CHAPTER 12 : OLIGOPOLY MARKET

12.1 Oligopoly

(A) Oligopoly Problem: Monopoly and Competition are two extreme forms of market under traditional analysis. Between these two forms there are other possibilities such as Oligopoly and Duopoly. When there are only a few producers or sellers the market is said to be an oligopoly. With one or more requirements of perfect competition missing or weak the market assumes a certain degree of imperfection. The number of firms may not be sufficiently large or the freedom of entry may not be fully available or knowledge about the market conditions may be inadequate or the factors of production may not be fully mobile. All such causes create market imperfections. Oligopoly and Duopoly are the result of a small number of producers. This is Quantitative Imperfection. Economic theory finds it difficult to find a solution to oligopoly or duopoly markets. This is because of the fact that with the presence of a few producers there is bound to be stiff rivalry among producers. This may cause endless price-cutting tendencies. As a result of this stable equilibrium solution may not be possible. Such a suspicion is unfounded since in reality oligopolists and duopolists do exist and perform successfully.

(B) Renewed Efforts: Though some economists fear instability in oligopolistic markets, efforts are made from time to time to analyze them. The earliest work in this respect is that of French economist, Cournot (1834). Since then Bertrand, Edgeworth, Stackelberg, Hall-Hitch, Chamberlin and others have produced different equilibrium models. The main difficulty that arises in this respect is about appropriate assumptions about behaviors and reactions of the rivals. Economists do not have adequate information on this subject. The latest work in this respect is that of Paul Sweezy. His model is based on a new tool of analysis that he has introduced. It is in the form of a Kinked Demand Curve. This has become a popular part of oligopoly analysis.

(C) Kinked Demand Curve: The demand or average revenue curve used in this analysis is Kinked. It has a Kink or a knot. The demand curve is not a smooth straight line but has two segments with a varying degree of flexibility or slope. Before we present the Kinked Demand Curve let us begin with its underlying assumptions. Sweezy has made the following two assumptions:

i) If the firm reduces its price the producer expects other competitors to introduce a similar price cut; the market demand will increase but the share of the firm will remain unaltered.

ii) If the firm raises the price then other competing firms will not follow the price rise. There will be a very small rise in demand but a significant reduction in the sales of the firm.

The two assumptions suggest that neither a fall nor a rise in price would benefit the firm. Oligopoly price is rigidly fixed. Moreover, such a price rigidity causes a Kink in the demand curve with its lower segment steeper or inelastic and its upper segment flatter and more flexible. Consequently there is no incentive to alter price under oligopoly. This will be clearer when explained with the help of a figure.