oligopoly
Different Market Structures
Oligopoly
An oligopoly is a market where a small number of firms dominate the industry. Think of it as a group of friends who all decide together what pizza toppings to order – each friend’s choice influences the others.
Key Features
- Few large firms (usually < 10)
- Products can be homogeneous (e.g., steel) or differentiated (e.g., cars)
- High barriers to entry (capital, technology, brand loyalty)
- Interdependence: each firm’s decision affects the others
- Potential for collusion or price leadership
Price Leadership Analogy
Imagine a group of friends where one friend (the leader) chooses the pizza size first. The others follow, adjusting their toppings to match. In an oligopoly, the leading firm sets the price and others either follow or compete on non‑price factors.
Non‑Price Competition
When firms compete on advertising, product design, or customer service instead of price. Example: smartphone makers adding new camera features or better battery life.
Kinked Demand Curve
The kinked demand curve explains why prices in an oligopoly are often stable even when costs change.
| Segment | Demand | Elasticity |
|---|---|---|
| Below the kink | $P = a - bQ$ (elastic) | Elastic (large reaction to price cuts) |
| Above the kink | $P = a - cQ$ (inelastic) | Inelastic (small reaction to price hikes) |
Mathematically, the kink occurs where the marginal revenue (MR) curve has a discontinuity: $$MR_{below} eq MR_{above}$$.
Game Theory in Oligopoly
- Identify the players (firms).
- Define possible strategies (price cuts, advertising).
- Determine the payoffs for each strategy combination.
- Find the equilibrium (e.g., Nash equilibrium).
Examples of Oligopolistic Industries
| Industry | Key Firms | Product Type |
|---|---|---|
| Automobile | Toyota, Volkswagen, Ford, GM | Differentiated |
| Airlines | British Airways, Lufthansa, Emirates | Homogeneous (air travel) |
| Soft Drinks | Coca‑Cola, PepsiCo, Dr Pepper Snapple | Differentiated |
Exam Tips
- Use the kinked demand curve to explain price rigidity.
- Explain price leadership with a real‑world example.
- Show how non‑price competition can be more effective than price wars.
- Remember barriers to entry and how they sustain oligopolies.
- Use game theory diagrams (e.g., payoff matrix) to illustrate strategic interaction.
Revision
Log in to practice.