Oligopoly (O)

4. Oligopoly
Assumptions of the model -
- A few firms dominate the industry (look up concentration ratio)
- There are many consumers and fewer producer (towards monopolistic assumption)
- Products can be identical (i.e. OPEC and oil), slightly differentiated (i.e. shower gel) or highly differentiated (i.e. cars).
- Tendency to try to block entry
- Non-price competition : Because firms can't compete using prices (to be analyzed below), they compete in other ways, for example through promotions, quality, coupons, advertising, special deals, etc.

There are two types of oligopolies. The easiest to understand and the one that's illegal (unless it's by countries) is the collusive oligopoly. These occur when firms agree upon a price or market share to charge consumers for the g/s. A cartel is a formal (explicit) agreement among firms that establishes such monopolistic prices. The quintessential example of this is the Organization for Petroleum Exporting Countries (OPEC) which controls one-third of the world's oil supply. Obviously, this can't be outlawed, but if they were firms and not countries, they would be. Tacit collusion occurs when firms secretly work together to restrict higher prices and restrict output. This is hard to prove and also very illegal. Fortunately, for our analysis, collusive oligopolies (formal and tacit) act exactly like monopolies, so see the post on "monopoly" for demand curve, profit maximization, SR and LR profit scenarios and efficiency.

A non-collusive oligopoly occurs when firms compete against each other in a non-monopolistic, "normal" manner. For this analysis, we used what's called a "kinked demand curve". Not kinky....kinked! This curve shows that firms can't just increase the price of their g/s nor lower the price...called price stickiness. If the firm raises the price, competitors will not follow and the original firm will lose business. If the firm lowers the price of it's g/s, other firms will follow and potentially undercut their competitor continuously, causing the price to plummet until MC no longer equals MR. This is obviously disadvantageous to all firms operating in this market structure. Therefore, we have price rigidity around the original price point because it doesn't move for these reasons. Firms will produce wherever MC=MR, which as can be seen in the graph below, can vary in the kinked demand curve. There is stability in the market (quantity) even though the price would differ. This reinforces the idea of price rigidity in this model.