Download Oligopoly

Oligopoly
Assumptions/Features
1. A few large firms dominate the market.
The entire market is made up of a few large firms. Eg. the airline, banking and supermarket
industries in Ireland
2. These firms are interdependent
The behaviour of firms is influenced by the other firms in the market. There may be one large market
leader. For example, the prices one supermarket charges are influenced by what the competition is
charging.
Firms may collude – either formally or implicitly on areas such as
 prices
 sales territories
 ancillary services
3. Price Stickiness
This is when firms don’t increase their prices, despite an increase in their costs.
This is sometimes reflected in a kinked demand curve (price rigidity).
Non-price competition is far more likely than a price war. Eg: Banks don’t compete in terms of
cheaper costs, because all that would happen is consumers would gain and they’d all lose.
4. There are Barriers to Entry.
Entry is not impossible, but it is difficult. These barriers include
 high start-up costs, such as in the banking industry
 the cost advantage of existing firms, such as in the airline industry
 limit pricing (existing firms lower the prices to make it harder for new firms to compete),
such as practised by supermarkets
5. Profit Maximisation may not be the main objective of the firm.
In the kinked demand curve model, we still assume the firm will produce where MC = MR.
However, it has been suggested (by Baumol and others) that maximising sales revenue or market
share may be more of a priority.
Diagrams
The Kinked Demand Curve (Paul Sweezy)
Another Note!!
The purpose of the diagram in this market is NOT to show AC, AR, SNP, etc. In this way, it’s unlike
all the other graphs.
What we’re getting at here is just showing a situation where a firm’s costs go up, but it continues to
charge the same price.
The AR Curve
In Oligopoly, the average revenue (AR)/demand curve facing the firm is kinked. This is because if the firm
puts up its prices it will sell a lot less (elastic demand), as consumers switch to other producers. However, if
the firm reduces its prices it will not gain any extra sales, because its competitors will also lower theirs.
The AR Curve
In effect, there are now TWO AR curves, and for each there is a separate marginal revenue (MR) curve, as
graphed below. This leads to a discontinuity in the MR curve, at the quantity where the firm is already
producing.
The MC Curves
Initially, the firms faces MC1, however an increase in costs, raises the marginal cost to MC2.
Equilibrium Output
Because we assume each firm tries to maximise profits, they will produce where MC = MR. This gives the
equilibrium quantity, Q. Reading up to the AR curve gives the price charged. However, when the costs
increase from MC1 to MC2 the intersection point with the MR curve remains at the same Q, and critically,
the price remains at P.
In this way, costs have increased, but the price the firm charges remains the same. It reluctantly absorbs the
increase in costs, rather than increase prices, because to do the latter would result in a huge fall off in sales.
A higher MC curve
If marginal cost rose to MC3, the MC = MR intersection would occur at a different point, and the firm would
have no option but to raise prices.