Chapter 10:
OLIGOPOLY
What determines how much market power a
firm has?
How do firms in an oligopoly set prices and
output?
What problems does an oligopoly have in
maintaining price and profit?
Oligopoly
Market Structure
✸ Oligopoly Behavior
✸ The Kinked Demand Curve
✸ Oligopoly vs. Competition
✸ Coordination Problems
✸ Barriers to Entry
✸ Antitrust Guidelines
✸
Oligopoly
Page 2
Oligopoly
✸
Market Structure
» Few, large firms
» Large market shares
–
Percentage of industry sales produced by
the firm
» High Concentration Ratios
–
Oligopoly
Percentage of industry output produced by
the the four largest firms
Page 3
Oligopoly
✸
Market Structure (continued)
» Differentiated or Homogeneous Product
» High Barriers to Entry
» Nonprice Competition
» Substantial Market Power
» Mutual Interdependence
–
Action of one firm influences the behavior
of the other firms, and firms recognize this
Oligopoly
Page 4
Oligopoly Behavior
✸
Goal of Oligopoly
» May not be profit maximization
» More concerned with market share
✸
Oligopoly Behavior
» No single model of oligopoly exist
Oligopoly
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The Kinked Demand Curve
✸
Oligopoly’s Demand Curve
» Depends upon the reaction of rivals
✸
One demand curve if it acts alone
✸
Another demand curve if rival react
» QD more responsive to price change
» QD less responsive to price change
Oligopoly
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The Kinked Demand Curve
✸
3 airline fly NY to Orlando
✸
✸
Demand curve for Delta
Initial price = $200 , QD = 400 passengers
✸
If lower price to $150
» Each has 33% market share
» QD increases to 700; if no one else lowers price
» QD increases to 450; if everyone else lowers price
✸
Raise price to $250
» QD decreases to 100; if no one else raises price
» QD decreases to 350; if everyone else raises price
Oligopoly
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The Kinked Demand Curve
250
200
Demand if
no one follows
150
Demand if
everyone follows
0
100
200
300
400
500
600
700
Oligopoly
Page 8
The Kinked Demand Curve
Kinked Demand Curve Theory
✸ What will rivals do?
✸
» Price reductions
–
All firms will match price cuts
» Price Increases
–
Oligopoly
No firm will follow price hikes
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The Kinked Demand Curve
250
No one follows
a price hike
200
150
Everyone follows
a price cut
Kinked demand curve
0
100
200
300
400
500
600
700
Oligopoly
Page 10
Oligopoly
✸
Price and Output
» Without collusion prices are “sticky”
✸
Sticky Prices
» There is little incentive to change prices
even if costs change
–
–
If lower price, all firms follow, so sales don’t
increase very much
If raise price, no firms follow, so sales drop
very much
Oligopoly
Page 11
Coordination Problems
Oligopoly Pricing Strategies
✸ Price Wars
✸
» Continual price cutting by rival firms
» In an attempt to increase sales
✸
Price Fixing
» Explicit agreement on pricing
» Act like a shared monopoly (cartel)
» Illegal in U.S.
Oligopoly
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Coordination Problems
✸
Price Leadership
» Implicit agreement on pricing
» Follow pricing of dominant firm
» Legal
✸
Predatory Pricing
» Temporary reduction in price to drive
competition out of business
» Illegal
Oligopoly
Page 13
The Economy Tomorrow:
Antitrust Guidelines
✸
Market Failure
» Imperfection which prevents optimal
resource allocation
✸
Market Power
✸
Antitrust
» Possible source of market failure
» Intervention to alter market structure
» Intervention to prevent abuse of power
Oligopoly
Page 14