OLIGOPOLY - 1

OLIGOPOLY – 1

Introduction:

Oligopoly is the most important form of imperfect competition and also the most prominent of market relations seen in the real world. It is defined as a market made up of a few but not many sellers. Its basic form is duopoly. It is of two kinds namely (a) Pure oligopoly where sellers deal in homogenous products and (b) Differentiated oligopoly where seller deals with differentiated but close substitute products.

Characteristics:

Unlike other market forms, oligopoly is a unique market structure. Its most important characteristics are as follows:

1. Interdependence: It is the most important feature and is the result of the presence of a few competitors. Each firm has to consider the product’s market demand along with competitors’ reaction to one’s market strategy.
2. Advertising and selling costs: High market rivalry due to strong interdependence, forces firms to engage in different shades of aggressive as well as defensive market strategy. This is done to gain or prevent fall in one’s market share.
3. Group behavior: There is a concerted form of competition (or) rivalry among firms in oligopoly. The demand curve is neither the result of mass seller behavior nor individual seller behavior. So traditional profit maximizing goal is not necessarily a satisfactory dimension of equilibrium for firms in this market.
4. Indeterminate demand curve: Due to interdependence between firms, no single firm can assume that rivals will not react to one’s market strategy behavior. Every firm will react to another’s price changes and so the demand curve is never stable but keeps shifting.

Fluidity of price & output:

A definite theory of price-output determination is difficult to evolve because of interdependence between competing firm’s market behavior and so an uncertain pattern of rival’s reactions. Different market behavior patterns are possible. It ranges from co-operative behavior (collusive oligopoly) between firms to cut throat competition among them (non-collusive oligopoly). Hence there is an indeterminateness of a theoretical framework of oligopoly price-output determination.

Interdependence between firm’s behavior is the most important reason for indeterminateness as to a theoretical framework of oligopoly. Rival’s reaction to each other’s market strategies is most evident as price reaction. There is also uncertainty about direction and intensity of rivals’ reaction. As a result market demand curve deeps shifting and cannot be easily determined. There is an “interplay of anticipated strategies and counter strategies which is tangled beyond hope of direct analysis.” (William J. Baumol, Economic Theory & Operational Analysis, 3rd edition).

In other words it is difficult to locate a definite shape of the AR and MR curves for a firm in an oligopolistic market. There is an infinite range of market situations. The equilibrium logic of the MC = MR and the slope of the MC being greater than slope of MR curve, cannot be applied to an individual oligopolistic firm without making additional qualifying assumptions. This is true be it collusive or non-collusive oligopoly.

A second reason for the lack of clarity with respect to a theory of oligopoly market is the uncertainty about the firm’s goals. The possibilities are reasonable stable profits over a long time (or) sales maximization or merely ‘satisficing’ market behavior. There is no single determinate solution of the oligopoly problem. The data available permits two or more or perhaps an infinite number of answers to price and output determination by firms in an oligopoly market. Hence economists claim ‘indertminacy’ about a theory of the firm in an oligopoly market.

Putting in another way, there are a number of determinate solutions depending on different assumptions that have been adopted. Four approaches emerge according to four fundamental assumptions adopted in the models. The first perspective is a model that ignores interdependence among competing firms’. Each firm operates on the belief of constant output and price policy with respect to its competitors. This automatically makes the demand curve of a firm determinate. Classical models of duopoly of Cournot, Edgeworth and Bertrand fall in this category.

The second perspective is a model assuming an oligopolistic firm’s ability to predict the reaction patterns and counter moves of rivals. Chamberlain’s model and Sweezy’s kinked demand curve model fall in this category. The third perspective is models that assume tacit or formal collusive behavior related to price or supply and price leadership behavior by a firm, both of which are consequent to the characteristic of ‘interdependence’ in an oligopoly market. The fourth perspective is a model adopting the theory of game. Here the firm does not assume anything about the competitors’ reaction pattern. Rather it calculates and speculates the optimal moves by rival firms. Accordingly a firm adopts its strategies. Neumann and Morgenstern model fall in this category.