PRICE DETERMINED UNDER OLIGOPOLY1 By: Rajat Sharma 12BSP1941 Sec:B
The Term “Oligopoly” has been derived from two Greek words.„Oligi‟ which means few and „Polien‟ means sellers.It is a competition among few big sellers each one of them selling either homogenous or differentiated products. 2
WHAT ARE SOME EXAMPLES OFOLIGOPOLY? Automobiles Steel Telecom service providers Internet service providers 4
WHAT DETERMINES IF A MARKETIS AN OLIGOPOLY?The concentration ratio 5
WHAT CONCENTRATION RATIOCONSTITUTES AN OLIGOPOLY?There is no magic number, but if a large percentage of the sales are from the 4 largest firms, it‟s an Oligopoly 6
WHAT IS AN EXAMPLE OF A HIGHCONCENTRATION RATIO?Out of 151 firms in the aircraft industry the leading 4 constitutes 79% of total sales 7
CHARACTERISTICS OF OLIGOPOLY Few Sellers Homogeneous or Differentiated Product Interdependence : Importance of Advertising and Selling costs Price Rigidity Restriction to Entry Ability to set price 8
HOW PRICES ARE DETERMINED? Interdependent Pricing Price wars Price Leadership Formal Agreement : Cartel 9
1. INTERDEPENDENT PRICINGEach firm in an oligopolistic industry keeps a close eye on the activities of other firms in the industry. Because oligopolistic firms engage in competition among the few, decisions made by one firm invariably affect others. 10
2. PRICE WARS Some economists assume that an oligopolistic is able to predict the counter moves of his rivals, and they provide a determinant solution to the price and output problem. The objectives of price wars :i. To seize the major part of the total salesii. To expand the monopoly power after victoryiii. To threaten the rivals so that they accept its leadership. 11
3. PRICE LEADERSHIP Another approach is that the firms in an Oligopoly would accept one firm as a leader and would follow him in setting prices. Such a leader firm may be dominant or low-cost firm producing a very large proportion of the total production and having a great influence over the market. The form of price leadership:i. Leadership of dominant firmii. Barometric price leadershipiii. Exploitative or Aggressive leadership 12
4. FORMAL AGREEMENT : CARTEL A group of firms that collude to limit competition in a market by negotiating and accepting agreed-upon price and market shares. Two models of imperfect cartels:i. Joint-Profit Maximizing Cartelsii. Market-sharing cartels 13
KINKED DEMAND CURVE MODEL According to the kinked demand curve hypothesis, the demand curve facing the Oligopolistic has a „Kink‟ at the level of the prevailing price. The kink is formed at the prevailing price level because the segment of the demand curve above the prevailing price level is highly elastic and the segment of the demand curve below the price level is inelastic. 14
£ KINKED DEMAND FOR A FIRM UNDER OLIGOPOLY Current price and quantity give one point on demand curveP1 fig O Q1 Q
STABLE PRICE UNDER CONDITIONS OF A £ KINKED DEMAND CURVE MC2P1 MC1 a D AR b O Q1 Q MR
KINKED DEMAND CURVE THEORY If the firm lowers its price below OP1, its rivals will follow. Its demand will expand along the relatively inelastic section of the demand curve below OP1 and total revenue will fall.
KINKED DEMAND CURVE THEORY If the firm raises its price above OP1, none of its competitors will follow. Its demand for prices above OP1 will contract along the relatively elastic section of the demand curve and total revenue will fall.
As a result of action and non-reaction to price changes, an oligopolist is faced with a kinked demand curve at OP1. Price rigidity is due to the kinked demand curve and the resulting discontinuity in the MR curve.
UNIQUE ABOUT OLIGOPOLY What is unique about firms in oligopolies is that they tend not to raise or lower prices, because at higher prices demand is elastic and at lower prices demand is inelastic – raising or lowering prices would result in revenue losses. As a result, MC can increase or decrease without affecting the profit- maximizing price and output level. 21
In the bottom diagram, we see that a rise in marginal costs will not necessarilylead to higher prices providing that the new MC curve (MC2) cuts the MR curveat the same output. The kinked demand curve theory suggests that there will beprice stickiness in these markets and that firms will rely more on non-pricecompetition to boost sales, revenue and profits. 22