 Oligopoly Market Structure

Oligopoly:- is a market structure in which a few firms dominate the industry

-Crucially these few firms recognize their rivalam and interdepended a fulley aware that
any action on their part is likely to induce conter actions by their rivals
 Key characteristics of Oligopoly
 A few large producers
 Homogeneous or differentiated product
 Control over price but mutual interdependence
 Entry barriers.
 The two types of Oligopoly model
I- Non- Conusive oligopoly
II- Collusive Oligopoly
I- Non collusive Oligopoly
- A types of oligopoly market, there is no collusion or no cooperation among rivals
- Each firms develops an expectation about what the other firm are likely to do since
firms are mutually independent, a firm expects same reaction from it’s rivals what it
decide to take a given course of action of increase own output or price it expect same
reaction from the rivals to it’s action.
- The kind of reaction firms expect to it’s action is the implication of this expectation on
behavioral pattern of oligopolistic
- The basic distinctions b/n the type of run collusive oligopoly mades
 The assumption as to the kind of action an oligopoly firm will take.
 The kind of reaction a firm will expect from it’s rival as respond to action
occurring as result
 The resultant effects of these behavioral pattern of oligopolist on equilibrium
output and price.
 Non-Collusive oligopoly Models

The basic four types of oligopoly models are:

1. The kinked demand model

2. Cllk not’s Dvopoly model
3. Bertrand’s Dvopoly model
4. Stackelbeig dvopoly model
5.
1. The kinked demand model
- Paul sweezy develop the “kinked demand” model to explain why plices often remain
stable in oligopoly market even when cost rise.
- The model develop b/c firms cance to believe that if they cut price the rivals will fallaw
the price cut and as a result the pirce cut will not produce much of increase in sales.
Therefore once price is reached it tends to remain effect in longe period.
- In kinked model, an oligopoly firm will face two demand curve to different ranges of
price.
 I. Suppose a firm at any time increase its’s price to all firms in industry will do the
same and face ABrelatively inelastic curve
II. No other firms follow price change the firm will instead it self on CD much more
elastic demand curve.

N.B. As a result of firms increase or decrease price of product

The quantity sened also increase or decrease and demand curve also changed

- If the firm decrease price P0 to P2 the firm only sale 0Q3 amount, hence the firm not be
able to sale OQ4 as given by demand curve CD Therefore the firm demand curve be
kinked at point “E” (CBE)

D. profit maximizing of kinked demand curve

- firms maximizing their profit by equating MR with MC.

The kinked hodel is different form other model is it explain as to why price is rigid in oligopolistic
market.

In kinked demand curve MR will be discountinue or break from B to C and allows a large flection of
MC but no effect on profit maximizing price & output. Therefore if MC profit maximizing quality Qe
B/c MR & MC equal at point C

If cost of product increase to MC, profit maximizing will be Qe b/c MC and MC1 the profit maximizing
price and quantity remain to be pe and Qe
 Kinked demand curve in monopolistic market

III. Collusive Oligopoly

- One way of avoiding uncertainty arising from oligopolistic interdependence is extern
into collusive agreements
- Two main types of collision are earless and price leadership
- The collusion agreement between firms in an industry is to set certain prices or to share
markets in certain ways.
I- Cartels a number of firms entering into an enforceable contract pertaining to
price and possibly other variable
- An other words, a cartel may be formed by secrete collusion among sellers.
- Typically there are two forms of cartel
- Cartel aiming at joint profit maximization
- Cartel aiming at the sharing of the market
a. Cartel aiming at joint profit maximizing
- Cartels imply direct agreement among the competing oligopolies with the aim of
reducing lencertainity arising from there mutual inter dependences
- The key aim is maximization of the joint profit on behalf of its members
- The firms – Uses centralized body to coordinate their price output, cost and revenue.
- Firms appoint certain agency to which they delegate authority to decide on quantity,
price, maximum profit, distribution etc
- Acts as multi plant monopolist, will set the price defined by the intersection of the
industry MR and MC curve.

Joint profit maximaxizing Carterl

- Given market demand curve D firms maximizing profit determined by the intersection of MC
and MR at point “e” of total output X and it will be sold at P
- Mathematically, it’s the same as multiplant monopolist, but in carter profit is maximizing on
when:-

NC1 = MR= NC2

  Assume the market demand:-
Px= 100-0.5x, where X= X1 +X2 given
 The two collusive firms cost are PX = 100 – 0.5 wher X = X1 + X2
C1= 5x1 cost of collusive firms
2
C2= 0.5X2 C1 = 5X1
 The central agency aiming profit maximization C2 = 0.5 X22
II = 1 +2
Where 1 = R1 –C1 and
 2 = R2 – C 2
Therefore II= (R1 + R2) –C1 –C2

1st R = P.x

= (100 -0.5x) x

= 100x -0.5x2

MR= dR = d (100x -0.5x2) = 100 - x

dx d(x) = substitute X1 + X2 for X

MC1 = dc1 = d(5x1) = 5

dx1 d (x)
MC1 = dC1 = d (0.5x22) = X2
dX2 d (X2)
nd
2 – profit maximizing level of output can be calculated as
MR = MC1 and MR = MC2
100 –X1 – X2 = 5 100 –X1 –X2 = X2
MR = MC1 and MR = MC2
100 – X1 – X2 = 5
100 – X1 – X2 = X2
The result of solving the above equation simultaneously is
X1 = 90
X2 = 5
 Substitute the quantity in demand function
PX = 100 – 0.5 X
= 100 – 0.5 (90 + 5)
= 52.5
 The calculate the profit for each firm
II1 = R1 – C1 II2 = R2 – C2
= Pxx1 – 5X1 = (Px X2) – (0.5 x X22)
= (52.5 x 90) – (5 x 90) = (52.5 x 5) – (0.5 x 52)
= 4275 = 250
Total profit =
 II = II1 + II2
= 4275 +250
= 4525
B. Market sharing cartel
 a firms agree to share the mallet, but keep a considerable degree of freedom concerning the style
of their output, their selling activity and other decision
 there are two method of market sharing
I- Non-price competition agreements
- In this form cartl the members of firms agree on the common price, at which each of them can
sell any quantity demanded. The price is set by bargaining, with the howest cost firms pressing
for a lower price and the high cost for a high price
- In this form cartel is indeed ‘Loose” in the sense that is the settled price is unstable

 In the above graph the two firms agree just to change a price p in such a way it allows both firms
to earn a certain amount of profit
 Price level p is not joint profit maximizing price level rather it’s decide through bargaining, to
maximize individual profit fir A change pa and firm B change P (at point where their MR equal
to MC) then firms bargain and finally they will agree b/n the two price.
 On the case of price reduction firm B will attack same existing customer away from firm A,
there for firm A will be the looser and this could led to a price war.

II. sharing of the market by agreement on quotas

- This is agreement b/n firms on the quotas that each members may sale at the agreement price
- If all firms have identical costs, the monopoly solution will emerge, with the market being
shared equally among member firm.
 Firm A Firm B Industry

Market sharing agreement based on quota

- The charge (reduction) in consumers surplus as a result of mcm is equal to area A +B

- Reduction from producers surplus is C while increase in producer’s surplus is A. therefore, B+C would
be deadweight loss
- In most case in monopolistic market, more over, prices are higher and output is lower

Price leadership

- Another form of collusion is price leadership in this form the behavior of oligopolistic is one
firm set a price and the other follow b/c is b/c it implies departures of followers from their profit
maximizing position.
- There is various forms of price leadership. The most common are
a. Price leadership by a low cost firm
b. Price leadership by large (dominant firms and
c. Barometric price leadership
a- The Model of low cost price leadership
- Two firms produce homogenous product at different costs which clearly sold at the same price,
but the firms may came to agreement to share the market equally or not
- The important condition, for the model is firms has un equal cost.
b- The model of the Dominant firm price leader
 Assume that there is a large dominant firm which has a considerable share of the total
market and small firms, each of them having a small market share.
  The market demand is assumed to be known to the dominant firm
 The dominant firm knows the supply function of small firm and can drive the market
supply curve of small firm.
c- Barometric price leadership
- In this model, formally or informally agree all firms will follow (exactly or approximately) the
change of the price of a firm considered to have a good knowledge of prevailing market
condition & can for cast better for future development of the market.
- The firm which chose as the leader is considered as a barometer, reflecting the changes in
economic environment
- The barometric firm may be neither a law cost not a large firm.
 Barometric price leadership may be established for various reason:
1st – Rival b/n several large firm in an industry may make it impossible to accept
one among them as the leader.
nd
2 – The follower avoid the continuous recalculation of costs, as economic
conditions charge.
rd
3 – The barometric firm usually has proven itself as a “reasonably” good for castor
of change in cost and demand condition in particular industry
 A numerical example of the price leadership model of the low –cost price leader
 Assume the market demand is given as:-
P = 105 -2.5X, where X = X1 +X2
 The cost function of two firms are
C1 = 5X1
C2 = 15X2
 The leader will be the law cost firm
 The lead will set it own price to maximize profit on the assumption of rival firm will
adopt the same price
 All firms produce the equal amount of output
 Assume that two firms market equally
 The demand curve of the law firm is:-
P = 105 – 2.5 (2x1) = 105 -5X1 and
 Profit function is:-
II1 = R1 –C1  P. X1 – X1

1st substitute the demand function for profit, we have

II1 = R1 – C1 d(II1) = d (100x1 -5X12)

II1 = (R1. X1 – C1) d(X1) d(X1)

II1= (105 -2.5 (2X1) X1 -5X1) 100 – 10X1 = 0

II1 = 105 – 5X1) X1 – 5X1) 100 – 10X1

II1 = 105X1 -5X12 – 5X1) 10 10

II1 105X1- 5X1 -5X12 X1= 10

II1 = 100X1 – 5X12

 P = 105 – 2.5 (2X1)

P = 105 – 2.5 (2x10)
P = 105 – 50
P = 55  price of leader firm

2nd – sine the follower adopt the same price (55) and will produce an equal level of aoutput

II2 = R2 – C2

P2 X2 – C2

II2 = (55x10) – (15X2)

II2 = (55X10) – 15X10)

II2 = 550 – 150

II2 = 400

 Since the two firms share the same demand curve, the profit function of the firm two will be
II2 = R2 – C2
pX – C2

II2 = (105 – 2.5 (2X2) X2 – 15X2)

II2 = (105 -5X2) X2 -15X2

II2 = 105X2 – 15X2 -15X2

II2 = 105X2 – 15X2 -5X22

d(II2) = (90X2 -5X22) = 0

d (X2) d(X2)

90-10x2 =0

90 = 10X2
10 10
X2 = 9
P = 105 – 5X2 = 105 – 5(9)
P = 60