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Oligopoly Characteristics

Oligopoly Characteristics. Rule of Thumb : few large firms control 70-80% of market . Key Understanding: Price control, but mutual interdependence & strategic behavior. Each firm sets its price, but must consider how its rivals will react to its strategy .

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Oligopoly Characteristics

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  1. Oligopoly Characteristics • Rule of Thumb: few large firms control 70-80% of market. • Key Understanding: Price control, but mutual interdependence & strategic behavior. • Each firm sets its price, but must consider how its rivals will react to its strategy. • Considerable nonprice competition.

  2. Barriers to Entry: • Economies of scale (aircraft, autos) • Control of raw materials (mining) • Patents/technology (cell phones, copiers) • Predatory practices (airlines, soft drinks) • “Urge to merge” to gain economies of scale (Exxon-Mobil, Sears-Kmart, JPMorgan-Chase, HP-Compaq)

  3. Modeling Oligopolies • Mutual interdependence creates complications for modeling this market structure. Without being able to predict actions of rivals, oligopolists can’t estimate D and MR. • “Governing Dynamics:” was Adam Smith wrong?

  4. Oligopoly Pricing • In a stable economy, oligopolist prices are generally stable. • Price, if it does change, tends to move “in concert.” • Kinked Demand Theory explains why prices are generally stable • Rivals match or ignore price changes (steep vs. flat demand curves), which leads to the likely outcome that rivals will match price cuts and ignore price increases (key graph p. 456)

  5. Kinked Demand Curve • Price Inflexibility: • Raising price results in losing customers • Lowering price results in only small sales increases • Changes in costs may not even cause a firm to change price (MR is vertical.)

  6. Price Leadership Model • One firm, usually the largest, initiates price changes and others follow. • Infrequent price changes • Limit Pricing—price may not be the profit maximizing price because that price may entice firms to enter the market • Potential problem: price wars

  7. Cartels and Collusion • Attempts to act as monopolies • Collusion—firms reach agreement to fix prices, divide market, restrict competition (illegal!) • Cartel—formal agreement among producers to limit production and control price (OPEC) • Problem: cheating creates more economic profit.

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