OLIGOPOLY

Oligopoly is a form of market organization where there are only few

firms/sellers in the market producing or selling homogeneous or
differentiated products.

Oligopoly is also often referred to as competition among the few.

If the products are homogeneous then we can call it as pure

oligopoly(for ex. steel and alumium)

On the contrary, if the products are heterogeneous then we have a

differentiated oligopoly (eg. Automobile and cement).

The simplest case of oligopoly is duopoly which prevails when there are
only two producers or sellers of a product. Duopoly is generally
regarded as a special case of oligopoly

Although entry into the oligopoly industry is possible, but it is very

difficult.
Some of the oligopolistic industries are, two wheelers, steel, alumium,
telecommunications, air lines etc.

Since there are only a few firms producing and selling a homogeneous or
differentiated products in an oligopoly market the action of each firm will
affect the other firms in the industry.

For example, when Maruti introduces a price rebate to promote sales

Hyundai immediately follows. Since price competition leads to an
enormous price war, oligopolistic always prefer nonprice competition
such as advertising expenditure, product differentiation and service they
provide. For example, when Pepsi mounted a major advertising campaign
in the late 1990, Cocacola responded with a large advertising campaign.
• In an oligopoly only a few firms are competing with each other and each
firm must carefully consider how its action will affect its rivals and how
its rival is going to react.
• As each firm’s behaviour rests on the actions and reactions of other
firms, price war is common in such market and the consequence of such
war is ruinous for the industry as a whole. Therefore, the price remains
the same for some time in the oligopoly market.
 Non pricing Strategy
• Advertisement
• Extending the service/warranty
• Longer time opening hours
• Keeping the price same for next year
Since an oligopolist know that its action will have significant impact on
other oligopolistic in the industry, each oligopolist must consider the
possible reaction of competitors in deciding its pricing policy, degree of
product differentiation to introduce, the level of advertising expenditure
to undertake, the amount of service to provide and so on.
Because of this interdependence, managerial decision-making is much
more complex under oligopoly than under other forms of market
structure.
 Features or Characteristics of Oligopoly
Few firms/sellers but many buyers
How many is few?
Approx. 10 firms.
Homogeneous (Identical) or differentiated products

High barriers to entry-though entry is possible in the long run but it is

very difficult (because the fixed cost is very high)

Interdependence
• In oligopoly, the action of each firm affects the other firm’s
decision. In other words, pricing strategies focus on strategic
interactions. Therefore, price competition can lead to ruinous
price war, and as such each firm tries to adopt various non-price
competition.
• prevalence of non-price competition
availability of close substitutes
 Sources or Causes of Oligopoly
Economies of scale: one important reason that a market may have few
firms in the existence of economies of scale. When economies of scale
exists, average cost falls rapidly over a large range of increase in level of
output. Thus big firms have advantage over small firms on account of
economies of scale. The larger the scale of production, the lower the
average variable cost of production.
Barriers to entry: A few firms in the industry may exist due to the
barriers of entry. There are two types of barriers(A) technological (B)
Legal. A technological barriers to enter arises for the small firms . Hence
they cant compete with the large firms. A legal barriers arises when
government imposes restrictions on the entry of new firms to avoid
harmful competition among the firms. For example, government of many
countries permit only a few firms to provide long distance telephone calls
or air line services. Patents are another source of legal barriers to the
entry of firms imposed by government.

A few firms own a patent for the exclusive right to produce a commodity
or to use a particular production process.
Sources or Causes of Oligopoly continues..

Established firms may have a loyal following of customers based on

particular quality and service(brand( that new firms would find very
difficult to match.
Few companies may own the scarce resources- A few firms may own
or control the entire supply of raw material required in the production of
the product
A large amount of fixed cost – huge capital investments and specialized
inputs are usually required to enter an oligopoly industry (say,
automobiles, aluminum, steel and similar industries)and this act as an
important natural barriers to entry.

These are not only the source of oligopoly but they also represent the
barriers to other firms entering the market in the long run.
 Collusive vs. Non-collusive oligopoly
Collusive oligopoly
Sometimes, firms may try to remove uncertainty related to acting independently and
enter into price agreements with each other. One way of avoiding the uncertainty arising
from oligopolistic interdependence is to enter into collusive agreements. There are two
main types of collusion, cartels and price leadership. Both forms generally imply tacit
(secret) agreements, since open collusive action is commonly illegal in most countries at
present.
• is a form of market in which few firms form a mutual agreement to avoid competition.
They form a cartel and fix the output quotas and the market price.
•Non-collusive oligopoly: If firms in an oligopoly market compete with each other, it is
called a non-collusive or non-cooperative oligopoly. Each firm has its price and output
policy is independent of the rival firms in the market. The entire firms enable to increase
its market share through competition in the market. Eg. Augustin Cournot's Mode,
Bertrand's Model, Sweezy's Kinked Demand Curve Mode.
Pricing Strategy followed in oligopoly
market
In such market structure, the action of each firm affects the other firm’s decision. In
other words, pricing strategies focus on strategic interactions. Therefore, price
competition can lead to ruinous price war and as such each firm tries to adopt
various non-price competition. In general, firms follow
•limit pricing-if the entry of the new firms where not so restricted, the industry
could not remain oligopolistic in the long run. Limit pricing exists when an existing
firm charges 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.
•Predatory pricing-It happens when one big firm wants to enter the market. Here
the big firm deliberately keeps very low price to attract more number of customer
and discourage the entry of new firms to enter the markets. For instance, reliance
Jio.
Pricing Strategy followed in oligopoly
market
predictor pricing is a pricing strategy where the product/service is set at a
very low price, intending to drive competitors out of the markets or create
barriers to entry for potential new competitors. This pricing strategy is
employed by a dominant firm to keep the prices very low to eliminate
competition. Predatory pricing is illegal under the antitrust laws. Predatory
pricing is an anti competitive practice by a firm which aims at
monopolizing the market and drive out other competitors. It is done by
charging prices less than the cost that a firm incurred in the production
process. Eg. Reliance Jio. Predictor price is good for the consumer for a
short-run point of view as they have to pay less. But in the long run point
of view, it is bad for the consumer.
•Gillette pricing-Once the consumer buys the product then recurring
expenditure is there. For instance printer, DTH, saving razor etc
• Dominant firm pricing,
•Pricing determined by cartel etc
 Price Leadership Model
• Price leadership is an important form of collusive oligopoly
• Under price leadership one firm sets the price and others follow it.
• The one which sets the price is a price leader and the others who
follow it are the followers.
• Price leadership come into existence either through secret or formal
(open) agreement
• The formal (open) agreement to establish price leadership are
generally illegal, price leadership is generally established as a result
of informal and secret understanding between the oligopolists.
• The followers firms adopt the price of the leader, even though they
have to depart from their profit maximising position, as they think
that it is to their advantage not to compete with their leader and
between themselves.
 Types of Price Leadership
Price leadership is of various types (1) Price leadership by a low cost
firm(2) price leadership of the dominant firm (3) Barometric price leader
ship
Price leadership by a low cost firm-in order to maximise profits, the low
cost firm set a lower price than the high cost firm. Since, the high cost
firms will not be able to sell their product at higher price, they are forced to
agree to the low price set by the low cost firm. The low cost price leader
has to ensure that the price which he sets must yield some profits to the
high cost firm-their followers.
 Price Leadership by a low cost firm
• Firm produce homogenous products
• Firm have different cost structures
• The low cost firm sets the lower price
• for the product by equalizing its MR and MC
• This price will be followed by the high-cost firm
• At this profit, the high cost firm(the follower) does not maximize profits
• However, prefers to follow the price leader in order to avoid the price war
Types of Price Leadership Continues….
• Price leadership of the dominant firm: Dominant firm may be producing
a very large proportion of the total production of the industry. The
dominant firm knows the total market demand. The dominant firm knows
the marginal cost of the small firms. The dominant firm fixes a price which
maximises its own profits. The other firms(followers) follows the
dominant firm and accept the price set by dominant firm and adjust their
output accordingly.

• Barometric price leader ship-All the firms agree to follow the price
change made by a firm which is very old firm, experienced firm, most
respected firm who has good knowledge of the market condition and can
forecast the future happenings in the market better than others. He will set
the price and others will follow.
 Cartel
• What is Cartel?
Cartel is a group of firms who have joined together to control its
production, sales and the price in the hope of obtaining the
advantages of monopoly.
• Cartel formation is possible only for homogeneous product.

• Why Cartel?
(i) To reduce the uncertainty arising from the interdependence of
oligopoly firms
(ii) To maximize joint profits. Cartel aims at joint profit
maximization.

• Types of Cartel
There are two types of cartel. Centralized cartel and Market sharing
cartel.
Centralized cartel is the most well known type of cartel. For example,
OPEC. Centralized cartel is a formal agreement among the oligopoly
firms/producer of a product to set monopoly price, allocate output
among its member and determine how profits are to be shared.
Centralized cartel aims at joint profit maximization.
 The Centralized Cartel
• They decide about the total quantity and the price at which it must be
sold. Distribute the maximum joint profit among the participating
members

• Allocate the production among the members of the cartel

• They have the authority to have the access to the cost figures of
individual companies

• They estimate and calculate the market demand

 Market sharing cartel
• Market sharing cartel: as the name implies, the
market sharing cartel gives each member the
exclusive rights to operate in a particular
geographical area. For example Du point.
• The agreement is on the quantity that each
member can sell at the agreed price
• Allocation of quota-share is based on the basis
of cost of the company and its bargaining skill
• During the bargaining process two things are
taken into consideration
(i) past levels of sales
(ii) productive capacity
 Some Cartels: Example
•OPEC: The root cause of the Oil Crisis
in 1973
•The Cartel of GM, DC and Ford
•The Japanese Automobile Cartel
The Centralized Cartel
The Centralized Cartel Continues
 Cartel success and failure story
Successful
1. International cartels have succeeded in raising prices. During
the mid-1970s, for example, the international Bauxite Association
quadrupled the bauxite price
2. OPEC
3. From 1928 through early 1970, a cartel called Mercurio
Europeo kept the price of mercury close to a monopoly level.

Failures
However, most cartels have failed to raise prices.
1. An international copper cartel operates till today, but it has
never had a significant impact on copper prices. Cattel’s attempt
to drive up the prices of tin, coffee, and tea has failed.
 Problems with the Cartel

• Inherently unstable given different cost structure of

different companies
• Strong tendency of Low-cost companies either to
break away from cartel openly and charge lower
price
• Low-cost company cheat by giving secret price
concessions
• The cheated companies together may decide to
wage a war against the company who is cheating
 Conditions for Cartel Success
Why do some cartels succeed while other fails? There are some
conditions for cartels to success. To be successful, a cartel must
1.Get agreement on prices and production levels: This does not mean,
however, that agreeing is easy. Different firm may have different costs,
different assessments of market demand, and even different objectives,
and they may therefore want to set prices at different levels
2.Prevent cheating by cartel members
Furthermore, each member of the cartel will be tempted to
‘cheat’ by lowering its price slightly to capture a large market share than
it was allotted.
Once the price is driven up and profitability increases, however, it
becomes tempting for each seller to offer a secret discount.
By offering a price slightly below the fixed price, any cartel
member can usually increases sales and profit. Even if cartel members
keep an eagle eye on each firm’s price. One firm can increase sales by
offering extra services, secret rebate and other concessions.
Conditions for Cartel Success continues…
• Restrict the entry of new competitors
If a cartel cant prevents new entry into the market, new firms will
eventually force prices down, squeeze economic profit, and disrupt
the cartel. The profit of the cartel attracts entry and increases market
supply which forces the prices to decrease. A cartel’s success
therefore depends on barriers that block the entry of new firms.
• Number of firms in the cartel: the more the number of firms in an
industry, the more difficult is to negotiate an acceptable allocation
of output among them
Kinked Demand curve
 Kinked Demand curve
• Kinked means the prices are sticky or inflexible. Many oligopoly industries
prices remain sticky or inflexible. Hence, there is no tendency on the part of the
oligopolist to change the price even if the economic condition undergo a
change.

• Each oligopolist believes that if he lowers the price below the prevailing level,
his competitors will follow him and will accordingly lower their prices,
whereas if he raises the price above the prevailing level, his competitor will not
follow his increase in price.

• In other words, each oligopolist firm believes that though its rival firms will not
match his increase in price above the prevailing level, they will indeed match
its price cut. These two different types of reaction of the competitors to
increase in price on the one hand and to the reduction in price on the other hand
make the portion of the demand curve above the prevailing price level
relatively elastic and the lower the portion of the demand curve relatively
inelastic.
• Since the oligopolist will not gain a large share of the market by reducing his
price below the prevailing level, and will have substantial reduction of sales by
increasing his price above the prevailing level, he will be extremely reluctant to
change the prevailing price.
Price decrease: If an oligopolist reduces its price below the prevailing price
level OP in order to increase his sales, his competitors will fear that their
customers would go away from them to buy the product from the former
oligopolist which had made a price cut. Therefore, in order to retain their
customers, they will be forced quickly to match the price cut. Because of the
competitors quickly following the reduction in prices by an oligopolist, he will
gain in sales only very little. His sales will increase not at the expense of his
competitors but because of the rise in total quantity demand due to the reduction
in the price of the goods. Very small increase in sales of an oligopolist following
his reduction in price below the prevailing level means the demand for him is
inelastic. Thus the segment KD of the demand curve which lies below the
prevailing price OP is inelastic showing that very little increase in sales can be
obtained by a reduction in price by an oligopolist.
Price increase: If an oligopolist raises his price above the prevailing
level, there will be a substantial reduction in his sales. His customer
will leave him and go to his competitors who will welcome the new
customer. These happy competitors will have therefore no motivation
to match the price rise. The oligopolist who raises his prices will be
able to retain only those customer who either have a strong preference
for his product or are loyal customers. A large reduction in sales
following an increase in price above the prevailing level by an
oligopolist means that demand is highly elastic. The segment dK of the
demand curve which lies above the current price level OP is elastic
showing large fall in sales if a producer raises its price .
• The demand curve facing an oligopolist according to the kinked
demand curve hypothesis has a “kink” at the level of the prevailing
price. The segment of the demand curve above the prevailing price
level is highly elastic and the segment of the demand curve below the
prevailing price level is inelastic. A kinked demand curve dD with a
kink at point K. The prevailing price is OP and the firm producing
and selling OM units of output. Now upper segment of dK of the
demand curve dD is relatively elastic and lower segment of KD is
relatively inelastic.

• The price OP will tend to remain stable or rigid as every

member of the oligopoly will not see any gain in lowering
the price or increasing the price.
• The oligopolist confronting a kinked demand curve will be maximising his
profit at the current price level. For finding the profit maximizing output
combination, marginal revenue MR corresponding to the kinked demand curve
dKD has been drawn. It is clearly visible that the MR curve is discontinuous i.e
it has broken in vertical portion. The upper part of MR curve corresponds to
upper part of demand curve dK. The lower part of MR curve corresponds to
lower part of demand curve KD. The length of the discontinuity depends upon
the relative elasticities of the two segment dK and KD of the demand curve at
point K. The greater the difference in the two elasticities, the greater the length
of the discontinuity. The marginal revenue curve corresponds to kinked
demand curve which has a discontinuous portion or gap of HR. Now, if the
marginal cost curve of the oligopolist passes at point E through the
discontinuous portion of HR of the marginal revenue curve MR it has no
effects on price and output. The oligopolist will be maximizing his profit at the
prevailing price level OP.
• If there is a change in costs, the price will remain stable as long as the MC
curves passes through the gap HR in the MR curve. When the MC curve shifts
upward from MC to MC’ due to increase in cost, the equilibrium price and
output remains unchanged since the new marginal cost MC’ also passes from
point E’ through the gap HR.
Exceptions
• Rise in cost: if there is a rise in the cost of the oligopolist industry,
the price is not likely to stay rigid. When there is a rise in the cost of
industry an oligopolist can reasonably except that his increase in price
will be followed by the others in the industry. Consequently the
segment of the demand curve above the prevailing price will become
less elastic.
• Increase in demand: when demand rises, the price is unlikely to
remain stable instead the price is likely to rise. In the event of
increase in demand, an oligopolist can expect that if he initiates the
increase in price, his competitors will most probably follow him.
Therefore the upper segment of dK of the demand curve will become
less elastic
Criticism
1.There is not much evidence that oiigopolist readily matched price
cuts not price increase
2.It didn’t explain at what price the kink will occur
 Pricing in Practice
• Peak load pricing-refers to charging of a higher price for goods and
services during the peak times than the off peak time. Eg. Electricity
Price is more during summer compared to Winter. Likewise hotels
charges more during summer than winter.
• Two part tariff- refers to the pricing practice in which the consumer
pay an initial fee while purchasing a product as well as usage fee or
price for each unit of the product they purchase. Oligopolistic and
monopolistic firms sometimes use this pricing method as a way to
increase their profit. Eg: British Library, Club house membership,
credit card etc
• Prestige pricing- deliberately setting high prices to attract prestige
oriented customers. E.g many people pay prices ranging from 30,000
to 70,000 to drive BMW rather than low priced automobiles. Most of
the times rich people prefers to pay higher price for a product though
similar product is available at lower price. They compare the price
with quality.
 Pricing in Practice continues…
Price lining-this refers to the setting of a price target by a firm and then
develop a product that would allow the firm to maximize total profit at that
price. For ex. tata nano
Skimming: this refers to setting of a high price when the product is introduced
and gradually lowering the price. This occurs most often in durable goods such
as TV, computer, washing machine etc. starting with a higher price will allow a
firm to sell a product to those customer who are willing to pay high price. Later
the firm will lower the price to increase the sales and discourage the new firms
who are trying to enter the market.
Predatory pricing-predictor pricing is a pricing strategy where the
product/service is set at a very low price, intending to drive competitors out of
the markets or create barriers to entry for potential new competitors. This
pricing strategy is employed by a dominant firm to keep the prices very low to
eliminate competition . Predatory pricing is illegal under the anti trust laws.
Predatory pricing is an anti competitive practice by a firm which aims at
monopolizing the market and drive out other competitors. It is done by charging
prices less than the cost that a firm incurred in the production process. Eg.
Reliance Jio. Predictor price is good for the consumer for short run point of
view as they have to pay less. But for long run point of view it is bad for the
consumer.
Pricing in Practice continues…
• Price matching- As a seller, I am telling you this is the best
price I am offering to you. You will not get this product with
this price anywhere. If you will come to know that any seller
are charging a lower price compared me, then you come to
me, I will be happy to match that price.
• Auction pricing- Bidding. Eg. IPL players.
• Bundling – Buy two, the price is Rs. 120. Buy one Rs. 80.
Thank You