examples of oligopoly firms

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					Chapter 25 Monopolistic Competition
and Oligopoly

  Monopolistic Competition
   1) large number of sellers
small market shares, no collusion,
independent action
   2) Differentiated products
  some control over price
   3)easy entry and exit to and from

  Advertising     nonprice competition

Price and Output in Monopolistic
  Demand curve downward sloping
   since there is some market power
   through product differentiation
  Demand curve , however, is highly
   elastic (quite flat)

 See fig 25.1: Firms can make profits or
  losses in the short-run
 In the long-run, however, firms will
  make normal profits( zero profit) since
  free entry will ensure that supernormal
  profits are eroded, and free exit will
  ensure that losses are eliminated.
 Note that under monopolistic
  competition there is neither productive
  nor allocative efficiency.
 No productive efficiency since price
  minimum ATC
 No allocative efficiency since price
 The fact that production is not at
  minimum ATC, implies that there is
  excess capacity in each firm. Firms
  could be more efficient by producing
  on a larger scale. Thus, there should be
  fewer firms in the industry . See fig
 Product variety

  How do monopolistic competitors
   survive if they can only make normal
  They need to get some type of market
   power through product differentiation
   and advertising.

 1) few large producers
 2) Homogeneous or differentiated
 3) Control over price, but mutual
 4) Entry barriers

  Measures of industry concentration
  How do we measure the degree to which
  oligopolistic industries are concentrated
  in the hands of the largest firms
 1) Concentration ratio: percentage of
  total output produced and sold by the
  industries largest firms

 However, how can we tell from a
  concentration ratio of 100% whether
  there is 1 firm in the industry or 4 firms
  each having 25% market share?
 We use the Herfindahl index
 Herfindahl index:
   (%s1 ) 2  (%s2 ) 2  (%s3 ) 2  ....  (%sn ) 2
  By squaring the terms , more weight is
  given to larger firms.
 Oligopoly and Game theory

 Often use game theory to analyse
  oligopoly behaviour
 Will look at a simple game theory model
 Suppose there are two firms in an
  oligopoly that agree (collude) that they
  will both charge a high price for their
 What happens if one of the firms cheats
  by selling a lower price thereby
  increasing its market share and
  increasing profits.

 fig 25.3 shows the payoff matrix of
  different scenarios
 We see that each firms profit depend
  both on its own pricing strategy and that
  of its rival. There is thus Mutual
  interdependence between members of
  an oligopoly

Three Oligopoly Models
 1) Kinked Demand Curve:
     Noncollusive Oligopoly
  Suppose there are three firms in an
   oligopoly who are not colluding with
   each other
  Refer to fig 25.4. What will firm 1’s
   demand curve look like.
  Suppose firm 1 is currently selling Q0
   at a price of P0.
  What happens if firm 1 changes its
   price. How will its rivals react?Will
   they match the price change or ignore
   the price change

 The assumption is that the rivals will
  only match a decrease in price but will
  ignore an increase in price
 Thus if the oligopolist increases the
  price as bove P0, it will lose a huge
  amount of demand. Thus, the demand
  curve is very elastic above P0
 If it decreases its price to below P0, its
  quantity demanded will increase but
  not to as greater extent.Why?
 A lower price will be matched by its
  rivals, therefore its market share won’t
  increase at all. A lower price, however,
  will cause industry demand as a whole
  to increase. Thus, the increase in
  quantity demanded is purely as a result
  of the general increase in industry
 Thus, the oligopolistic firm has a
  kinked demand curve as that shown in
  fig 25.4 b
 The change in elasticity in the demand
  curve at price p0, causes the marginal

   revenue curve to be discontinuous at
   this point

Price Inflexibility
   The analysis helps explain why prices
    are generally inflexible in noncollusive
   From the demand side:An increase in
    price will substantially decrease
    revenue. A decrease in price will
    usually also decrease revenue due to
    the inelastic portion of the demand
   From the cost side: A decrease in MC
    from MC1 to MC2( i.e on any portion
    of the discontinuous portion of the MR
    curve) will not result in a change in
    equilibrium quantity and price
   However, exceptions occur in times of
    upswings and recessions. In recessions
    price wars may result from successive
    rounds of price cuts from rivals in
    order to maintain their market shares.

 2)Collusive pricing: Cartels and
  other collusion
 Suppose there are three firms in an
  oligopoly each having demand and
  cost conditions as set out in fig 25.5..
  Note the demand curve is not kinked
  since it is assumed that any price
  change( increase or decrease) will be
  matched by the rivals
 Suppose firm 1 wants to maximize its
  profit. It will sell Q0 at a price P0.
 If its rivals decide to gain market share
  by selling at a price lower than p0, they
  could start a price war and each firm
  might land up making losses
 In order to avoid this situation, firms
  collude and agree to all charge the
  price p0
 One form of collusion is a cartel. A
  cartel is a group of producers that
  creates a formal written agreement
  specifying how much each member
  will produce and charge

 This is overt collusion. An example is
 In the US collusion is illegal and if it
  happens, it happens in secret

 Obstacles to collusion
 Demand and cost differences
 Number of firms
 Cheating
 Recession
 Potential entry
 Legal obstacles: antitrust law

2) Price Leadership Model
Implicit agreement whereby dominant
firm sets price and other firms follow

Since oligopolistic firms try and not
compete on price, how do they compete?
 Through product development and

Oligopoly and Efficiency
Neither productive nor allocative
efficiency is reached.


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