Each firm has its own demand curve having the same elasticity as that of the market demand curve. There can be two possible reactions of rival organizations when there are changes in the price of a particular oligopolistic organization. Oligopoly Classification Oligopoly can be classified on different basis: 1. The monopoly price depends upon the market demand as well as the aggregate marginal costs in the industry. A still later study by Primeaux and Bomball found that during 1959-62 and 64-70: a Price decreases were not followed any more frequently than price increases; b Price increases were more nearly simultaneous than were price decreases; c There was significantly more price rigidity in monopoly market structures than in oligopoly market structures. Thus the chances are greater for individual firms to leave the cartel on account of personal bickering and antagonism of member firms over allotment of quotas and division of profits which are likely to affect adversely joint profit maximisation and end the cartel agreement.
Difficulties of a Cartel : The above analysis is based on perfect collusion in which all firms relinquish their individual price-output decisions to a central board of the cartel which acts like a multi-plant monopolist. Full oligopoly is a state of less equal status with no price leadership. Assumptions : The analysis of joint profit maximisation cartel is based on the following assumptions: 1. By producing large quantity, it can achieve a low price and, hence, offer the product at a price lower than its competitors. Besides these problems in the working of a cartel, it is more difficult to form and run a cartel for long in the case of a differentiated product than in the case of a homogeneous product.
The individual firms surrender their price-output decisions to this central board. Problems of Price Regulation : A competitive price may not suit the economically weaker sections that may have to curtail their demand, or drop out of the market at this price. Thus it is not a theory of price determination as was thought when it was first proposed. Furthermore, by squaring the market share ofeach firm, the Heirfindahl index appropriately gives a much large weight to largerthan to smaller firms in the industry. The firm will not be able to push the demand much as the rival firms will immediately retaliate by lowering their respective prices as well. Steel was the leader in setting prices in the steel industry.
Once a brand has created a positive outlook among its consumers, the firm is said to have built brand equity. Negbennebor, A: Microeconomics, The Freedom to Choose page 299. . This is because it takes long time for the members to arrive at an agreed price. A very high price will encourage followers to undercut the price and capture a large chunk of demand leaving only a small demand for the leader. Another method of estimating the degree of concentration in an industry is theHeirfindahl index H.
In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. This tempts the retailers into selling above the official price. This would imply control over the price. Firm 1 wants to know its maximizing quantity and price. Collusion occurs when businesses agree to act as if they were in a monopoly position. A Course in Microeconomic Theory. In short, p e is the equilibrium price.
Non-Price Competition in Oligopoly 1. However, it should be noted that all types of cartels are temporary, where the cost of production of different firms in the oligopoly market is different. In circumstances of low inflation, they may be reluctant to change or they may wait and move to another significant price like £10. There is another type of collusion, known as leadership, which is based on tacit agreements. Kinked Demand Curve The Kinked demand curve suggests firms have little incentive to increase or decrease prices.
On the other hand, oligopoly is imperfect then the competing firms are not homogeneous. This factor can diversely affect them. Sometimes, state administered pricing also has a stabilising effect on prices and output. On the other hand, in the face of a decline in demand it is very certain that the increase in price by one oligopolist will never be followed by others. Or if the firm is considering a price increase, it may want to know whether other firms will also increase prices or hold existing prices constant. Additional sources of barriers to entry often result from government regulation favoring existing firms making it difficult for new firms to enter the market.
As a result of the increase in the gap that is, the length of discontinuity in the marginal revenue curve, the lower marginal cost curve is likely to pass through this gap showing that the price and output remain the same as before. In this model, the firms simultaneously choose quantities see. Large reduction in sales following an increase in price above the prevailing level by an oligopolist means that demand with respect to increases in price above the existing one is highly elastic. Buyers have only imperfect knowledge as to price, cost and product quality. In some oligopolies, there may be an element of price leadership. Let us take a hypothetical example of a firm in a typical monopolistic situation where it is making substantial amount of economic profits.
These happy competitors will have therefore no motivation to match the price rise. A rational seller would take this a step further, and gather as much market information as possible in an attempt to set a price which achieves a given number of sales at the outset. In a perfectly competitive economy it's also the minimum of the Average Variable Cost curve. Imperfect collusion Price leadership Now we will discuss price-output determination under two types of collusion. Higher prices tend to reduce demand while encouraging supply, and lower prices increase demand while discouraging supply.
Pure oligopoly refers to the situation where all the rival firms are producing an identical or homogeneous product, while differentiated oligopoly refers to market situation in which each rival is producing a different variety of a product. But the main agreement relates to the sharing of the market equally among member firms so that each firm gets profits on its sales. An oligopoly involves an unspecified number of buyers but only a small number of sellers. If both companies would only keep prices high, they will jointly maximise profits. An industry in which the four-firm concentrationratio is close to 100 is clearly oligoplistic, and industries where this ratio is higherthan 50 or 60 percent are also likely to be oligopolistic. If the firm raises prices it will lose all its customers.