Literally, oligopoly means "few sellers." This market structure is characterized by:
In short, an oligopoly is competition among the few.
A key factor here is the pricing behavior of close rivals, or interdependence between firms. This means that each firm must take into account the likely reactions of other firms in the market when making pricing decisions. Because the reactions of those rivals cannot be determined, the precise price and output that will emerge under an oligopoly cannot be determined. Only a potential range of prices can be indicated.
There are three basic pricing strategies.
1. The assumption of pricing interdependence is that firms will match a price reduction and ignore a price increase. The idea is that if a firm raises prices, other firms won't follow, because they won't worry about losing market share to a firm that is raising its prices. However, if the firm lowers its prices, other firms will respond by lowering their prices also, since they don't want to lose market share.
The demand curve that a firm believes it faces has a kink at the current price P and quantity Q.
The kinked demand curve can be thought of as two demand curves.
The kink in the demand curve means that the MR curve is discontinuous at the current quantity - shown by the gap AB in the figure.
Fluctuations in MC that remain within the discontinuous portion of the MR curve leave the profit-maximizing quantity and price unchanged.
For example, if costs increased so that the MC curve shifted upward from MC0 to MC1, the profit-maximizing price and quantity would not change.
The beliefs that generate the kinked demand curve are not always correct and firms can figure out this fact. If MC increases enough, all firms raise their prices and the kink vanishes.
2. The assumption of the Cournot model is that a firm will embrace another's output decisions in selecting its profit-maximizing output but that decision is fixed. This means that each firm is naively conjecturing that should either one of them alter their output decisions, the other will not react.
Assume there are 2 firms. The market demand takes the following form: P = 30 - Q, where Q = Q1 + Q2 and Q1 = Q2 (i.e., industry output constitutes firm 1 and 2's output respectively and both firms share the market).
Firm 1's total revenue (TR) is P x Q1 = (30 - Q) x Q1 = [30 - (Q1 + Q2)] x Q1 = 30 x Q1 - Q12 - Q1 x Q2.
This equilibrium can be compared with that of perfect competition and monopoly.
We can see that 2 firms operating under Cournot assumptions offer a better welfare outcome than under monopoly.
If the number of firms increases, then the Cournot equilibrium approaches the competitive equilibrium.
3. Nash equilibrium is a concept of game theory where a firm does what is best for itself after it takes into account other firms' actions. For example, McDonald's charges $2.99 for a Value Meal based on what Burger King and Wendy's are charging for a similar menu item. McDonald's would reconsider its pricing if its rivals were to change their prices.
An Oligopoly Price-Fixing Game
Collusion is the opposite of competition. It involves cooperative actions by sellers to turn the terms of trade in favor of the group and against buyers.
If there is no collusion and each oligopolist act independently, seeking to maximize profits by offering consumers a better deal than its rivals, the market price would be driven down to its lowest level and firms would be just able to cover their per-unit cost. This is like a pure competitive market.
However, there is a strong incentive for oligopolists to collude, agreeing to raise price and to restrict output. They can form a cartel (such as OPEC) or they can collude without such a formal organization. In this case, the highest price occurs.
Oligopolists have a strong incentive to collude since they can profit by restricting output and raising price. There are six major factors that affect the chances of successful collusion:
Optimal Price and Output
There is no single optimum price and output analysis that fits all oligopoly market situations. Consider a dominant firm model where the market consists of a dominant firm and some fringe firms. The dominant firm becomes the price maker. It operates as a monopoly, faces a residual demand curve, and chooses price and output to maximize its profit (MR = MC). Other firms are price takers or followers.
The following figure shows a dominant firm industry. On the left are 10 small firms and on the right is one large firm.
| Yass0707: i don't understand how can get MR for the 1st firm from TR. |
If TR=30Q1 - Q1(square2) - Q1Q2
how we can get MR=30 - 2Q1 - Q2
|Yass0707: never mind, i figured out :)|
| kcanales4: I can't seem to figure out how MR=30-2Q1-Q2. Can someone please explain? Thanks!|
|Bududeen: You differentiate! That is find the first derivative|
|schweitzdm: Could someone please explain how you find Q1 = 6 from that same example? This reading is causing a major headache.|
|robbiecow: Sub Q1 = 9 -.5Q2 into Q2 = 9 - .5*(9 - .5Q2) ... Q2 = 6, which also means that Q1 = 6.|
|abellochs: are they serious with all those derivatives and differentiation?? Just spent an hour remembering all that. Can't wait to use it in the real world. SMH|