OLIGOPOLY Oligopoly is a market structure in which the number of sellers is small.

Oligopoly requires strategic thinking, unlike perfect competition, monopoly, and monopolistic competition. Under oligopoly, a seller is big enough to affect the market. You must respond to your rivals choices, but your rivals are responding to your choices. In oligopoly markets, there is a tension between cooperation and self-interest. If all the firms limit their output, the price is high, but then firms have an incentive to expand output. Characteristics of Oligopoly: 1. Interdependence: The firms under oligopoly are interdependent in making decision. They are interdependent because the number of competition is few and any change in price & product by a firm will have a direct influence on the fortune of its rivals, which in turn retaliate by changing their price and output. Thus under oligopoly a firm not only considers the market demand for its product but also the reactions of other firms in the industry. No firm can fail to take into account the reaction of other firms to its price and output policies. There is, therefore, a good deal of interdependences of the firm under oligopoly. 2. Importance of advertising and selling costs: The firms under oligopolistic market employ aggressive and defensive weapons to gain a greater share in the market and to maximise sale. In view of this firms have to incur a great deal on advertisement and other measures of sale promotion. Thus advertising and selling cost play a great role in the oligopolistic market structure. Under perfect competition and monopoly expenditure on advertisement and other measures is unnecessary. But such expenditure is the life-blood of an oligopolistic firm. 3. Group behaviour: Another important feature of oligopoly is the analysis -of group behaviour. In case of perfect competition, monopoly and monopolistic competition, the business firms are assumed to behave

in such a way as to maximize their profits. The profit-maximizing behaviour on his part may not be valid. The firms under oligopoly are interdependent as they are in a group. 4. Indeterminateness of demand curve: This characteristic is the direct result of the interdependence characteristic of an oligopolistic firm. Mutual interdependence creates uncertainty for all the firms. No firm can predict the consequence of its price-output policy. Under oligopoly a firm cannot assume that its rivals will keep their price unchanged if he makes charge in its own price. As a result, the demand curve, facing an oligopolistic firm losses its determinateness. The demand curve as is well known, relates to the various quantities of the product that could be sold it different levels of prices when the quantity to be sold is itself unknown and uncertain the demand curve can't be definite and determinate. 5. Elements of monopoly: There exist some elements of monopoly under oligopolistic situation. Under oligopoly with product differentiation each firm controls a large part of the market by producing differentiated product. In such a case it acts in its sphere as a monopolist in lining price and output. 6. Price rigidity: Under oligopoly there is the existence price rigidity. Prices lend to be rigid and sticky. If any firm makes a price-cut it is immediately retaliated by the rival firms by the same practice of price-cut. There occurs a price-war in the oligopolistic condition. Hence under oligopoly no firm resorts to price-cut without making price-output decision with other rival firms. The net result will be price -finite or price-rigidity in the oligopolistic condition. Kinked-Demand Curve Short-run production activity of an oligopolistic firm is often illustrated by a kinked-demand curve, such as the one presented in the exhibit to the right. A kinked-demand curve has two distinct segments with different elasticity that join to form a kink. The primary use of the kinkeddemand curve is to explain price rigidity in oligopoly. The two segments are:

(1) A relatively more elastic segment for price increases and (2) A relatively less elastic segment for price decreases. The relative elasticity of these two segments is directly based on the interdependent decisionmaking of oligopolistic firms. The kink of the demand curve exists at the current quantity (Qo) and price (Po). Because competing firms are not likely to match the price increases of an oligopolistic firm, the firm is likely to lose customers and market share to the competition. Small price increases result in relatively large decreases in quantity demanded. However, because competing firms are likely to match the price decreases of an oligopolistic firm, the firm is unlikely to gain customers and market share from the competition. Large price decreases are needed to gain relatively small increases in quantity demanded. Each segment of the demand curve has its own marginal revenue segment. This actually means that the marginal revenue curve facing an oligopolistic firm, labeled MR in the exhibit, contains three distinct segments.
Kinked-Demand Curve

Top Segment: The flatter top portion of the marginal revenue corresponds to the more elastic demand generated by price increases. Bottom Segment: The steeper bottom portion of the marginal revenue corresponds to the less elastic demand generated by price decreases. Middle Segment: The vertical middle segment connecting the top and bottom segments that occur at the output quantity Qo corresponds with the kink of the curve. The vertical segment is key to the analysis of short-run

production by an oligopolistic firm. It means that the firm can equate marginal revenue with marginal cost, and thus maximize profit, even though marginal cost increases or decreases. If marginal cost increases a bit, the profit-maximizing price and quantity remain at Po and Qo. If marginal cost decreases a bit, the profit-maximizing price and quantity also remain at Po and Qo.

Game Theory
Soft Drink Advertising

Soft Drink Advertising A technique often used to analyze interdependent behavior among oligopolistic firms is game theory. Game theory illustrates how the choices between two players affect the outcomes of a "game." This analysis illustrates two firms cooperating through collusion are better off than if they compete. The exhibit to the right illustrates the alternative facing two oligopolistic firms, Juice-Up and OmniCola, as they ponder the prospects of advertising their products. In the top left quadrant, if OmniCola and Juice-Up BOTH decide to advertise, then each receives $200 million in profit. However in the lower right quadrant, if neither OmniCola nor Juice-Up decides to advertise, then each receives $250 million in profit. They receive more because they do not incur any advertising expense. Alternatively, as shown in the lower left quadrant, if OmniCola advertises but Juice-Up does not, then OmniCola receives $350 million in profit and Juice-Up receives only $100 in profit. OmniCola receives a big boost in profit because its advertising attracts customers away from Juice-Up. But, as shown in the top right quadrant, if Juice-Up advertises and OmniCola does not, then Juice-Up receives $350 million in profit and OmniCola receives only $100 in profit. Juice-Up receives a big boost in profit because its advertising attracts customers away from OmniCola. Game theory indicates that the best choice for OmniCola is to advertise, regardless of the choice made by Juice-Up. And Juice-Up faces EXACTLY the same choice. Regardless of the decision made by OmniCola, Juice-Up is wise to advertise. The end result is that both firms decide to advertise. In so doing, they end up with less profit ($200 million each), than if they had colluded and jointly decided not to advertise ($250 million each).

The Bad of Oligopoly Like much of life, oligopoly has both bad and good. The bad are that oligopoly: (1) Tends to be inefficient in the allocation of resources and (2) Promotes the concentration, and thus inequality, of income and wealth. Inefficiency: First and foremost, oligopoly does NOT efficiently allocate resources. Like any firm with market control, an oligopoly charges a higher price and produces less output than the efficiency benchmark of perfect competition. In fact, oligopoly tends to be the worst efficiency offender in the real world, because perfect competition does not exist, monopolistic competition inefficiency is minor, and monopoly inefficiency has the potential for being so bad that it is inevitably subject to corrective government regulation. Concentration: Another bad is that oligopoly tends to increase the concentration of wealth and income. This is not necessarily bad, but it can be self-reinforcing and inhibit pursuit of the microeconomic goal of equity. While the concentration of wealth is not bad unto itself, such wealth can then be used (or abused) to exert influence over the economy, the political system, and society, which might not be beneficial for society as a whole.

The Good of Oligopoly With the bad comes a little good. The two most noted goods from oligopoly are (1) By developing product innovations and (2) Taking advantage of economies of scale. Innovations: Of the four market structures, oligopoly is the one most likely to develop the innovations that advance the level of technology, expand production capabilities, promote economic growth, and lead to higher living standards. Oligopoly has both the motive and the opportunity to pursue innovation. Motive comes from interdependent competition and opportunity arises from access to abundant resources. Economies of Scale: Oligopoly firms are also able to take advantage of economies of scale that reduce production costs and prices. As large firms, they can "mass produce" at low average cost. Many modern goods--including cars, computers, aircraft, and assorted household products-would be significantly more expensive if produced by a large number of small firms rather than a small number of large firms.