LECTURE 1

OBJECTIVES:
Students should be able to:
Identify and explain the
characteristics of oligopoly.

OLIGOPOLY
Imperfect Competition among the
FEW

OLIGOPOLY
Definition
A market structure in which a few firms
dominate the supply of an industrys
output and compete with each other for
markets.

Market Structure
Oligopoly Competition amongst the few

Industry dominated by small number of large firms

Many firms may make up the industry
High barriers to entry
Products could be highly differentiated branding or
homogenous
Nonprice competition
Price stability within the market - kinked demand curve?
Potential for collusion?
Abnormal profits
High` degree of interdependence between firms

OLIGOPOLY
Example
Car industry
Airline industry
Cigarettes
Cleaning products
Electrical appliance

Characteristics
Few dominant firms
Supply is concentrated in the hands of a
relatively few firms.
Market domination of firms can be
measured by concentration ratio.

OLIGOPOLY
Measuring Oligopoly:
Concentration ratio the proportion of market
share accounted for by top X number of firms:
E.g. 5 firm concentration ratio of 80% - means top 5
five firms account for 80% of market share
3 firm CR of 72% - top 3 firms account for 72% of
market share

Oligopoly
Example:
Music sales

The music industry has

a 5-firm concentration
ratio of 75%.
Independents make up
25% of the market but
there could be many
thousands of firms that
make up this
independents group.
An oligopolistic market
structure therefore
may have many firms
in the industry but it is
dominated by a few
large sellers.

Market Share of the Music Industry 2002. Source IFPI: http://www.ifpi.org/site-content/press/20030909.html

Market shares of the

largest brewers

In 1985 - 3 firm concentration ratio is 47.

In 1985 5 firm concentration ratio is 68.
In 2002 3 firm concentration ratio is 63.
In 2002 5 firm concentration ratio is 83.

Characteristics
Implication of market domination
Strong mutual interdependence among
dominant firms in their price and output
decisions.

Characteristics
Homogeneous or Differentiated Products
Homogeneous product- pure oligopoly eg.
Raw materials (oil, petrol, tin)
Differentiated product- imperfect/
differentiated oligopoly eg. Cars, detergent

Characteristics
Barriers to Entry
Substantial barriers, similar to monopoly
but not as restrictive eg. Petroleum
industry

Characteristics
o Non-price competition
Compete not through price but other
methods (advertising, after-sales service,
free gifts)

NON-PRICE COMPETITION
Practiced by oligopoly and monopolistic competition.
Various forms:
Competitive advertising to reinforce product
differentiation and harden brand loyalty.
Promotional offers eg. Household detergent,
toothpaste, shampoo (buy 2 get 1 free), (25% extra
at no extra cost).
Extended guarantees/after sales service esp. for
consumer durables, by offering free spare parts,
labour guarantee.
Better credit facility
Attractive gift wrappings

 Price Rigidity
Prices are very inflexible
Despite changes in underlying costs of
production, firms are often observed to
maintain prices at a constant level.

 Collusion
Make agreement amongst themselves so
as to restrict competition and maximise
their own benefit.

LECTURE 2
OBJECTIVES:
Students should be able to:
Identify oligopoly models.
Identify the practices of oligopoly- collusion
and price leadership
Explain the equilibrium of oligopoly ie. the
kinked demand curve theory.
Examine advantages and disadvantages of
oligopoly.

OLIGOPOLY MARKETS

1.PRICE DETERMINATION 2.PRICE RIGIDITY

MODELS
MODELS

1.PRICE DETERMINATION
MODELS
CARTELS
PRICE LEADERSHIP

2. PRICE RIGIDITY MODELS

KINKED DEMAND CURVE THEORY

1.PRICE DETERMINATION MODELS

CARTELS
Collusive model
- an agreement between firms to fix prices or mutually
divide the market.
Firms work together and act like a profit maximising
monopolist.
Collusion may be FORMAL (collusive oligopoly) or TACIT
(non-collusive oligopoly).

 Disadvantages of collusion
Higher prices
Output restricted
Producer sovereignty
Productive Inefficiency
Allocative Inefficiency

1. PRICE DETERMINATION
MODELS
PRICE LEADERSHIP
Usually there is a price leader in oligopoly
collusion (esp. tacit) to determine price.
The dominant firm will emerge as the
leader.

2. PRICE RIGIDITY MODEL

THE KINKED DEMAND CURVE THEORY
(reaction model) Paul Sweezy 1930s
This model recognises that demand for a
firms product is determined both by the
market demand for a product as well as by
rival firms behaviour

Kinked demand for a firm under

oligopoly
Current price
and quantity
give one point
on demand curve

P1

Q1

fig

Stable price under conditions of

a kinked demand curve

MC2
MC1

P1

D AR

b
O

Q1

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.

 Note: An oligopolistic firm faces a

relatively more ELASTIC DDcurve at
prices ABOVE a given market price and a
relatively more INELASTIC DD curve at
prices BELOW a given market price.

 Changing cost conditions

Even though MC may be rising or falling,
MC=MR in the portion of discontinuity will
leave price and output unchanged at OP1
and OQ1.
Ie. Changes in costs has no effect on
profit maximising price and out put
because the firm is still producing where
MC=MR.

ADVANTAGES OF OLIGOPOLY
When firms collude monopoly
supernormal profit extra profit extra
capital to fund R&D benefit to
consumer.
Product differentiation non-price
competition greater variety to consumers.
Price stability/rigidity helps in planning,
reduce uncertainty.

DISADVANTAGES OF
OLIGOPOLY
Collusive oligopoly
if they agree upon output no variety and
improvement in quality bad for consumers.
o Acting like a monopoly
Restrict output and charge a higher price
Producer sovereignty
Consumer sovereignty not respected
Greater inequality in income (supernormal
profits)

D2 (Rival matches your price change)

PH
P0
PL
D1

Q0

(Rival holds its

price constant)
Q

D2 (Rival matches your price change)

Demand if Rivals Match Price
Reductions but not Price Increases

P0

D1
D
Q0

(Rival holds its

price constant)
Q

Key Insight
The effect of a price reduction on the quantity
demanded of your product depends upon whether
your rivals respond by cutting their prices too!
The effect of a price increase on the quantity
demanded of your product depends upon whether
your rivals respond by raising their prices too!
Strategic interdependence: You arent in complete
control of your own destiny!

Sweezy (Kinked-Demand)
Model
Few firms in the market
Each producing differentiated products.

Barriers to entry
Each firm believes rivals will match (or
follow) price reductions, but wont match
(or follow) price increases.
Key feature of Sweezy Model
Price-Rigidity

Sweezy Marginal Revenue

P

D2 (Rival matches your price change)

P0
D1

MR2
MR1
Q0

MR

(Rival holds its

price constant)
D
Q

Sweezy Profit-Maximization
P
MCH
MC
MCL
P0

D
Q0

MR