Oligopoly 8

Chapter 8

 Definition    

Characteristics Types of Oligopoly Kinked Demand Curve The firms equilibrium

 Come

from the Greek word “Oligos” means “ a little”  a market structure with a few no of large firms producing & supplying all output in the market  eg: Petroleum industry & steel industry, Automobile manufacturers, Personal Care Products, Cigarette Manufacturers 

if there is only two firms in the market, it’s known as “Duopoli”

A few large firms  Mutual interdependence  Price rigidity(stable)  homogenous or differentiated product  Difficult to entry 



such as petroleum industry (Shell, BP, Caltex, PETRONAS)



makes a decision based on the reaction of other firms in the industry



eg: if General Motor increase it price, the cars will be more expensive than Ford’s. the consumer will choose Ford’s cars and this will make General Motor lose so, GM will reduce the price

Price is rigid when it changes very slowly over a period of time  when 1 oligopolist firm increase price, the others not follow because they can steal the market share from the firm 

– the firm will incur loss & has to decrease P to avoid loss – due to price interdependency, P can’t changed

some maybe have the same function but different in brand name , shape, quality, etc..  eg: PETRONAS vs. Shell these firm give the same function (petrol) but differ in brand name & quality 



Legal barriers such as government franchises, licenses & patents

There have 2 types: – perfect oligopoly





All firms produced identical product eg: steel industry

– imperfect oligopoly 

All firms produced differentiated product Eg: automobile product

 Known 

as collusive oligopoly use the “Sweezy’s Model”

 Sweezy’s

Model – there 2 assumptions: i) there are only 3 firms (A,B & C) ii) they are interdependent (there is no collusion between them)

 Sweezy’s

Model – the shape of the oligopolists demand curve depend on how the firm’s rival will react to a price change introduce by firm A. 

rivals will match a P

without any collusion Make P decision(price maker) 



, but ignore a P

There are two possible reactions  





MATCH PRICE CHANGES if A reduce the P  B & C will follow  so, the increase in sales for A is small, because B & C also will gain the mkt share If A increase in price  B & C will follow  its sales will loss modestly Thus, Demand curve is steep & demand curve is P / cost inelastic

  





IGNORE PRICE CHANGES Another possibility is B & C ignore A’s price changed If A reduce price, B & C do not changed the price  A will gain higher mkt share (sales increase substantially) If A increase price, and B & C do not changed the price  A will lose big mkt share (sales drop substantially) So, demand curve is less steep & elastic P / cost AR = Dd

MR

AR = Dd Qty

MR Qty

n a is 1 R tic ve M s D 1 ela cur in d n a m e d

Price

The Kinked Demand A combined strategy Curve

D1 MR1

Qty

The Kinked Demand A combined strategy Curve Price D2 MR2 is an elastic demand curve

Pe

D2 Pe & Qe are equilibrium price & eqb Qty respectively

MR2 D1 Qe

MR1

Qty

The Kinked Demand A combined strategy Curve Price Rivals tend to If the firm raises the price from Pe to P1, other firm will not follow, and the firm will lose a mkt share where qty Dd decrease This is from Qeon to Q1 shown elastic Dd curve D2

follow a price cut or ignore a price increase

P1 Pe

D2

D1 Q1

Qe MR 1

Qty

MR2

The Kinked Demand A combined strategy Curve Price If the firm lowers Rivals tend to its price from Pe to P2, other firm will forllow to avoid losing a share mkt to the firm which lowers its price. Lowering the price will increase the Qty Dd from Qe to Q 2. is the small This increase because other firm will also lower the price & they manage to attain the same share in the mkt. the situation is shown on elastic Dd

follow a price cut

Pe

D2 P2

D1 Qe

MR1 Q2 Qty

MR2

The Kinked Demand A combined strategy Curve Price So the actual Dd curve of the firm combination of D1 & D2. so the demand curve is kinked (as shown at yellowline)

Effectively creating a kinked demand curve

D2

D1 MR1

Qty

MR2

The Kinked Demand A combined strategy Curve Price So the actual Dd curve of the firm combination of D1 & D2. so the demand curve is kinked (as shown at yellowline)

Effectively creating a kinked demand curve

D MR

Qty



to maximize profit, the oligopolist firm will not involve in price competition. (price rigid)

 They

will try to minimized cost of production as lower as possible.

 Means

the price is still fixed or same but to get the maximum profit, they will minimized cost as lowest as they can afford to do it.

Price At higher Marginal cost, C1, the output produced is Qe and the price at P e Pe The profit is area A

Profit maximization MR = MC occurs at the kink MC1 A e1

D Qe

MR

Qty

Price If the frim becomes more efficient, MC will decrease MC1 to MC The2 output produced is still at Qe at the same price, Pe . MC2

Profit maximization MR = MC occurs at the kink MC1

Pe

The profit has increased to area A+B So, without changing the price, the firm can maximized profit by reducing cost efficiency in production

A

MC2

e1

B

e2 Qe

MR

D Qty

Price

Profit is maximized when MR = MC As long as the curve intersect at the vertical gap of MR curve, the profit maximizing quantity & price will be at kinked.

Pe = 50

MC AC

25 17 8

D Qe = 40

MR

Qty

Price

If the amount of MC is within RM 8 to RM 25, the equilibrium output will be 40 units and price will be RM 50

Pe = 50

MC AC

25 17 8

D Qe = 40

MR

Qty

Price

Qe = 40 units Pe = RM 50 TR = P x Q = 50 x Pe =50 40 = 2000 TC = AC x 25 Q = 17 x 17 40 8 ∏ = = 680 TR - TC = 2000 680 = 1320

MC AC

D Qe = 40

MR

Qty

Price

Qe = 40 units Pe = RM 50 TR = P x Q = 50 x Pe =50 40 = 2000 TC = AC x 25 Q = 17 x 17 40 8 ∏ = = 680 TR - TC = 2000 - 680 = 1320 (supernormal

In order to max , firm will try to minimize cost since there is no competition in terms of price

MC AC

D Qe = 40

MR

Qty

Price

Wat will happened when MC is AT kinked point???

MC AC Pe = 50 25 17 8

D Qe = 40

MR

Qty

Price

Wat will happened when MC is ABOVE kinked point???

MC AC

75 Pe = 50 25 17 8

D Qe = 40

MR

Qty

Market Structure Characteristics

Perfect Competition

Monopolistic Competition

Oligopoly

Number of firms

Very large number

Many

Few

Barriers to entry

None

Low

High

Market power (control over price

None

Some

Substantial

Type of product

Standardized Differentiated Standardized

or differentiated

Market Structure Characteristics

Perfect Competition

Duopoly

Monopoly

Number of firms

Very large number

Two

One

Barriers to entry

None

High

High

Market power (control over price

None

Substantial

Substantial

Type of product

Standardized Standardized Unique or differentiated

End of Chapter 8