Oligopolies
A2 Economics
Barriers to Entry
• Write down as many
barriers to entry in an
oligopolistic market as
you can.
• With short description.
Aims and Objectives
Aim:
• To understand firm behaviour in an oligopoly.
Objectives:
• Define the different barriers to entry in an oligopolistic
market.
• Explain the behaviour of firms in an oligopolistic market.
• Analyse the kinked demand curve.
• Evaluate the kinked demand curve’s relevance .
Competitive Oligopoly (imperfect).
• Rival firms are interdependent.
• They must take account of the reactions of
rival firms when deciding a market strategy.
• They decide their strategies without
co-operation and collusion.
• Firms are uncertain of other firms reactions.
Kinked Demand Curve Theory
• How competitive oligopolists are affected by rival’s
reaction to price and output decisions.
• Firms that change their prices may be punished by the
reactions of their competitors.
• Explains why there is a lack of price competition among
firms and why prices remain stable in an oligopoly.
Kinked Demand Curve Theory
•
Initial output of OB and initial price of OA.
•
If the firm increases it’s price above OA, it’s competitors will
leave their prices where they are.
•
The firm will suffer a reduction in sales, profit, and market
share.
•
To what extent depends on the firms’ brand loyalty.
Kinked Demand Curve Theory
• Firm lowers it’s price below OA, the demand
curve becomes inelastic.
• If a firm lowers it’s price, total revenue will
fall.
• All other firms will lower their prices.
• Could create a price war.
Kinked Demand Curve: Price War
• Below the price OA, a price war may occur.
• Leading to an inelastic demand curve as firms
copy.
• If firms lower their prices, the resulting price
war, will lead to total revenue falling.
• Firms who compete like this may incur losses.
Kinked Demand Curve Theory
• Firms prefer to stay at point X.
• They are fearful and uncertain of how rivals will
react to a change in price.
• The best policy may be to not compete on price,
and leave price unchanged.
Kinked Demand Curve and Stable Prices
• Second theory as to why prices are stable in an
oligopoly.
• Marginal Revenue Curve.
• Vertical section at output Q1, shown by the
distance B-C.
• This area links the MR curves associated with
the AR curves.
Kinked Demand Curve and Stable Prices
• Initial marginal costs are MC1, pt A.
• The MC curve can rise or fall anywhere on the
vertical.
• Doesn’t affect the profit maximising equilibrium of
(Q1,P1).
• If marginal costs rise above MC2 at point B.
• Or falls below MC3 at point C.
• The profit maximising output changes.
Kinked Demand Curve and Stable Prices
• The oligopolist in both these cases would have
to change their prices to maximise profits.
But..
• The oligopolist’s selling price remains stable at
P1, if the Marginal Costs lie between MC2 and
MC3.
• Oligopolists’ price remains stable, despite quite
considerable changes in costs.
Criticisms of the Kinked Demand Curve
• No explanation of how and why a firm chooses in the first
place to be at point x.
• Theory only explains price competition, and not non-price
competition.
• Model assumes that oligopolists will react in a certain
manner and this is often not the case in reality.
• Under some circumstances firms may feel that they wish to
compete on price, reckoning that it is the strongest firm in
the market.