Oligopoly & Monopolistic CompetitionOligopoly literally means a few sellersEach seller controls significant size of

marketProduct/ service could be (1)

differentiated/ (2) undifferentiatedEg:(1) Cars, TVs, paints; (2) Oil, Cement,

Decisions of every seller in the market matters

Interdependency of firms is key feature of oligopolistic industry

Some Examples of OligopolyTata, Leyland, Volvo, etc. ------

Caterpillar, Komatsu, BEML, etc -----

Hero Honda, Bajaj, TVS, Kinetic etc. in ---

Maruti, Tata, HM, Hyundai, Fiat, Honda, etc in--

Asian Paints, J&N, Berger, Goodlas Nerolac etc-

MRF, Ceat, Modi, JK Tyre, Goodyear, Apollo, Goodyear

Kelvinator, Godrej, Voltas, Videocon, LG in ---

Castrol, Servo, HP, Gulf, Shell, Mobil, etc in ----

Oligopoly Examples. …contd.Leela, Taj, Oberoi, Sheraton, Ramada, Hyat,

Centaur etc. in ------Videocon, Onida, LG, Samsung, Philips, Akai,

BPL, etc. in ------ACC, L&T, Nagarjuna, Ramco, Priya,Pepsi, Coca Cola, Thumbs Up, etc. in ----Bisleri, AuqaFina, Bailley, Ganga, etc in----The Hindu, Indian Express, HT, ToI etc. in ---Economic Times, Financial Exp., B.Std., etc

in--

Main FeaturesIt is in between the Monopoly and

Monopolistic market modelsEvery seller can exert significant influence

on marketIndeterminate demand curve; due to

dependency on rival’s reactionsBuyers keenly compare the price/ distinct

features of each seller’s product

Collusion and cartelsCollusion:explicit or implicit agreement between

existing firms to avoid or limit competition with one another

Cartel:It is a situation in which formal

agreements between firms are legally permitted e.g. OPEC

Collusion is difficult if….There are many firms in the industryThe product is not standardisedDD and cost conditions are changing

rapidlyThere are no barriers to entryFirms have surplus capacity

The kinked demand curve (1)

Q0

P0

Quantity

Rs.

Consider how a firm may perceive its demand curve under oligopoly.

It can observe the currentprice and output.

but must try to anticipaterival reactions to anyprice change.

Q0

P0

Quantity

Rs.

The kinked demand curve (2)

The firm may expect rivalsto respond if it reducesits price, as this will be seenas an aggressive move

… so demand in response to a price reduction is likely to be relatively inelastic

The demand curve will be steep below P0.

D

The kinked demand curve (3)

Q0

P0

Quantity

Rs.

D

…but for a price increaserivals are less likely to react,

so demand may be relatively elasticabove P0

so the firm perceivesthat it faces a kinkeddemand curve.

The kinked demand curve (4)

Q0

P0

Quantity

Rs.

D

Given this perception, thefirm sees that revenue willfall whether price is increasedor decreased,

so the best strategy is to keepprice at P0.

Price will tend to be stable,even in the face of an increase in marginal cost.

Game Theory: Some terms

Game: A situation in which intelligent decisions are always interdependent

Strategy: Game plan describing how a player will act or move in every conceivable situation

Dominant strategy: Here a player’s best strategy is independent of those chosen by others

Select Cases of PricingIf the product is undifferentiated, it becomes

indeterminate to guess/ predict price, as it depends on rivals’ reaction. But, it will be lesser than under monopoly.

With product differentiation, each seller can have some flexibility in varying price/ output

Normally, if there is a sudden rise in DD for one seller, he hesitates to raise price, since others will ignore it.

Likewise, if costs of one seller go down, he may not reduce price at once, as others may reduce more

Kinky Demand CurveIntroduced by Paul Sweezy, it deals with why

prices of products like steel at $28 per ton during 1901-16; again at $43 between 1922-33; Sulphur prices remained at $18 per ton between 1926-38 excepting 2-3 cents variation/ ton in two years.

Hints to draw Kinky DD CurveAR has a kink at the prevailing priceMR becomes discontinuous below the kinkIf MC passes through the Gap, holding price-

output constant is the best alternativeNew industry, in early stages, this model is useful

in shorter term.

Price LeadershipDominant Firm Intel’s 386 cut chips price from $152 to $99 in

1992 (till 1991, it was monopoly), AMD had to follow it

Barometric Price LeadershipOld, experienced & largest firm assumes the role of

a leader; protects the interests of other sellers. Others’ costs of production is considered before fixing price

Exploitative/ aggressive pr. LeadershipLargest firm acts as an aggressive leader, and

compels other firms to fix the same price as it fixes. Other firms must follow its price irrespective of cost conditions

Collusive OligopolyThe small number of firms can arrive at

tacit or formal agreement about price/ output.

Formal agreement is termed as a cartel Though some minor rivalry/ self interest

still persists, under the cartel, group interest is given prime importance. In case of a conflict of interests between the two, self interest is ignored.

OPEC CartelMembers of major oil producers (13, incl.

Iraq) formed in 1960)In 1975, OPEC accounted for 55% of world

oil output & 80% trade; now produces 30% of world output

Determination of oil price (meets at Vienna twice a year normally), own & control oil resources directly

Saudi Arabia is major player in the cartelThey are now operating in a $22-28 per

barrel price band, and vary output accordingly.

Venezuela strike pushes up price/ US-Iraq conflict affects the price (Jan/ 03)

Effects of OligopolyPossibility of restricted output/ high pricesEntry barriers make consumers pay higher

priceFirms will not be able to build/ operate at

optimum levels of productionSales promotional strategies waste

resourcesNeither liked by the players/ nor good for

consumers/ government as less tax collection.

Lower employment opportunities

Monopolistic CompetitionIt is a market which has many sellers

producing goods which are close substitutesProducts are similar but not identical.This means there is product differentiation-

real ( physical) or perceivedCollusion is unlikely as all players have

limited control over market supply and priceThis market can be treated as a set of

various monopolists competing with one another.

Entry is difficult; but not restricted

Some ExamplesNearly 40-50 brands of toilet soaps in IndiaAbout 20 Tooth pastes Number of convent schools in a cityOrganised textile industry Private Travel services (60-70) between two

citiesManufacturers of pesticides Domestic publishers (25-30) for leading

subjects of college texts/ guides/ note books

Price-Output DeterminationShort run:For a typical firmSame as the monopoly equilibrium for

profits/ losses (MC=MR, MC cuts MR from below)

There is scope for making supernormal profits in short run

In long run, the firms will be earning just normal profits, as some more firms can enter and output increases

In long run, AR/MR are downward sloping and AR is tangential to AC.

Group EquilibriumAn assumption made here is that there is

uniformity in costs and demand faced by various firms within a group.

Individual firm’s decisions are negligible; no retaliation by others

If a firm within a group develops a good that becomes popular, it enjoys huge profits in short run. Later, these are competed away and only normal profits result

Effects of Monopolistic Competition

Slightly lesser output than in perfect competition and higher price

Better variety exists here than in PCHuge selling costs, low benefit to consumerWeak/ inefficient firms are allowed to operateTransportation costs (each firm wishes to cater to

consumers spread across the country)It does not promote specialisation for firmsIt does not encourage standardization; hence low

capacity utilisation by all firms

SummaryOligopoly and Monopolistic models are closer

to realityBoth are not extreme models like Monopoly

and PCWhile entry is very difficult (but not

impossible) in oligopoly, it is relatively easier in monopolistic competition.

Efficiency is better in oligopoly than under monopolistic competition.