Oligopoly

Learning Outcome

• To discuss the oligopoly market in the real world.

• To analyse the relevance of selling cost in oligopoly
market.

• Introduction: https://www.youtube.com/watch?
v=TdGNBdWyY94
 OLIGOPOLY

– Market structure in which there are only a few firms selling

either standardized or differentiated products and it restricts the
entry into and exit from the market.
 Characteristics

– Few numbers of firms

– Homogeneous or differentiated product

– Barriers to entry

– Price War

– Non-pricing strategies

– Interdependence
Which of the following is not true about Oligopoly?
A.Single seller
B.Price war
C.Selling cost
D.Entry barrier
Which of the following is an example of Oligopoly?
A.Railways
B.Agricultural products
C.Airlines
D.None of these
 OLIGOPOLY

• Price Rigidity and Kinked Demand Curve

– Since there is mutual interdependence between oligopoly firms,

the prices in the market are more stable. This is called price
rigidity in oligopoly market.

– The price rigidity explains the behaviour of an oligopoly firm that

has no incentive to increase or decrease the price.
 OLIGOPOLY

– The theory of the kinked demand curve is based on two

assumptions.

1. First assumption: If an oligopolist reduces its price, its rivals will follow and
cut their prices to prevent losing the customers.

2. Second assumption: If an oligopolist increases its price, its rivals do not

increase the price and keep their prices the same, thereby they gain
customers from the firm that increases the price.
 OLIGOPOLY (cont.)
Because of this According to the assumption, An oligopoly firm faces
assumption, an when the firm increases the two demand curve,
oligopolist faces kinked price (P*), no other firms will individual demand
Price (RM) demand curve. follow. Above P*, the firm will curve (dd) and industry
follow the dd curve. demand curve (DD).
If the firm decreases the price,
other firms will follow. Below
P*, the firm follow the DD
curve.

P*

dd

DD

Q* Quantity
 OLIGOPOLY (cont.)

This shows the price At this range of MR, any
rigidity in the oligopoly change in the MC does not
market. reflect changes in the profit
Price (RM)
maximizing price and
output.
The kinked demand
curve  below Point E
creates a gap in the
MR, which is indicated
by the dotted line ab.

MC1
MC2
E
P*

b DD

Q*
MR Quantity
 Duopoly

• Duopoly is that type of oligopoly in which only two players operate

(or dominate) in the market.
• Used by many economists like Cournot, Stackelberg, Sweezy, to
explain the equilibrium of oligopoly firm, as it simplifies the analysis.
Price and Output Decisions
• No single model can explain the determination of equilibrium price
and output
– Difficult to determine the demand curve and hence the revenue curve of the
firm
– Tendency of the firm to influence market conditions by various activities like
advertisement, and fear of price war resulting in price rigidity .
 Collusive Oligopoly
• Rival firms enter into an agreement in mutual interest on various
accounts such as price, market share, etc.
• Explicit collusion: When a number of producers (or sellers) enter into
a formal agreement.
• Tacit collusion: A collusion which is not formally declared.
• Cartel
• Agreement price and output.
• Small number of sellers with homogeneous product.
• Price fixation, total industry output, market share, allocation of
customers, allocation of territories, establishment of common sales
agencies, division of profits, or any combination of these.
 Factors Influencing Cartels

• Number of firms in the industry

• Nature of product

• Cost structure

• Characteristics of sales
 Informal and Tacit Collusion

• Formed when firms do not declare a cartel, but informally

agree to charge the same price and compete on non price
aspects.
What is the role of non-price strategies in oligopoly?
 Models of Oligopoly

Price Leadership Model

a.Price Leadership by Low-Cost Firm
b.Price Leadership by a Dominant Firm
c.Barometric Price Leadership
 How firm compete?

• Non price competition

– “any effort made by firms other than a change in the price
of the ‘product in question’ in order to influence the demand
for their product.”
• Non price determinants
– Taste and preference, income, prices of substitutes and
complementary goods, no. of buyers, future expectations.
Let’s Discuss a Case Study
 Cartels in the cement Industry

• India ranks second in the world in cement production. The cement industry
is highly fragmented as its faces tremendous pressure on price realization.
The demand for cement is price –elastic. Any imbalance in the demand and
supply leads to a disproportionate increase in the price. Based on the
season, the price is determined by the supply. When the cement
manufacturers increase their capacities, the enhanced capacity leads to
excess supply. As the supply is more than demand, cement prices fall and
demand picks up, leading to an increase in price.
• Since cement production is highly capital-intensive, profit margins are low.
The declining profit margins have prompted cement companies to form
cartels. For example, five big players in the industry cut production by 10%
and managed to increase profit by 50%.
• There are two important factors affecting cement production, namely,
sales tax benefits, and the direct cost incurred in production. Sales tax
incentive varies from state to state. Tamil Nadu offers sales tax exemption
for seven years and the payment can be deferred up to 14th year. Gujarat
offers exemption from sales tax for seven years. Based on the cost
structure and the freight and packing charges, the firm arrives at its profit
or loss. The price and supply of cement in a particular state is fixed by local
cartel. Profit margin depends upon incentives, direct costs, and decisions
of the cartel. The cartel decides the floor price and the sales volume for
individual members in a region. Normally, cement cartels do not last into
the long run; cartelization is more of a short-run phenomenon.
• What are the reasons for the formation of cartels in the cement industry?

• Why cartels do exists only in the short run?

• What if cartels were not illegal?