Chapter 8

Definition Characteristics Types of Oligopoly Kinked Demand Curve The firms equilibrium

Come from the Greek word “Oligos” means “ a little”

a market structure with a few no of large firms producing & supplying all output in the market

eg: Petroleum industry & steel industry, Automobile manufacturers, Personal Care Products, Cigarette Manufacturers

if there is only two firms in the market, it’s known as “Duopoli”

A few large firms Mutual interdependence Price rigidity(stable) homogenous or differentiated product Difficult to entry

such as petroleum industry (Shell, BP, Caltex, PETRONAS)

makes a decision based on the reaction of other firms in the industry

eg: if General Motor increase it price, the cars will be more expensive than

Ford’s. the consumer will choose Ford’s cars

and this will make General Motor lose so, GM will reduce the price

Price is rigid when it changes very slowly over a period of time

when 1 oligopolist firm increase price, the others not follow because they can steal the market share from the firm

– the firm will incur loss & has to decrease P to avoid loss

– due to price interdependency, P can’t changed

some maybe have the same function but different in brand name , shape, quality, etc..

eg: PETRONAS vs. Shell these firm give the same function (petrol) but differ in brand name & quality

Legal barriers such as government franchises, licenses & patents

There have 2 types: – perfect oligopoly

All firms produced identical product eg: steel industry

– imperfect oligopoly All firms produced differentiated product

Eg: automobile product

Known as collusive oligopoly use the “Sweezy’s Model”

Sweezy’s Model – there 2 assumptions: i) there are only 3 firms (A,B & C) ii) they are interdependent (there is no collusion between them)

Sweezy’s Model – the shape of the oligopolists demand

curve depend on how the firm’s rival will react to a price change introduce by firm A.

rivals will match a P , but ignore a P without any collusion

Make P decision(price maker)

MATCH PRICE CHANGES if A reduce the P B & C

will follow so, the increase in sales

for A is small, because B & C also will gain the mkt share

If A increase in price B & C will follow

its sales will loss modestly

Thus, Demand curve is steep & demand curve is

inelastic

IGNORE PRICE CHANGES Another possibility is B & C

ignore A’s price changed If A reduce price, B & C do not

changed the price A will gain higher mkt share

(sales increase substantially) If A increase price, and B & C do

not changed the price A will lose big mkt share

(sales drop substantially) So, demand curve is less steep

& elastic

There are two possible reactions

P / cost

Qty

AR = DdMR

P / cost

Qty

MR

AR = Dd

D1

MR1Qty

Pri

ce

The Kinked Demand CurveA combined strategy

D 1 MR 1 i

s an

inelastic

demand curve

MR2

D1

D2

MR1Qty

Pe

The Kinked Demand CurveA combined strategy

D2 MR2 is an elastic demand curve

Pe & Qe are equilibrium price & eqb Qty respectively Qe

Price

MR2D1

D2

MR1Qty

Price Rivals tend tofollow a price cut

or ignore aprice increase

The Kinked Demand CurveA combined strategy

Pe

Qe

P1

Q1

If the firm raises the price from Pe to P1, other firm will not follow, and the firm will lose a mkt share where qty Dd decrease from Qe to Q1 This is shown on elastic Dd curve D2

MR2D1

D2

MR1

Rivals tend tofollow a price cut

The Kinked Demand CurveA combined strategy

Price

Qty

Pe

Qe

P2

Q2

If the firm lowers its price from Pe to P2, other firm will forllow to avoid losing a share mkt to the firm which lowers its price. Lowering the price will increase the Qty Dd from Qe to Q2. This is the small increase because other firm will also lower the price & they manage to attain the same share in the mkt. the situation is shown on elastic Dd curve D1

MR2D1

D2

MR1

Effectively creatinga kinked demand curve

The Kinked Demand CurveA combined strategy

Price

Qty

So the actual Dd curve of the firm combination of D1 & D2. so the demand curve is kinked(as shown at yellowline)

D

MR

Effectively creatinga kinked demand curve

The Kinked Demand CurveA combined strategy

Price

Qty

So the actual Dd curve of the firm combination of D1 & D2. so the demand curve is kinked(as shown at yellowline)

to maximize profit, the oligopolist firm will not involve in price competition. (price rigid)

They will try to minimized cost of production as lower as possible.

Means the price is still fixed or same but to get the maximum profit, they will minimized cost as lowest as they can afford to do it.

D

MR Qty

Price

MC1

At higher Marginal cost, C1, the output produced is Qe and the price at Pe

Profit maximizationMR = MC occurs

at the kink

Qe

Pe

e1

AThe profit is area A

D

MR Qty

Price

MC2

If the frim becomes more efficient, MC will decrease MC1 to MC2

Profit maximizationMR = MC occurs

at the kink

Qe

Pe

e2

AThe profit has increased to area A + B

B

MC1

e1

The output produced is still at Qe at the same price, Pe . MC2

So, without changing the price, the firm can maximized profit by reducing cost efficiency in production

D

MR Qty

Price

MC

Qe = 40

Pe = 50

AC25

178

Profit is maximized when MR = MCAs long as the curve intersect at the vertical gap of MR curve, the profit maximizing quantity & price will be at kinked.

D

MR Qty

Price

MC

Qe = 40

Pe = 50

AC25

178

If the amount of MC is within RM 8 to RM 25, the equilibrium output will be 40 units and price will be RM 50

D

MR Qty

Price

MC

Qe = 40

Pe =50

AC25

178

Qe = 40 unitsPe = RM 50TR = P x Q = 50 x 40 = 2000TC = AC x Q = 17 x 40 = 680∏ = TR - TC = 2000 - 680 = 1320

D

MR Qty

Price

MC

Qe = 40

Pe =50

AC25

178

Qe = 40 unitsPe = RM 50TR = P x Q = 50 x 40 = 2000TC = AC x Q = 17 x 40 = 680∏ = TR - TC = 2000 - 680 = 1320(supernormal profit)

In order to max , firm will try to minimize cost since there is no competition in terms of price

D

MR Qty

Price

MC

Qe = 40

Pe = 50

AC

25

178

Wat will happened when MC is AT kinked point???

D

MR Qty

Price MC

Qe = 40

Pe = 50

AC

25

178

Wat will happened when MC is ABOVE kinked point???

75

Market Structure

Characteristics Perfect

Competition Monopolistic Competition Oligopoly

Number of firms Very large number

Many Few

Barriers to entry None Low High

Market power (control over price

None Some Substantial

Type of product Standardized Differentiated Standardized or differentiated

Market Structure

Characteristics Perfect

Competition Duopoly Monopoly

Number of firms Very large number

Two One

Barriers to entry None High High

Market power (control over price

None Substantial Substantial

Type of product Standardized Standardized or differentiated

Unique

End of Chapter 8