Oligopoly: Price leadership, its types and difficult

COLLUSIVE OLIGOPOLY“PRICE LEADERSHIP”

CREATED BY PETER FRANCIS MILLANZI (BA-

ECONOMICS)S T U D E N T AT T H E U N I V E R S I T Y O F D O D O M A

OLIGOPOLYPRESENTATION

OLIGOPOLY

The term ‘oligopoly’ has been derived from Greek words, oligi meaning ‘few’ and polein meaning ‘sellers’ for example automobiles company, soft drinks companies like coca cola and Pepsi, and oil companies.

An oligopoly is a form of market structure characterized by:-

a) Few firms selling either differentiated or homogeneous products at the market, “and how few are the sellers” is not easy to tell or define numerically in the oligopolistic market structure due to the fact that economists are not specified about a definite number of sellers for the market to be oligopolistic in its form; it may be two, three, four, five or more.

Characteristics of Oligopoly

In addition to the point, few in their number brings oligopolist in intensive competition (in the form of non-price competition, that involves differentiation and advertisement) with one another; if we carefully observe other market structures like perfect competition, competition is non-existent as the number of firms is so large and under monopoly, there is a single seller and therefore there is absolutely no competition, under monopolistic competition, where the number of firms is so large that a degree of competition is considerably reduced but under oligopoly, the number of sellers is so small that any move by one seller immediately affects the rival sellers as result firms keep watch on the activities of the rival firms and prepare itself with a number of aggressive and defensive marketing strategies.


b)Interdependence of Business Decisions. The nature and degree of competition among oligopolists make them interdependent(mutually supporting or dependent) in respect of decision making. The reason for interdependence between oligopolists is that a major policy change in one firm affects the rivals seriously and immediately, thus it is a source of action and reaction, moves and counter-moves by the competing firms.


c) Barriers to entry, in along run barriers are strong to entry of new firms to the industry. If entry is free, new firms attracted by super-normal profits, if it exists, enter the industry and the market eventually becomes competitive. Example of the common barriers that do exist are economies of scale, price-cutting, control over important inputs, patent rights and licensing, absolute cost advantage to old firms, indeterminate price and existence of excess capacity. Such factors prevent the entry of new firms and preserve the oligopoly.

TYPES OF OLIGOPOLY “KINDS OF OLIGOPOLY MODELS”

There are two types of oligopoly and that are─ NON-COLLUSIVE OLIGOPOLY─ COLLUSIVE OLIGOPOLY

COLLUSIVE OLIGOPOLY

In collusive oligopoly, firms are assumed to act in unison that is in collusion (knowledge or approval or agreement) with one another; this assumption is based on empirical facts, rather than being conjectural(hypothetical or imaginary).

Or Refers to the oligopoly market in which the oligopolistic firms make joint-

pricing and output decisions where by the firms agreed to have a uniform price-output policy to be pursued by competition among themselves.

WHY COLLUSION? It reduces the degree of competition between the firms and help them act

monopolistically in their effort of profit maximization It forms a kind of barrier to the entry of new firms. It reduces oligopolistic uncertainty surrounding the market since in the

cartel members are not supposed to act independently and in a manner that is detrimental(harmful or disadvantageous) to the interest of other firms.

COLLUSIVE OLIGOPOLY

How ever there are two main types of collusion oligopoly:─ CARTEL─ PRICE LEADERSHIP PRICE LEADERSHIP A price leadership is informal position of a firm in an oligopolistic

setting to lead other firm in fixing or publishing price of their product ahead of its competitors who closely follow the prices already announced; it emerges spontaneously(instinctively or suddenly) due to technical reasons as size efficiency, economies of scale and ability of firm to make forecasting concerning market conditions accurately or out of explicit agreements between the firms to assign leadership role to one of the them.

N.BPrice leadership is possible under both product homogeneity and

differentiation or heterogeneity.

PRICE LEADERSHIP

The price readership consist of several types such as:-

─ Price leadership by a low cost-firm─ Price leadership by the dominant firm─ The barometric price leadership─ The exploitative or aggressive price

leadership

Price leadership by a low cost-firm

It occurs when the low cost firm sets a lower price than the profit maximizing price of the largest firm for the small firm to maximize its profit. Thus the high cost firms will not be able to sell their products at the highest price hence they are forced to agree to lower prices to such of the low cost firms.


Consider the figure below The figure shows two firms that face

identical revenue curves i.e. AR =D

and MR but the largest or l0w-cost

P3 H MC2 AC2 firm (L) has its cost i.e. AC1 and MC1,

P2 L MC1 where the small firms have AC 2

AC1 and Mc2. the largest firm has economies

P1 of scale and its cost of production is low

MR AR = D lower than that of other firms,

0 Q1 Q2 hence find it profitable to fix a price at OP2(=Q2H) and

sell at quantity OQ2, and it is at this point where the level of output its MC=MR, hence maximum profit.


On the other hand the high-cost firms (H) would be in position to maximize profit at price OP3 and quantity OQ1, however the low-cost firms charge profit maximizing price OP2, the low-cost firms would lose their customers to high-cost firms charging low price OP2, and recognize the price leadership of the largest firm.

Note: largest firm can eliminate other firms and become a

monopolist, by cutting its price down to OP1 and still offer the same quantity OQ2 and make , only normal profit as AC1=OP1, but it may not do so for the fear of anti-monopoly laws.

Price leadership by the dominant firm

Happens when a dominant firm shares a large part of the market along with small firms by producing very large proportional of total production of the industry therefore dominate the market product. Hence, the dominant firm has the great influence over the market for the product as a result estimate its own demand curve and set the price which maximizes profit since small firms have no individual effects on the price of the products, therefore they follow the dominant firm and accept the price set and adjust their products as well just like a firm in a perfectly competitive market, assuming their demand curve is a straight horizontal line.


This is common than the low-cost firm, in its analysis of price leadership, it is assumed that there exists a low-cost firms(largest firms) in the industry, which supply a large portion in the total market and its dominance is indicated by the fact that it can possibly eliminate all its rival firms in the market by price-cutting but later on they gain monopoly which may create legal problems, hence compromising the with the existence of the rival firms in the market as largest firms use their dominance to set profit maximizing price.


The price leadership and market sharing between the largest firms and the small firms can be illustrated as follow.

Price cost and price

P3 E P3

P A B P P MCL ACL AR=MR=D

P2 C F P2P1 P1 DM

DL

0 output (small firms) output (dominant firms) QL MRL


The above illustration shows the problem confronting the dominant firms when come to determine price and output to maximize their profits. Te dominant may decide to set price at OP = PQL and maximize profit, but also if the dominant firms set price at OP1 may get loss in a short run and eliminate small firms as they will fail to survive

Note AB stands part of market demand that is unsupplied

by the small firms, hence create market share of the dominant firms is zero (OP3 = P3E).

The demand for dominant firms (AB or CF)= PB - PA

Barometric Price Leadership

Is the price leadership where the price leader is the one firm assumed to be either an old (established in the past) or experienced or largest (but it is not necessary) or most respected firm which assesses the changes and have better knowledge of prevailing market conditions in the most satisfactory way and has ability to predict the market conditions more precisely than any of its competitors with regard to the demand for the product, competition from the related product, cost of production and make changes in prices which are the best for the view point of all firms in the industry. Naturally other firms follow it willingly.

Note Price decisions by a firm having the qualifications of price

leadership is regarded as barometer which reflects the changes in the business conditions and environment of the industry.

Barometric Price Leadership

The barometric price leadership evolves for various reasons include:-

The rivalry between large firms lead to cut-throat (aggressive or competitive) competition that gives disadvantages to all firms but also may make them unacceptable as a leader, thus firm with a better predictive ability emerges as a price leader.

Most of firms in the industry may have neither the capacity nor the desire to make continuous calculations of cost, demand and supply conditions, hence they find it advantageous to accept price changes made by a firm which have been proven able to make reasonably good forecasts.

Barometric price leadership often develops as a reaction to long economic warfare in which all the firms are losers.(A. D. H. Kaplan, Joel B. Dirlam and Robert F. Lanzilotti, 1958)

4. AGGRESSIVE PRICE LEADERSHIP

It occurs when a very large or dominant firm establishes its leadership by following aggressive price policies and thus forces other firms in the industry to follow him in respect of price. Such a firm will often initiate a more threat to compete the other firms out of the market if they do not follow him in setting their prices.

It is also known as exploitative price leadership.Note one big firm built its supremacy in the market by following

aggressive price leadership. It compels other firms to follow it and accept the price fixed by it. In case the other firms show any independence, this firm threatens them and coerces them to follow its leadership.

Difficulties of Price Leadership

Difficulties of Price Leadership: The following are the challenges faced by a price leader:

(a) It is difficult for a price leader to correctly assess the reactions of his followers.

(b) The rival firms may secretly charge lower prices when they find that the leader charged unduly high prices. Such price cutting devices are rebates, favorable credit terms, money back guarantees, after delivery free services, easy installment sales, etc.

(c) The rivals may indulge in non-price competition. Such non-price competition devices are heavy advertisement and sales promotion.

(d) The high price set by the price leader may also attract new entrants into the industry and these new entrants may not accept his leadership.

REFERENCES

PRINCIPLE OF ECONOMICS BY MANKIW N. G. 5ed .

WIKIPEDIA.

END OF PRESENTATION

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