MODULE 5: OLIGOPOLY

Collusive Oligopoly
Collusion is the act of firms working together or
cooperating to establish the price and output levels
in a particular market.

If a few firms face identical or

highly similar demand and costs...
They will seek joint profit
maximization...

Cartels

Cartel
Group of firms that have explicitly and openly agreed to
work together to set the price that will be charged in a
particular market or the production quotas for all the
firms.
Centralized Cartel
Formal agreement among member firms to set a
monopoly price and restrict output
Incentive to cheat
Market-Sharing Cartel
Collusion to divide up markets

Collusive Pricing Model

The Centralized Cartel Model:

The Oligopolists Get Together (Since
There are So Few of Them) and Act As If
They Were One Monopolist.
Collectively Produce the Monopolistic
Quantity (establish quotas) - Thus
Maximizing Profit as a group.
Example: OPEC

Motivations for Collusion

a) Decrease competition, achieve monopoly-like behavior
b) Decrease uncertainty
c) Decrease ease of entry

Problems With Cartels

Generally, They Are Not Legal
(Price Fixing)
They Are Difficult to Organize
and Monitor
Cant Force New Firms to Join
Usually there is Cheating

The Incentive to Cheat

On A Cartel

If the Cartel Maintains the Monopoly Price,

The Individual Member of the Cartel Can Act
Like a Price Taker (They Can Sell the Quota
amount at the Market Price)
As a Price Taker, They Maximize Profit
Where MC = MR.
This Quantity is Greater Than the Cartel
Wants the Individual Firm to Produce.
All Firms in the Cartel Do This and the
Cartel Falls Apart

Obstacles to Collusion
Demand & Cost Differences
Number of Firms
Cheating
Recession
Potential Entry (or new)Entry
Legal Obstacles: Antitrust

Dominant Firm Price Leadership

One dominant firm (largest or lowest

cost) and several other rival firms
Dominant firm determines price to
maximize profit
Other firms take price and sell what they
can at that price.
All firms watch output to prevent excess
supply and the need to reduce price.

Dominant Firm Oligopoly

A dominant firm oligopoly may exist if
one firm:
Has a big cost advantage over the other

firms.
Sells a large part of the industry output.
Sets the market price.
Other firms are price takers.

Dominant Firm Oligopoly

Lets use Big-G as an example.
Big-G is the dominant
gas station in a city.

Dominant
Firm
Oligopoly
Tensmallfirmsandmarketdemand
BigGspriceandoutput
decision

Price(dollarspergallon)

S10

1.50

1.00

MC

1.50

1.00

D
0.50

0.50

XD
MR

10

20

Quantity(thous.ofgal./week)

10

20

Quantity(thous.ofgal./week)