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Answer.

INTRODUCTION:

Oligopoly is the most prevalent form of market organization in the manufacturing sector of
most nations, including India. Some oligopolistic industries in India are automobiles,
aluminium, steel, glass, breakfast cereals, cigarettes, and many others. Some of these
products such as steel and aluminium are homogeneous, while others are differentiated.

FEATURES AND PRICING STRATEGY:

An oligopolist knows that its own actions will have a significant impact on the other
oligopolists in the industry; each oligopolist must consider the possible reaction of
competitors in deciding its pricing policies.

The main features of oligopoly are:-

 The industry is dominated by few firms.


 Interdependence of firms which affect the pattern of product pricing.
 There are barriers to entry and exit of firms.
 The industry competes on the basis of product differentiation which makes
advertising of the product essential.

A barrier to entry is provided by limit pricing, where, existing firms charge a price low
enough to discourage entry into the industry. By doing so, they willingly sacrifice short-run
profits in order to maximize long-run profits.

 Kinked demand curve:

One model explaining why oligopolists tend not to compete with each other on price, is the
kinked demand curve model of Paul Sweezy. In order to explain this characteristic of price
rigidity i.e. prices remaining stable to a great extent, Sweezy suggested the kinked demand
curve model for the oligopolists. The kink in the demand curve arises from the asymmetric
behaviour of the firms. Let us start from P1 in Figure.

If one firm reduces its price and the other firms in the market do not respond, the price cutter
may substantially increase its sales. This result is depicted by the relative elastic demand
curve, dd. For example, a price decrease from P1 to P2 will result in a movement along dd
and increase sales from Q1 to Q2 as customers take advantage of the lower price and abandon
other suppliers. If the price cut is matched by other firms, the increase in sales will be less.

(Source: www.economicshelp.org)

Since other firms are selling at the same price, any additional sales must result from increased
demand for the product. Thus the effect of price reduction is a movement down the relatively
inelastic demand curve, DD, and then the price reduction from P1 to P2 only increases sales
to Q2.

When the firm is operating in the non-cooperative oligopolistic market it results in decline in
sales if it changes its price to P1. Now if the firm reduces its price below P1 say P2, the other
firms operating in the market show a cooperative behaviour and follow the firm. This is
shown in the figure as the curve below the existing price P1.

The true demand curve for the oligopolistic market is dD and has the kink at the existing
price P1. The demand curve has two linear curves, which are joined at price P.

In the presence of a kinked demand curve, firm has no motive to change its price. If the firm
is a profit maximizing firm where MR=MC, it would not change its price even if the cost
changes.

PRICE COMPETITION: CARTELS:

We already know now that in an oligopolistic competition, the firms can compete in many
ways such as price, advertising, product quality, etc. Firms may not like competition because
it could be mutually disadvantageous.
For example, advertising. In this case, many oligopolies end up selling the products at low
prices or doing high advertising resulting in high costs and making lower profits than
expected. Therefore, it is possible for the firms to come to an agreement and raise the price
together, increasing the output without much reduction in sales.

A cartel is a market sharing and price fixing arrangement between groups of firms where the
objective of the firm is to limit competitive forces within the market.

 OPEC:-

Throughout the 1970s, the Organization of Petroleum Exporting Countries (OPEC) conspired
to raise the price of crude oil from $3 per barrel in 1973 to $30 per barrel in 1980. By the end
of 1970s, it was predicted that the price of oil would rise to $100 per barrel by the end of the
century. Then suddenly the cartel seemed to collapse. Prices moved down, briefly touching
$10 per barrel in early 1986. Today the price of a barrel is about $24. OPEC is the standard
example used for explaining cartel behaviour.

 De Beers:-

There is a relationship between price and supply. A low supply, drives up the product's price.
This explains why OPEC countries have been able to push up the price of crude oil in the last
several years. In 2008, as oil price approached $ 110 a barrel, OPEC refused to increase
production. With tight supply, strong demand, and a great deal of speculation, oil price was
kept high.

Diamonds, likewise, respond pretty much to the same relationship. However, there is one
major difference between diamonds and oil. Oil is more of a necessity. Diamonds, in contrast,
are more of an optional purchase, and such purchases can be postponed.

Still, diamonds and their prices react to the world's supply and demand. DeBeers controls the
supply of diamonds to a large degree. Its usual practice is to invite companies for "sight"
where they are offered a certain quantity at a specified price. Companies do not have to buy
what is offered, but they will not be invited back for another "sight." This strategy is most
effective when DeBeers is the only game in town. Since companies do not have a long-term
alternative, they simply have to go along with DeBeers's practice. DeBeers's pricing aim is to
make the market as well as the price stable. DeBeers’s pricing is based on its semi-monopoly
situation. The strategy makes sense, assuming that the company can control large enough
portion of supply to control the market.