluded that each seller ultimately supplies one-third of the market and both the firms charge the same price. each owning a spring of mineral water and water being produced at zero cost.11. (v) Game Theory model of oligopoly. Cournot developed his model with the example of two firms. onethird of the market remains unsupplied. The market open to B the market unsupplied by A. will be discussed in the next chapter. 13. its MC = O. This market equals QM is half the total market. Now let another firm B enter the market. Augustin Cournot.
Thus. the respective shares of sellers.The division of market output may be expressed as Q = QA + QB = 90 . To maximize his profit under the new conditions. Following Cournot's assumption.2.QA) . it is not possible for any of the two sellers to increase their market share beyond one-third of the market as shown in the last row of the table. For. The formula for determining the share of each seller in an oligopolistic market is: Q / (n + 1).P As noted above. according to Cournot's model. Similarly. B. Cournot's model of duopoly can be extended to a general oligopoly model.2 Determination of Market Share Algebraic Solution:.Cournot's model may also be presented algebraically. It is now for A reappraise the situation and adjust his price and output accordingly. This process of action and reaction continues in successive periods. when seller A a monopolist in the market. A and B fixed at QA and QB . B supplies. profit is maximum where MC = MR = 0 and when MR = 0. The firms. Now it is B's turn to react. The actions and reactions and equilibrium of the sellers A and B. given the action and reaction.P) When another seller.QB) . the profit maximizing output is 1/2 (Q). under zero cost condition.P . where Q = market size. reach their equilibrium position where each one supplies one-third of the market and both charge the same price and one-third of the market remains unsupplied. 1/2 x 5/8 = 5/16 of the market. B assumes that A will continue to supply only 3/8 of the market and the rest of the market is open to him. is determined at half of the total market. enters the market. a situation is reached when their market shares equal 1/3 each. Any further attempt to adjust output produces the same result. In the process. That is. Let us suppose that the market demand function for mineral water is given by a linear function as Q = 90 . A continues to lose his market share and B continues to gain. 1/4 of the market remaining unsupplied. if there are three sellers in the industry. according to the profit maximizing rule under zero cost condition. therefore. each one of them will be in equilibrium when each firm supplies 1/4 of the market. For example.P)] Thus.3/8 = 5/8. his profit-maximizing output (QA). his profit maximizing output QB = 1/2 [(1/2(90 . Table 13. A's initial market share QA = 1/2 (90 . Eventually.P The demand function for A now be expressed as QA = (90 . Cournot's equilibrium solution is stable. which equals 1 . are presented in Table 13. and n = number of sellers.market. The three sellers together supply 3/4 of the total market. It is noteworthy that A's market share has fallen from 1/2 to 3/8.P and for B as QB = (90 .when there are four firms each one of them supply 1/5th of the market and 1/5th of the market remains unsupplied.
Qb = (90 .60)1/2 = 15. then A's = [(90 .. That is. both the sellers are in equilibrium. For example.32).33) is B's function. ie. QB = 30).QA)/2. 30. Point E is. Thus.32) and (13. substitution.33). (13. will be QB = 90 .QB A 2 and similarly for B. Fig. Second.(13. The two reaction functions intersect at point E.QA B . his assumption of zero cost of production is unrealistic though dropping .QA)/2 QA = 2 QA = 30 Similarly. each seller continues to assume that his rival will not change his output even though he observes time and again that his rival firm does change its output.. the point of stable equilibrium.30). The profit maximizing output for A be half of the market size. A's output = (90 .60 = Rs. It can similarly be shown that Eq.33) represent the reaction functions of sellers A and B..33) 2 The Eqs. Cournot's behavioural assumption [assumption (d) ] is naIve as it implies that firms continue to ...12 Reaction Function and Equilibrium: Cournot Model . If B chooses to produce 30 units. (13. market price will be P = 90 . Given the market demand curve. both the sellers will produce 30 units each. (ie.32) and (13. The profit maximizing output of A on the value of QB. each seller sells only 30 units. It means that the assumptions of A and B coincide at point E and here ends their action and reaction. The reaction function shown by line AM shows how A react on the assumption that B not react to changes in his output once B's output is fixed.30)1/2] = 30. At equilibrium. (13.Given the demand function (13. 13. it has been criticized on the following grounds.(13. the output which B assumed to produce. Eq.Q .respectively . First. the market open to A (at P = 0) is 90 – QB. 13. (13.12.32) The reaction functions of A and B graphed in Fig.Q = BA 2 2 Since. (13. ie. QA= 90 .make wrong calculations about the competitor's behaviour.. The market equilibrium takes place where 90 . consider Eq. it can be shown that QB = 30. we get first term as 90 .Q = 90 . Thus. If B chooses to produce 60 units. therefore.(90 ... The reaction function BD shows a similar reaction of B.32) is A's reaction function. At this point. The market output will be 60 units. . Criticism :Although Cournot's model yields a stable equilibrium. The same result can be obtained by equating the two reaction Eqs.
This model is. 13. In either case.13 Kinked Demand Curve Analysis of Oligopoly . it seeks to establish that once a price-quantity combination is determined. (ii) the rival firms do not follow the price changes. The kinked demand curve analysis does not deal with price and output determination. . if rival firms do not follow the price changes. An oligopoly firm believes that if it reduces the price of its product. therefore. There are three possible ways in which rival firms may react to change in price made by one firm. To begin with. the price raising firm stands to lose. i. let us suppose that the market demand curve for a product is given by dd' curve and that the initial price is fixed at PQ Fig. To look more closely at the kinked demand curve analysis. The kinked demand curve model of oligopoly was developed by Paul M.this assumption does not alter his position. at least a part of its market share. Demand curve dd is less elastic because the expected changes in demand in response to changes in price are neutralized by the counter-moves of the rival firms. rival firms would either maintain their price or may even cut their price down.. find it more desirable to maintain their price and output at the existing level. Note that the firm initiating the price change faces two different demand curves -dd' DD'-conforming two different kinds of reactions (i) and (ii). let us look into the possible actions and reactions of the rival firms to the price changes made by one of the firms. 13. Note also that the demand curve dd' based on reaction (i) less elastic whereas demand curve DD' based on reaction (ii) is more elastic. (i) the rival firms follow the price changes. This behavioural assumption is made by all the firms with respect to others. The logic behind this proposition is as follows. famous by Sweezy's name as his model is treated to be analytically superior. rival firms would follow and neutralize the expected gain from price reduction. the price changing firm will move along demand curve D D' . respectively. Sweezy's kinked demand curve model is the best known model explaining relatively more satisfactorily the behaviour of oligopolistic firms. the price changing firm moves along the demand curve dd'. Now let one of the firms change its price. therefore. Rather. they react with hike for hike and cut for cut. both cut and hike. if it raises its price. He has shown through his kinked demand curve analysis that price and output once determined under oligopolistic conditions. But.e. discuss here the kinked demand curve model as developed by Sweezy. however. tend to remain stable. an oligopoly firm does not find it profitable to change its price even if there is a considerable change in cost of production. The oligopoly firms.13. Sweezy and also by Hall and Hitch in the same year (1939). Fig. If rival firms react in manner (i). We will. (iii) rival firms follow the price cuts but not the price hikes.
Given the MR (DJ-KL). both price and output remain fixed.2QI P2 = 160 . Q1 . Now suppose. This can be established by allowing an oligopoly firm to alternatively increase and decrease its price.(13. 13.35). the two parts of the demand curve -DP and Pd'-put together. Demand curves D1 and D2 intersect at point K. Thus. firm's own stipulated demand curve (D2) corresponding to DD in Fig. more realistic one. let us suppose that the original marginal cost curve is given by the curve MC1 which intersects MR at point K.. Then the rival firms. Let us now draw the MR for the firm initiating the price change.. the price cutting firm moves down along the Pd' segment of the demand curve. What we need now is to work out MR1 and MR2 corresponding to the two demand functions.13.(13.34) and (13. that the firm decreases its prices. Therefore.(13. TRI = P1 .(13. we need to find TRI and TR2. MR = MC1 firm makes maximum profit.e. Given the demand functions (13.36) The demand functions (13. i. alternatively. 13. to the DP and Pd' of the kinked demand curve.. forced down from demand curve dp to DP. it loses a part of its market to its rivals.. The DJ and KL segments of the MR curve correspond.34) (ii) D2 : Q2 = 160 . makes only a part of the two demand curves relevant and produces a kinked demand curve. let us now introduce and examine the result of reaction (iii). the relevant segment of demand curve for the price hiking firm is DP..5Q2 . Let us suppose market demand curve (D1) corresponding to demand curve dd'. If a firm increases its price and rivals do not follow. This is what the kinked demand curve analysis seeks to establish. the firm has no motivation for increasing or decreasing its price. respectively. cut down their prices.Q2 ... give the demand curve for the price changing firm as DPd' which has a kink point P. Since at output OQ. The firm is. Recall that MR = AR . they would lose their customers. Thus. given their asymmetrical behaviour.38) asfollows.37) (13.35) (iii) TC = 300 + 20Q + 0.AR/e. To work out MRI and MR2.35) are shown by D1 and D2 in Fig.38) The TRI and TR2 functions can be worked out by using price functions .13 and its total cost function (TC) given as follows.. The MR curve drawn on the basis of this relationship. dd' and DD'.0. therefore. even if cost of production increases and MC shifts upwards to MC2 or to any level between points J and K. DPd'. This asymmetrical behaviour of the rival firms. The demand for its product decreases due to cross elasticity.(13..14. kinked demand curve is drawn and marked by BKD1.. Therefore. Now. and MC from the cost function. Thus.37) .34) and (13. firms do not find it gainful to increase the price even though their profit would be affected. takes a shape as shown by a discontinuous curve DJKL Fig.Given the two demand curves. 13. the relevant segments of the demand curve for price cut is Pd'. Otherwise. the rival firms follow the price-cut but do not follow the price-hike.P2 . (i) D1 : Q1 = 100 . This counter price-move by the rivals prevents the firm from taking the advantage of price-cut.5P1 . Thus. PI and P2 can be obtained as PI = 200 .(13..
13.(13.Q2)Q2 = 160Q2 .(13. given the price.(13.(13.. We know that at the intersection point PI = P2.Q Q = 40 By substituting 40 for Q in any of the price functions. . Fig.39) and TR2 = P2 . 80 . At the kink point (K).42) The MRI and MR2 are shown by truncated lines MRI and MR2 Fig. we can get price (P) at the point of intersection. Now Q and P at the kink point K can be known as follows. . So when we get PI or P2.2Q2 = 160 . 40 and MR2 = 160 .2(40) = Rs. PI = P2 200 .4(40) = Rs.. we can derive the MRI and MR2 functions. we can work out quantity demanded at the point of kink by equating the price functions as follows. Q2 = (160 .14 Sweezys Kinked Demand Model Having worked out P and Q..40). QI = Q2 = Q. .4(40) = Rs. Thus.. 120 This can be verified from Fig. Since at the point of intersection of DI and D2 curves.Q2 . price P is given.2Q = 160 . DI and D2 are equal at the given price. respectively. by using price function (PI). 13.2QI)QI = 200QI – 2QI2 . Let us assume that.4Ql = 200 . at the point of intersection. MR1 = 200 .14.39) and (13..QI = 200 .4Q1. by substituting Q for QI and Q2 in price functions (13.14. As regards MC curve. QI = Q2 = Q.43) Having derived the MRI.38). The MR curve corresponding to the kinked demand curve is drawn through points BLM and along the line MMRI.5Q2) MC = .= (200 .41) and MR2 = 160 .(13. Thus.= = 20 + Q oQ oQ .2Q2.37) and (13. 13. as given below.36). we get P.. we now illustrate the conclusions of the kinked demand curve analysis. MR1= 200 . let us now verify the main thesis of Sweezy's model that the variation in MC within a range will not affect the price.. And.40) By differentiating TRI and TR2 functions (13. we get P = 200 . Let us first find price (P) quantity demanded (Q) at kink point K. The upper limit of MC variation is given by point M at the MR1 at price P and the lower limit by point L at MR2 at the same price. it can be obtained by differentiating the TC function (13. MR2 and MC functions. Thus. 0 TC 0 (300 + 20Q + 0.
Now let the cost of production increase and cost function change to TC = 400 + 30Q + 0. Monopoly prices have been found to be more stable than oligopoly prices. Criticism of Sweezy's Model: A major criticism against Sweezy's model is that it explains only the stability of output and price-it does not say how the initial price is determined at a certain level. 70. Sometimes. ie. price differences commensurate with product differentiation. iii)Products are. Besides. the price stability does not stand the test of empirical verification-there is a surprising lack of price rigidity in oligopolistic markets. 60. the largest firm in the industry. The dominant firm takes lead in making price changes and the smaller ones follow. price leadership is barometric. tend to be stable in the oligopoly market.g. Price differentials may also exist on account of cost differentials. however.. Furthermore.5Q Then MC = 30 + Q Given the MC function. at Q = 40. iv)Demand for industry is inelastic or has very low elasticity and v)Firms have almost similar cost curves. efficiency. MC = 30 + 40 = Rs. Since MC = 70 is within the lower and upper range. Another important aspect of price leadership is that it often serves as a means to price discipline and price stabilization. not necessarily the dominant one. Price leadership may emerge spontaneously due to technical reasons or out of a tacit or explicit agreement between the firms to assign a leadership role to one of them. In the barometric price leadership one of the firms. by and large. exist and work effectively only under the following conditions. Let us now discuss price determination under different kinds of price leadership . Stigler's findings were further supported by the findings of Simon. price will not change. e. ii)Entry to the industry is restricted. At Q = 40. 40 and Rs. Stigler found in case of seven oligopolistic industries that there 'little evidence'of reluctance to the price hike made by other firms. The price leadership is found under both product homogeneity and product differentiation. This proves Sweezy hypothesis that prices once determined. for example.. Such a leadership can.Thus. the lower and upper limits of MC variation that will not affect the price at Q = 40 lie between Rs. however. homogeneous. prices of most oligopolistic firms. MC = 20 + 40 = Rs. takes the lead generally in announcing a change in price. i)The number of firms is small. The spontaneous price leadership may be the result of such technical reasons as size.Even in India. Achievement of this objective establishes an 'effective price leadership'. at PQ. particularly when such a change is due but is not effected due to uncertainty in the market. prices of cars and computors have been fluctuating. 80. The most typical case of price leadership is the leading role played by the dominant firm. There may be. economies of scale or firm's ability to forecast market conditions accurately or a combination of these factors. Price leadership is an informal position of a firm in most oligopolistic industries.
13. This is so because the largest firm has the economies of scale and its cost of production is lower than that of other firms.15. but they have different cost curves. have higher cost and their cost curves are as shown by AC2 and MC2. Suppose all the oligopoly firms face identical revenue curves as shown by AR and MR curves. (a) Price Leadership by Low-Cost Firm :The price and output decisions under the leadership of a low-cost firm is illustrated in Fig. The largest firm is the low-cost firm and has its cost curves as shown by ACl and MCl. smaller in size. All the rival firms.models. .
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