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Oligopoly & Monopolistic Competition

Oligopoly literally means a few sellers Each seller controls significant size of market Product/ service could be (1) differentiated/ (2) undifferentiated Eg:(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 Oligopoly


Tata, 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

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 Features
It is in between the Monopoly and Monopolistic market models Every seller can exert significant influence on market Indeterminate demand curve; due to dependency on rivals reactions Buyers keenly compare the price/ distinct features of each sellers product

Collusion and cartels


Collusion: 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 industry The product is not standardised DD and cost conditions are changing rapidly There are no barriers to entry Firms have surplus capacity

The kinked demand curve (1)


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

Rs.

P0

It can observe the current price and output.


but must try to anticipate rival reactions to any price change. Q0
Quantity

The kinked demand curve (2)


The firm may expect rivals to respond if it reduces its price, as this will be seen as an aggressive move so demand in response to a price reduction is likely to be relatively inelastic D Q0
Quantity

Rs.

P0

The demand curve will be steep below P0.

The kinked demand curve (3)


but for a price increase rivals are less likely to react, so demand may be relatively elastic above P0

Rs.

P0

D Q0
Quantity

so the firm perceives that it faces a kinked demand curve.

The kinked demand curve (4)


Given this perception, the firm sees that revenue will fall whether price is increased or decreased, so the best strategy is to keep price at P0.

Rs.

P0

D Q0

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

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 players best strategy is independent of those chosen by others

Select Cases of Pricing


If 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

Introduced 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 Curve
AR has a kink at the prevailing price MR becomes discontinuous below the kink If MC passes through the Gap, holding priceoutput constant is the best alternative New industry, in early stages, this model is useful in shorter term.

Kinky Demand Curve

Price Leadership
Dominant Firm Intels 386 cut chips price from $152 to $99 in 1992 (till 1991, it was monopoly), AMD had to follow it Barometric Price Leadership
Old, 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. Leadership


Largest 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

Collusive Oligopoly
The 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 Cartel
Members 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 cartel They 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 Oligopoly
Possibility of restricted output/ high prices Entry barriers make consumers pay higher price Firms will not be able to build/ operate at optimum levels of production Sales promotional strategies waste resources Neither liked by the players/ nor good for consumers/ government as less tax collection. Lower employment opportunities

Monopolistic Competition
It is a market which has many sellers producing goods which are close substitutes Products are similar but not identical. This means there is product differentiation-real ( physical) or perceived Collusion is unlikely as all players have limited control over market supply and price This market can be treated as a set of

Some Examples
Nearly 40-50 brands of toilet soaps in India About 20 Tooth pastes Number of convent schools in a city Organised textile industry Private Travel services (60-70) between two cities Manufacturers of pesticides Domestic publishers (25-30) for leading subjects of college texts/ guides/ note books

Price-Output Determination
Short run:For a typical firm Same 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 Equilibrium
An assumption made here is that there is uniformity in costs and demand faced by various firms within a group. Individual firms 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 PC Huge selling costs, low benefit to consumer Weak/ inefficient firms are allowed to operate Transportation costs (each firm wishes to cater to consumers spread across the country) It does not promote specialisation for firms It does not encourage standardization; hence low capacity utilisation by all firms

Summary
Oligopoly and Monopolistic models are closer to reality Both are not extreme models like Monopoly and PC While 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.