Oligopoly: Characteristics, Models, and Market Structures, Lecture notes of Microeconomics

Download Oligopoly: Characteristics, Models, and Market Structures and more Lecture notes Microeconomics in PDF only on Docsity!

MICROECONOMICS II

LECTURE NOTE

By Adem E (BSc in AgEc) Department of Agec, Assosa University

CHAPTER 1: OLIGOPOLY

• (^) Oligopoly is a market structure which is dominated by a few large

producers of a homogeneous or differentiated product.

• (^) Crucially, these few firms recognize their rivalry and

interdependence, fully aware that any action on their part is likely

to induce counter-actions by their rivals.

• (^) This leads us to consider strategies and counter-strategies

between market participants.

• (^) Duopoly: is a special case of oligopoly in which there are only two firms in the industry.
• (^) In general, oligopoly market is divided in to two:

1. Non-collusive oligopoly

2. Collusive oligopoly

Types of oligopoly models

• (^) There are different models to explain the behavior of oligopolistic firms.
• (^) There are non-collusive models and collusive models.
• (^) The classification of oligopoly firms as collusive or non-collusive is based up on whether there exist some agreements between firms or not.
• (^) When firms enter into some form of agreement as to the price level they charge or the quantity of output they produce, such firms are said to be collusive oligopoly.

• (^) Fore example, when a firm increases its own

output or price, it expects some reaction from

the rivals to its action; increment of output or

price.

• (^) However, the question is ‘what kind of

reaction’ does a firm expect to its action?

• (^) What then is the implication of this

expectation on the behavioral pattern of

oligopolists?

There are four common non-collusive oligopoly models. These are:

1. The Kinked Demand Model • 2. Cournot's Duopoly Model • 3. Bertrand’s Duopoly Model • 4. Stackelberg’s Duopoly • Model

1. Sweezy’s kinked demand curve model of oligopoly

• (^) This model is developed by Paul Sweezy to explain why prices in

oligopoly markets are stable or rigid, even when costs rise.

• (^) If you closely look at the prices of products produced by oligopoly

firms,

• (^) You may easily see that prices are more stable as compared to the

prices of products in other market structures.

 Example, the prices of soft drinks, beer, cigarettes and other similar

products, you come to realize that once price is set it remains

relatively for a long period of time.

This is because firms come to believe that If they cut prices their rivals will follow the price cut and, as a result, the price cut will not produce much of an increase in sales.

• (^) However, a price increase will not be followed and will, therefore, result in a significant loss of sales to the firm raising its price.
• (^) As a result, once a price is reached, it tends to remain in effect for long periods.

The Kinked Demand Curve

The Kinked Demand curve

and the corresponding MR curve

quantity $ D MR Q* P*

If costs shift up slightly, but MC still intersects MR in the vertical

segment, there will be no change in price. This price rigidity is

seen in real world oligopoly markets.

quantity $ D MR Q* P* MC MC’

The ATC curve can be added to the graph. To show positive profits, part of ATC curve must lie under part of the demand curve. quantity $ D MR Q* P* MC ATC

2. Cournot's Duopoly Model

• (^) Cournot’s model is the earliest duopoly model (developed in 1838).
• (^) The original version of the model makes the following “heroic” assumptions: o The duopolists have identical (homogeneous) products and identical costs, o The marginal (additional) cost is zero for both firms, o The firms fully know their linear demand curve, and o Each firm acts (decides on its own output to maximize profit) on the assumption that the competitor will not change its output level.

• (^) Assume that firm A is the first to start producing and selling mineral water (and refer to Figure 2.1 below). It will produce quantity A and sells at price P1 because MR = MC (= 0) at point A – the mid-way between O and D'.