Oligopolies

1. Oligopolies A2 Economics

2. Barriers to Entry • Write down as many barriers to entry in an oligopolistic market as you can. • With short description.

3. Aims and Objectives Aim: • To understand firm behaviour in an oligopoly. Objectives: • Define the different barriers to entry in an oligopolistic market. • Explain the behaviour of firms in an oligopolistic market. • Analyse the kinked demand curve. • Evaluate the kinked demand curve’s relevance .

4. Competitive Oligopoly (imperfect). • Rival firms are interdependent. • They must take account of the reactions of rival firms when deciding a market strategy. • They decide their strategies without co-operation and collusion. • Firms are uncertain of other firms reactions.

5. Kinked Demand Curve Theory • How competitive oligopolists are affected by rival’s reaction to price and output decisions. • Firms that change their prices may be punished by the reactions of their competitors. • Explains why there is a lack of price competition among firms and why prices remain stable in an oligopoly.

6. Kinked Demand Curve Theory • Initial output of OB and initial price of OA. • If the firm increases it’s price above OA, it’s competitors will leave their prices where they are. • The firm will suffer a reduction in sales, profit, and market share. • To what extent depends on the firms’ brand loyalty.

7. Kinked Demand Curve Theory • Firm lowers it’s price below OA, the demand curve becomes inelastic. • If a firm lowers it’s price, total revenue will fall. • All other firms will lower their prices. • Could create a price war.

8. Kinked Demand Curve: Price War • Below the price OA, a price war may occur. • Leading to an inelastic demand curve as firms copy. • If firms lower their prices, the resulting price war, will lead to total revenue falling. • Firms who compete like this may incur losses.

9. Kinked Demand Curve Theory • Firms prefer to stay at point X. • They are fearful and uncertain of how rivals will react to a change in price. • The best policy may be to not compete on price, and leave price unchanged.

10. Kinked Demand Curve and Stable Prices • Second theory as to why prices are stable in an oligopoly. • Marginal Revenue Curve. • Vertical section at output Q1, shown by the distance B-C. • This area links the MR curves associated with the AR curves.

11. Kinked Demand Curve and Stable Prices • Initial marginal costs are MC1, pt A. • The MC curve can rise or fall anywhere on the vertical. • Doesn’t affect the profit maximising equilibrium of (Q1,P1). • If marginal costs rise above MC2 at point B. • Or falls below MC3 at point C. • The profit maximising output changes.

12. Kinked Demand Curve and Stable Prices • The oligopolist in both these cases would have to change their prices to maximise profits. But.. • The oligopolist’s selling price remains stable at P1, if the Marginal Costs lie between MC2 and MC3. • Oligopolists’ price remains stable, despite quite considerable changes in costs.

13. Criticisms of the Kinked Demand Curve • No explanation of how and why a firm chooses in the first place to be at point x. • Theory only explains price competition, and not non-price competition. • Model assumes that oligopolists will react in a certain mannerand this is often not the case in reality. • Under some circumstances firms may feel that they wish to compete on price, reckoning that it is the strongest firm in the market.