Me M7 Oligopoly


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Me M7 Oligopoly

  1. 1. OLIGOPOLY ME – M7
  2. 2. OLIGOPOLY <ul><li>Baumol describes Oligopoly as an industry with small number of large firms producing the bulk of its output . </li></ul>
  3. 3. Oligopoly <ul><li>Main features: </li></ul><ul><li>Sellers are few in number. </li></ul><ul><li>Increase or decrease of anyone’s output will appreciably affect the market price. </li></ul><ul><li>Each seller knows his competitors individually in each market.   </li></ul><ul><li>Each oligopolist realizes that any change in his price and advertising policy may lead rivals to change their policies. The smaller the number of firms, the more interdependent are their policies. The reactions of rivals will be immediate and strong and therefore, tendencies to close collaboration in price determination are apt to appear. </li></ul><ul><li>  </li></ul>
  4. 4. Oligopoly <ul><li>Foundations of Oligopoly :  </li></ul><ul><li>Absolute cost advantages due to control of strategic supplies or due to patented production techniques. </li></ul><ul><li>Advantages resulting from product differentiation and consumer loyalty to established brands/products. </li></ul><ul><li>Economies of scale that make it difficult for newcomers to finance the large size firms capable of producing at low costs. </li></ul><ul><li>Restriction on entry of new firms exercised by he existing firms. </li></ul><ul><li>Restrictions imposed by the State on entry of new firms.   </li></ul><ul><li>In Oligopoly, the emphasis is on barriers to entry, market collusion and other practices that ensure high profits for the few sellers. Competition is imperfect because of the control of the market rather than the presence of unique products. </li></ul><ul><li>  </li></ul>
  5. 5. Oligopoly <ul><li>Kinked Demand Curve in Oligopoly : </li></ul><ul><li>A kinked demand curve is said to occur when there is a sudden change in the slope of the demand curve; this gives rise to a kink, that is, sharp corner in the demand curve. We would get such a curve in an Oligopoly, when it is assumed that the rivals will lower their prices when the oligopolist lowers his own price but that rivals will not raise their prices when the oligopolist raises his price. </li></ul>
  6. 6. Oligopoly, Kinked Demand Curve and Price Rigidity <ul><ul><ul><ul><ul><li>D </li></ul></ul></ul></ul></ul>Price change unmatched Price change matched d d’ D’ K Quantity Price
  7. 7. Kinked Demand Curve in Oligopoly <ul><li>The point K in the diagram represents the firm’s current price quantity combination. </li></ul><ul><li>Now, if the Oligopolist changes the price, the rivals’ reactions are likely to be as follows:- </li></ul><ul><li>(a) Reaction to price reduction: If the oligopolist reduces his price, his rivals will experience a drain on their customers and consequently will match this price cust by reducing their own prices. The ultimate result will be that there will not be a significant increase in the sales of the oligopolist, for downward price movements from point K, the relevant portion of the Oligopolist demand curve will be the segment KD. </li></ul>
  8. 8. <ul><li>(b) Reaction to price increase: </li></ul><ul><li>If the Oligopolist raises his price, his rivals will get customers moving away from him. They will welcome the new customers and will have no motivation to raise their prices. Thus, a price increase by an oligopolist will lead to a big decline in his sales. Hence, for price increases, the relevant part of the demand curve will be the elastic segment dK. </li></ul>
  9. 9. <ul><li>Conclusion </li></ul><ul><li>We may conclude that an oligopolist faced with a kinked demand curve will be extremely unwilling to change his price. For aql fall in his price will cause no large increase in his sales. Thus, neither a price increase nor a price reduction will be an atrractive proposition for the oligopolist. </li></ul><ul><li>During inflationary periods, however, oligopoly firms often follow one another’s price increase; to this extent, the kinked demand curve analysis can be said not to hold true. </li></ul>
  10. 10. Oligopoly and Non-price competition <ul><li>Non-price competition is usually unrestrained, when compared to price-cutting. </li></ul><ul><li>Retaliation is much more difficult against advertising, personal selling or product improvements than against price-cutting . Patent and knowhow barriers, long and usually secretive gestation period, and delay in imitation are other important factors. </li></ul><ul><li>Sales effects of a particular promotional strategy are far less clear than the effects of price-cutting. </li></ul><ul><li>Various forms of non-price competition are stronger and more durable products, product research and development, better packing and appearance, easier credit terms, home delivery, after-sales service, longer guarantee period, promotional effectiveness, dealer loyalty etc. </li></ul><ul><li>Non-price competitive stratgegy would vary according to the nature of the product and the characteristics of the buyers of that product. </li></ul>
  11. 11. Non-price competition <ul><li>Benefits to producer: Higher sales induced by non-price competition may lead to lower unit costs and higher profits and eliminate seasonal fluctuations thus stabilising production. But the risk is that changes in product design may not be acceptable to consumers. </li></ul><ul><li>Benefits to customer: </li></ul><ul><li>From the customers point of view, non-price competition is a boon as it results in better quality products and services. </li></ul>
  12. 12. Price War or Cut-throat competition <ul><li>The existence of idle capacity or accumulated inventory, often lead sellers to cut prices successively to a point where non of them can even recover his cost and earn a fair return on his investment. Such a situation is known as cut-throat competition. </li></ul><ul><li>The most common causes of price-war are :- </li></ul><ul><li>The existence of heavy inventories and resulting competition among sellers to unload their supplies. </li></ul><ul><li>An aggressive seller trying to elbow his way into the mrket or to expand his operations. </li></ul><ul><li>Seller grnting price concessions to gain or protect sales volume from declining. </li></ul><ul><li>The use of certain merchandise items (cigarettes) as a leader for attracting patronage, and a resulting retaliatory action by rival vendors. </li></ul><ul><li>Introduction of a technical innovation accompanied by greatly reduced operating costs and reduction in prices. </li></ul>
  13. 13. General principles of Oligopoly pricing <ul><li>If a rival cuts the price, it is better to match the cut than to undercut his price. </li></ul><ul><li>It is safer to engage in secret price concessions for selected customers than to reduce prices openly with the possibiliy of retaliation. </li></ul><ul><li>Price reductions, once made, are not easily reversible. </li></ul><ul><li>Oper price competition in oligopoly, degenrates into an open price-war. </li></ul><ul><li>Oligopolists believe that their demand curve is kinked I.e. inelastic for price-cuts but elastic for price increases. Hence, oligopolists prefer rigidity in prices than using price change as their competitive weapon. </li></ul><ul><li>Since rigid prices are difficult to adhere in a dynamic economy, Oligopoly firms resort to such devices as </li></ul><ul><ul><ul><ul><li>Non-price competition </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Collusion and ) may be restrained by law (MRTP) as being </li></ul></ul></ul></ul><ul><ul><ul><ul><li>3. Price leadership. ) “restrictive trade practices”. </li></ul></ul></ul></ul>
  14. 14. Price Leadership <ul><li>Price leadership is said to exist when firms fix their prices in a manner dependent upon the price charged by one of the firms in the industry. The firm which takes the initiative in announcing its price changes is clled the price leader. All other firms in the industry which either match the leader’s price or some variation thereof, are termed price followers. </li></ul>
  15. 15. Price leadership – Dominant and Barometric <ul><li>Price leadership may be either dominant or barometric. </li></ul><ul><li>“ Dominant price leadership occurs when the leading firm is powerful enough to set a price which all other firms will be forced to follow. </li></ul><ul><li>Barometric price leadership occurs when the leading firm is followed merely because the price it sets reflects the market forces and the needs of the other firms in the industry .” </li></ul>
  16. 16. <ul><li>Price leadership is evident in mature and stble industries such as steel, oil, cement, etc. and is characterised by considerable product differentiation. </li></ul><ul><li>More often than not, price leadership exists without any explicit agreements. Price leadership frequently arises due to the following circumstances. </li></ul><ul><li>1. Lower costs and enough financial resources having clear cost advantage and a high productive capacity. </li></ul><ul><li>2. Substantial share of the market. Often it is the largest firm which becomes the leader. It is presumed to have greatest stake in the welafare of the industry, greater power to enforce followership and best informed about demand and supply conditions and best equipped to determine the price policy. </li></ul><ul><li>3. A reputation for sound pricing decisions based on better information and more experienced judgment than others have. Other firms accept the leader because of his ability to coordinate the industry’s growth with that of its members. </li></ul><ul><li>4. Initiative: Often the company which first develops a product or area retains the price leadership. </li></ul><ul><li>5. Aggressive pricing. Often a company may grab leadership through lower prices and thereby snatch large and profitable markets from conservative rivals. </li></ul>
  17. 17. Characteristic Features of Price leadership: <ul><li>To retain followership, the price leader usually aims at making few but larger and dramatic price changes. </li></ul><ul><li>Normally the price leader leads only in price rises but becomes a follower in cases of price reduction. </li></ul><ul><li>The leader should change the price only when he feels that the change in cost and demand conditions is permanent. Temporary drop in price should be given by informal concessions from the official price. </li></ul><ul><li>The price leader should be in a position to incur the risks of price war in order to establish and maintain leadership. </li></ul><ul><li>The price leadwer has an important part to play in forecasting demand and cost conditions, accurately and in line with the confidence and trust of the followers. </li></ul>
  18. 18. <ul><li>6. Where there are significant differences in quality, service and reputation in an industry, the price leader operates on the upper quality stratum and charges a price premium for his superiority. </li></ul><ul><li>7. Once the price leadership is established, it is generally maintained for a long period both by the leader and followers. </li></ul><ul><li>8. With the passage of time, the price leader tends to lose the relative market position usually without affecting the leadership, unless the situation deteriorates too much. </li></ul><ul><li>9. Price leaders have a tendency to take long-run point of view and the prices they establish reflect this point of view. In other words, price leaders are willing to sacrifice short term benefits for long term gains. </li></ul><ul><li>In conclusion, the price leader can maintain leadership only by pursuing a consistent pricing policy, by using his power with restraint, by recognising tacitly at least, the rights of his followers to their respective market positions. </li></ul>
  19. 19. Oligopsony <ul><li>Features: </li></ul><ul><li>Few large buyers control most of the demand. </li></ul><ul><li>Because of the huge size of each one of them, an increase or decrease in the firm’s demand, considerably affects the price. </li></ul><ul><li>No single buyer can afford to ignore the reactions of his rivals to policies he might initiate. </li></ul>