Oligopoly is the most prevalent form of market organization in the manufacturing sector of most

nations, including India. Some oligopolistic industries in India are automobiles, primary
aluminum, steel, electrical equipment, glass, breakfast cereals,cigarettes, and many others.
Some of these products (such as steel and aluminum)are homogeneous, while others (such as
automobiles, cigarettes, breakfast cereals, and soaps and detergents) are differentiated.

Oligopoly exists also when transportation costs limit the market area. For example, even though
there are many cement producers in India, competition is limited to the few local producers in a
particular area .Since there are only a few firms selling a homogeneous or differentiated product
in oligopolistic markets, the action of each firm affects the other firms in the industry and vice
versa.

For example, when General Motors introduced price rebates in the sale of its automobiles, Ford
and Maruti immediately followed with price rebates of their own. Furthermore, since price
competition can lead to ruinous price wars ,oligopolists usually prefer to compete on the basis
of product differentiation ,advertising, and service.

These are referred to as non price competition. Yet, even here, if GM mounts a major
advertising campaign, Ford and Maruti are likely to soon respond in kind. When Pepsi mounted
a major advertising campaign in the early 1980s Coca-Cola responded with a large advertising
campaign of its own in the United States. From what has been said, it is clear that the
distinguishing characteristic of oligopoly is the interdependence or rivalry among firms in the
industry.

This is the natural result of fewness. Since an oligopolist knows that its own actions will have
a significant impact on the other oligopolists in the industry, each oligopolist must consider the
possible reaction of competitors in deciding its pricing policies, the degree of product
differentiation to introduce, the level of advertising to be undertaken, the amount of service to
provide, etc. Since competitors can react in many different ways (depending on the nature of
the industry, the type of product, etc.) We do not have a single oligopoly model but many-each
based on the particular behavioural response of competitors to the actions of the first.
Because of this interdependence, managerial decision making is much more complex
under oligopoly than under other forms of market structure. In what follows we present some of
the most important oligopoly models. We must keep in mind, however, that each model is at
best incomplete. The sources of oligopoly are generally the same as for monopoly. That is,

(1) economies of scale may operate over a sufficiently large range of outputs as to leave only a
few firms supplying the entire market;

(2) huge capital investments and specialized inputs are usually required to enter an oligopolistic
industry (say, automobiles, aluminum, steel, and similar industries), and this acts as an
important natural barrier to entry;
(3) a few firms may own a patent for the exclusive right to produce a commodity or to use a
particular production process;

(4) established firms may have a loyal following of customers based on product quality and
service that new firms would find very difficult to match;

(5) a few firms may own or control the entire supply of a raw material required in the production
of the product; and

(6) the government may give a franchise to only a few firms to operate in the market.

The above are not only the sources of oligopoly but also represent the barriers to other firms
entering the market in the long run. If entry were not so restricted, the industry could not remain
oligopolistic in the long run. A further barrier to entry is provided by limit pricing, whereby,
existing firms charge a price low enough to discourage entry into the industry. By doing so, they
voluntarily sacrifice short-run profits in order to maximize long-run profits. As discussed earlier
oligopolies can be classified on the basis of type of product produced. They can be
homogeneous or differentiated. Steel, Aluminium etc. come under homogeneous oligopoly and
television, automobiles etc. come under heterogeneous oligopoly.

The type of product produced may affect the strategic behaviour of oligopolists. According to
economists, two contrasting behaviour of oligopolists arise that is the cooperative oligopolists
where an oligopolist follows the pattern followed by rival firms and the non-cooperative
oligopolists where the firm does not follow the pattern followed by rival firms. For example, a
firm raises price of its product, the other firms may keep their prices low so as to attract the
sales away from the firm, which has raised its price. But as stated above, price is not the only
factor of competition. As a matter of fact other factors on the basis of which the firms compete
include advertising, product quality and other marketing strategies. Therefore, we normally have
four general oligopolistic market structures, two each under cooperative as well as non-
cooperative structures.

We have firms producing homogeneous and differentiated products under each of the two
basic structures. All these differences exist in the oligopolistic market. This shows that each firm
tries to make an impact in the existing market structure and have an effect on the rival firms.
This tends to be a distinguishing characteristic of an oligopolistic market. Price Rigidity: Kinked
Demand Curve Our study of pricing and market structure has so far suggested that a firm
maximizes profit by setting MR = MC. While this is also true for oligopoly firms, it needs to be
supplemented by other behavioural features of firm rivalry.

This becomes necessary because the distinguishing feature of oligopolistic markets is

interdependence. Because there are a few firms in the market, they also need to worry about
rival firms behaviour. One model explaining why oligopolists tend not to compete with each
other on price, is the kinked demand curve model of Paul Sweezy. In order to explain this
characteristic of price rigidity i.e. prices remaining stable to a great extent, Sweezy suggested
the kinked demand curve model for the oligopolists. The kink in the demand curve arises from
the asymmetric behaviour of the firms. The proponents of the hypothesis believe that
competitors normally follow price decreases i.e. they show the cooperative behaviour if a firm
reduces the price of its products whereas they show the non-cooperative behaviour if a firm
increases the price of its products. Let us start from P1 in Figure .

If one firm reduces its price and the other firms in the market do not respond, the price cutter
may substantially increase its sales. This result is depicted by the relative elastic demand curve,
dd. For example, a price decrease from P1 to P2 will result in a movement along dd and
increase sales from Q1 to Q2 as customers take advantage of the lower price and abandon
other suppliers. If the price cut is matched by other firms, the increase in sales will be less.

Since other firms are selling at the same price, any additional sales must result from increased
demand for the product. Thus the effect of price reduction is a movement down the relatively
inelastic demand curve, DD, then the price reduction from P1 to P2 only increases sales to Q2.

Here we assume that P1 is the initial price of the firm operating in a non
cooperative oligopolistic market structure producing Q1 units of output. P is also the point of
kink in the demand curve and is the initial price and DD is the relatively elastic demand curve
above the existing price P1.

When the firm is operating in the non-cooperative oligopolistic market it results in decline in
sales if it changes its price to P1. Now if the firm reduces its price below P1 say P2, the other
firms operating in the market show a cooperative behaviour and follow the firm. This is shown in
the figure as the curve below the existing price P1.

The true demand curve for the oligopolistic market is dD and has the kink at the existing price
P1. The demand curve has two linear curves, which are joined at price P. Associated with the
kinked demand curve is a marginal revenue function. This is shown in Figure . Marginal
Revenue for prices above the kink is given by MR1 and below the kink as MR2.

At the kink, marginal revenue has a discontinuity at AB and this depends on the elasticities of
the different parts of the demand curve. Therefore, in the presence of a kinked demand curve,
firm has no motive to change its price. If the firm is a profit maximizing firm where MR=MC, it
would not change its price even if the cost changes. This situation occurs as long as changes in
MC fall within the discontinuous range i.e. AB portion.

Price Competition: Cartels and Collusion

Cartel Profit Maximization
We already know now that in an oligopolistic competition, the firms can compete
in many ways. Some of the ways include price, advertising, product quality, etc.
Many firms may not like competition because it could be mutually disadvantageous.
For example, advertising. In this case many oligopolies end up selling the products
at low prices or doing high advertising resulting in high costs and making lower
profits than expected. Therefore, it is possible for the firms to come to a consensus
and raise the price together, increasing the output without much reduction in sales.

In some countries this kind of collusive agreement is illegal e.g. USA but in some it is
legal. The most extreme form of the collusive agreement is known as a cartel. A cartel is
a market sharing and price fixing arrangement between groups of firms where the
objective of the firm is to limit competitive forces within the market.

The forms of cartels may differ. It can be an explicit collusive agreement where
the member firms come together and may reach a consensus regarding the price
and market sharing or implicit cartel where the collusion is secretive in
nature. Throughout the 1970s, the Organization of Petroleum Exporting Countries
(OPEC) colluded to raise the price of crude oil from under $3 per barrel in 1973 to over
$30 per barrel in 1980.

The world awaited the meeting of each OPEC price-setting meeting with anxiety. By the
end of 1970s, some energy experts were predicting that the price of oil would rise to
over $100 per barrel by the end of the century. Then suddenly the cartel seemed to
collapse. Prices moved down, briefly touching $10 per barrel in early 1986 before
recovering to $18 per barrel in 1987. Today the price of a barrel is about $24. OPEC is
the standard example used in textbooks when explaining cartel behaviour. The cartel
profit maximizing theory can be explained using figure
The market demand for all members of the cartel is given by DD and marginal revenue
(represented by dotted line) as MR. The cartels marginal cost curve given by MCc is the
horizontal sum of the marginal cost curves of the member firms. In this the basic
problem is to determine the price, which maximizes cartel profit. This is done by
considering the individual members of the cartel as one firm i.e. a monopoly. In the
figure this is at the point where MR= MCc, setting price = P.

The problem is regarding the allocation of output within the member firms. Normally a
quota system is quite popular, whereby each firm produces a quantity such that its MC =
MCc. One serious problem that arises from this analysis is that while the joint profits of
the cartel as a whole are maximised, each individual member of the cartel has an
incentive to cheat on its quota. This is because the price for the product is greater than
the members marginal cost of production. This implies that an individual member can
increase its profit by increasing production. What would happen if all members did the
same?

The market sharing arrangement will breakdown and the cartel would collapse. Here lies
the inherent instability of cartel type arrangement and can be summarized as follows.
There is an incentive for the cartel as a whole to restrict output and raise price, thereby
achieving the joint profit maximizing result, but there is an incentive on the part of the
members to increase individual profit. If this kind of situation occurs, it leads to break-up
of the cartel. The difficulty with sustaining collusion is often demonstrated by a classic
strategic game known as the prisoners dilemma

1. Evaluate DeBeers's pricing practice.

 There is a relationship between price and supply. When the supply of a
product or commodity is high, its price is depressed. A low supply, on the
other hand, drives up the product's price. This explains why OPEC countries
have been able to push up the price of crude oil in the last several years. In
early 2004, for example, as demand slowed, OPEC announced that its
members would cut back on production. Consequently, the high gasoline
prices are being maintained. In 2008, as oil price approached $ 110 a barrel,
OPEC refused to increase production. With tight supply, strong demand, and
a great deal of speculation, oil price was kept high.

Diamonds, likewise, respond pretty much to the same relationship.

However, there is one major difference between diamonds and oil. Oil is
more of a necessity. Diamonds, in contrast, are more of a discretionary
purchase, and such purchases can be postponed (when necessary). Still,
diamonds and their prices react to the world's supply and demand.

DeBeers controls the supply of diamonds to a large degree. Its usual

practice is to invite companies for "sight" where they are offered a certain
quantity at a specified price. Price haggling is not allowed. Companies do not
have to buy what is offered, but they will not be invited back for another
"sight." This strategy is most effective when DeBeers is (or is perceived to
be) the only game in town. Since companies do not have a viable and long-
term alternative, they simply have to go along with DeBeers's practice.

For DeBeers to maintain its power, it must be able to control the

amount of diamonds to be made available to the world market. As such, it
is obligated to buy rough diamonds from virtually any producers. On the
one hand, it has to offer prices that are reasonably attractive so as to
prevent the producers from bypassing DeBeers. On the other hand, it must
be able to finance its expensive inventory, especially when demand is slow
and when supply rapidly increases.

DeBeers's pricing aim is to make the market as well as the price

stable. It is willing to sacrifice extra profits in the booming period in order to
avoid heavy losses and price cutting in the period of declining demand.
DeBeers's pricing is based on its semi-monopoly situation. The problem with
this pricing strategy is that DeBeers is not a true monopolist. Several
countries market their diamonds to users while bypassing DeBeers. Also
DeBeers has to lower prices during recession because of weak demand. Still
the strategy makes sense, assuming that the company can control the large
portion of supply--large enough to control the market.

2. Evaluate DeBeers's attempt to promote a new image.

As a cartel, DeBeers does not have a good image to begin with. In the
United States, the largest diamond market in the world, a cartel is illegal.
That explains why DeBeers executives avoid traveling to the United States
where they can be arrested. Interestingly, OPEC countries
and their government officials have no such problem. Actually, OPEC
countries even have a significant amount of influence on the policies of
the U.S. government.

The fact that DeBeers is (or, at least, was) involved with blood
diamonds damaged the cartel's image even more. The brutality and cruelty
of the rebel groups have made it difficult for the world to ignore the
sufferings of Angolans. Certainly, DeBeers cannot afford to antagonize the
U.S. government. In addition, its tarnished image could invite the other
governments to impose sanctions.

So it was a smart move on the part of DeBeers to promote itself as a

responsible organization. By refusing to buy rough diamonds from Angola,
Congo, and Sierra Leone, it can claim that it has lived up to its social
obligations. Moreover, it no longer has to stockpile expensive diamonds, thus
cutting down on its inventory costs. Yet, DeBeers does not really have to
loosen control on the supply of diamonds. Because of a global accord that
stops trade in diamonds from the conflict zones, this excess supply is
automatically contained.

3. Will consumers care where a diamond comes from?

For a marketer to have pricing freedom, its offering must be perceived

by its customers as a product rather than a commodity. A commodity is an
undifferentiated, often unbranded, product. In contrast, a product is a value-
added, differentiated, and branded commodity. Commodities (e.g., corn,
soybeans, beef, steel, etc.), interestingly, have no pricing problem since the
producers of commodities cannot do anything about their prices anyway.
They simply have to accept and adhere to a market price. Because their
offerings are not different from those offered by competitors, they cannot
ask for an above-market price. Buyers simply refuse to pay more because
they can buy exactly the same commodity at the market price from the
other producers. Along the same line, there is absolutely no reason for any
producers to cut their prices since they can already sell all they can at the
prevailing market price.

It should be evident that diamonds are basically a commodity.

Consumers have no good reason to believe that diamonds from particular
countries (e.g., South Africa, Canada, the United States, etc.) are superior.
After all, the pricing of a diamond is based on a standard formula related to
the 4 Cs (carat, clarity, cut, and color). Diamonds can be certified and priced
by the GIA and other organizations. Therefore, a standardized pricing
formula can be used.

It is possible that particular diamonds (e.g., the Hope diamond) may

have acquired a unique mystique or image, but such diamonds are
extremely few. It is also true that some couples may want to associate
diamonds with romance and that they want to stay away from anything
that is associated with torture and suffering. This insistence, however,
means that they will have to pay more for comparable diamonds. It is
doubtful that most people will be willing to pay such a premium.

It discusses the relationship between country of origin and perceived

product quality. The discussion also mentions that, regardless of the country
of origin, the perceived image of a product can be influenced by brand
image as well as the image of a retailer.
In this case, country of origin is unlikely to matter. Since diamonds are not
branded, brand image is not an issue either. Nevertheless, the prestige of a
retailer can be something else altogether.