Market Structures &

Firm Equilibrium
Oligopoly
Oligopoly – Competition amongst
the few

• Industry dominated by small number of large firms

• High barriers to entry
• Products could be highly differentiated
• Non–price competition
• Price stability within the market - kinked demand curve?
• Potential for collusion?
• Abnormal profits
• High degree of interdependence among firms as very few
sellers
• Assuming complete and full information
 Sources of Oligopoly
• Economies of scale
• Large capital investment required
• Patented production processes
• Brand loyalty
• Control of a raw material or resource
• Government franchise
• Limit Pricing
 Measures of Oligopoly
• Concentration Ratios
• The degree by which an industry is dominated by few large firms
is concentration ratios. This is given by percentage of total
industry sales . 4, 8, or 12 largest firms in an industry
• Herfindahl Index (H or HHI)
• H = Sum of the squared market shares of all firms in an industry
 Herfindahl Index, HHI

• An H below 0.01 (or 100) indicates a highly

competitive industry.
• An H below 0.15 (or 1,500) indicates an
unconcentrated industry
• An H between 0.15 to 0.25 (or 1,500 to 2,500)
indicates moderate concentration.
• An H above 0.25 (above 2,500) indicates high
concentration
 Question

•Calculate HHI

•One firm has 70%, one has 20%, one has 10% share
of market
 Answer

• H = (70)2 + (20)2 + (10)2 = 4,900 + 400 +

100 = 5,400.
Topics of Discussion
Oligopoly
• Duopoly
• Kinked demand curve
• Perfect Collusion: Cartels
• Price Leadership
• Cournot Model
• Non price competition and game
theory
 Oligopoly

• Duopoly – case of 2 sellers

• Pure oligopoly – homogenous product
• Differentiated product – differentiated oligopoly
e.g. Supermarkets, Banking industry, Chemicals,
Oil, Medicinal drug, broadcasting
 Duopoly
Industry dominated by two large firms
• Possibility of price leader emerging – rival will
follow price leaders pricing decisions
• High barriers to entry
• Abnormal profits likely
• Most scenarios in the long-run result in both
competitors losing and one or both going out of
business.
• In this situation a strategy of collusion or
cooperative pricing for mutual benefit is optimal.
 Tacit Collusion

• When firms limit production and raise prices in a

way that raises each others profits, even though
they have not made any formal agreement, they
engage in tacit collusion
 No Collusion
Kinked Demand Curve Model
• Proposed by Paul Sweezy
• If an oligopolist raises price, other firms will not follow, so
demand will be elastic
• If an oligopolist lowers price, other firms will follow, so
demand will be inelastic
• Implication is that demand curve will be kinked, MR will
have a discontinuity, and oligopolists will not change price
when marginal cost changes
 Kinked demand curve

• Oligopolists prefer non price competition

• They face a demand curve with a kink at prevailing
price
• This explains price rigidity in oligopoly
• The demand curve is highly elastic for price
increase but much less elastic for price cuts
• Oligopolists recognise their interdependence but
act without collusion
Kinked Demand Curve Model
 Collusive oligopoly

• In collusive oligopoly, firms act in unison, in

collusion with one another as to
a. Reduce degree of competition and helps in profit
maximising
b.Reduces uncertainty surrounding market
c.Form a kind of barrier to entry of new firms
 Perfect Collusion
• Collusion refers to a formal or informal agreement
among oligopolists on what prices to charge and/or
how to divide the market.
• Collusion is result of mutual interdependence
among firms. It averts price wars and increases
industry profits
• Overt collusion refers to a formal agreement such
as cartel and may be illegal . Tacit collusion is an
informal agreement as price leadership
 Cartels
• Collusion
• Cooperation among firms to restrict competition in order to
increase profits, price fixing and market sharing
• Market-Sharing Cartel
• Collusion to divide up markets, geographic
• Centralized Cartel
• Formal agreement among member firms to set a monopoly price
and restrict output
• Incentive to cheat
 The Cartel:
• To maximize profit, cartel managers must allocate production
based on the rule of marginal cost, which dictates that MR = MCA
= MCB = …= MCn for all participants.
Centralized Cartel
 Weakness of cartels

• Difficult to assess market demand accurately

• Firms want greater profit or withdraw
• Members may cheat by selling more than quota
• Existence of monopoly profits may attract new
firms
• OPEC
 Price leadership
• A firm that is recognised as a price leader initiates a
price change and then the other firms in the industry
follow,

The price leader may be

a. Dominant firm
b. Low cost firm
c. Barometric firm
 Price Leadership
• Implicit Collusion
• Price Leader
• Largest, dominant, barometric or lowest cost firm in the industry
sets price
• Demand curve is defined as the market demand curve less supply
by the followers
• Followers
• Take market price as given and behave as perfect competitors, sell
output where price = MCf
Price Leadership