OLIGOPOLY

Oligopoly
• Oligopoly: Market structure characterised by the presence of a few firms
and substantial barriers to entry
• Few large producers
• Homogenous or differentiated products
• Control over price: Each oligopoly firm is a price maker
• Mutual interdependence: Each firm’s profits depends not just on its own
price and sales but also on those of other firms
• Entry barriers: Economies of scale, patents and ownership of raw
materials
Oligopoly: A game theory perspective
• Game theory: The study of how people behave under mutual interdependence
• Game is any decision-making situation in which people compete with each other
for the purpose of gaining the maximum possible payoff (profits)
• Players are the people playing the game: The managers of the oligopoly firms
• Payoffs are the individual outcomes that represents rewards or benefits (profits)
• Strategy is a rule or plan of action for playing the game. For example, choice of
price, quantity, advertisement expenditure or expansion decision etc.
• “I’ll keep my price high as long as my competitors do the same, but once a competitor lowers his price, I’ll
lower mine even more.”
• Dominant strategy: Strategy that provides the best outcome irrespective of the
rival’s action
The payoff matrix

𝑷𝒆𝒑𝒔𝒊

High price Low price

𝑨 𝑩
High price ₹𝟏𝟓, ₹𝟏𝟓 ₹𝟓, ₹𝟏𝟕
𝑪𝒐𝒌𝒆

𝑪 𝑫
Low price ₹𝟏𝟕, ₹𝟓 ₹𝟏𝟎, ₹𝟏𝟎
Decision making when rivals make simultaneous
decisions (Prisoner’s Dilemma)

𝑷𝒆𝒑𝒔𝒊

High price Low price

𝑨 𝑩 Pepsi
High price ₹𝟏𝟓, ₹𝟏𝟓 ₹𝟓, ₹𝟏𝟕
𝑪𝒐𝒌𝒆
𝑪 Coke 𝑫 Coke Pepsi
Low price ₹𝟏𝟕, ₹𝟓 ₹𝟏𝟎, ₹𝟏𝟎
Practices that facilitate cooperation
• Facilitating practices: Practices that encourages cooperation either by
reducing the benefits of cheating or by increasing the costs of cheating
• Price matching and price leadership

• Price matching: Making a commitment through public announcement

(advertisement) to match any lower prices offered by its rivals
• With price matching, the benefit to cut prices to steal rival’s customers vanishes

• Price leadership: Pricing strategy where one oligopoly firm (the leader)
sets its price to maximise total industry profits and the rest of the firms
follows by setting the same price
Kinked demand curve model
• Price rigidity in oligopoly markets
• A price cut by one firm yields in a price cut by rivals and a price war ensues
• A unilateral increase in prices by one firm results in loss in sales
Kinked demand curve model
• 𝑑𝑑 ′ : Demand curve faced by a firm when rivals do not change their prices
• 𝐷𝐷′: Demand curve faced by a firm when rivals change their prices
Kinked demand curve model
• 𝑑𝐴: MR curve corresponding to demand curve 𝑑𝑑′
• 𝐵𝑀2 : MR curve corresponding to demand curve 𝐷𝐷′
Kinked demand curve model
Cartel
• Cartel: A group of firms or nations entering an explicit agreement to
restrict competition for the purpose of driving up prices. e.g. OPEC
• Limited number of cartels worldwide
• Legal restrictions on the operation of cartels
• Prisoner's Dilemma

• Persistence of cartels
• International cartels and the inapplicability of legal restrictions
• Insignificant punishment on detection relative to benefits
THANK YOU