OligopoliesA2 Economics

Barriers to Entry

•Write down as many barriers to entry in an oligopolistic market as you can.

•With short description.

Aims and Objectives

Aim:

• To understand firm behaviour in an oligopoly.

Objectives:

• Define the different barriers to entry in an oligopolistic

market.

• Explain the behaviour of firms in an oligopolistic market.

• Analyse the kinked demand curve.

• Evaluate the kinked demand curve’s relevance .

Competitive Oligopoly (imperfect).•Rival firms are interdependent.

•They must take account of the reactions of

rival firms when deciding a market

strategy.

•They decide their strategies without

co-operation and collusion.

•Firms are uncertain of other firms

reactions.

Kinked Demand Curve Theory

• How competitive oligopolists are affected by rival’s

reaction to price and output decisions.

• Firms that change their prices may be punished by the

reactions of their competitors.

• Explains why there is a lack of price competition among

firms and why prices remain stable in an oligopoly.

Kinked Demand Curve Theory

• Initial output of OB and initial price of OA.

• If the firm increases it’s price above OA, it’s competitors

will leave their prices where they are.

• The firm will suffer a reduction in sales, profit, and

market share.

• To what extent depends on the firms’ brand loyalty.

Kinked Demand Curve Theory

•Firm lowers it’s price below OA, the

demand curve becomes inelastic.

• If a firm lowers it’s price, total revenue will

fall.

•All other firms will lower their prices.

•Could create a price war.

Kinked Demand Curve: Price War•Below the price OA, a price war may occur.

•Leading to an inelastic demand curve as

firms copy.

• If firms lower their prices, the resulting

price war, will lead to total revenue falling.

•Firms who compete like this may incur

losses.

Kinked Demand Curve Theory

• Firms prefer to stay at point X.

• They are fearful and uncertain of how rivals will

react to a change in price.

• The best policy may be to not compete on

price, and leave price unchanged.

Kinked Demand Curve and Stable Prices

•Second theory as to why prices are stable in an oligopoly.

•Marginal Revenue Curve.

•Vertical section at output Q1, shown by the distance B-C.

•This area links the MR curves associated with the AR curves.

Kinked Demand Curve and Stable Prices

• Initial marginal costs are MC1, pt A.

• The MC curve can rise or fall anywhere on the vertical.

• Doesn’t affect the profit maximising equilibrium of (Q1,P1).

• If marginal costs rise above MC2 at point B.

• Or falls below MC3 at point C.

• The profit maximising output changes.

Kinked Demand Curve and Stable Prices

•The oligopolist in both these cases would have to change their prices to maximise profits.

But..•The oligopolist’s selling price remains stable at

P1, if the Marginal Costs lie between MC2 and MC3.

•Oligopolists’ price remains stable, despite quite considerable changes in costs.

Criticisms of the Kinked Demand Curve

• No explanation of how and why a firm chooses in the first

place to be at point x.

• Theory only explains price competition, and not non-price

competition.

• Model assumes that oligopolists will react in a certain

manner and this is often not the case in reality.

• Under some circumstances firms may feel that they wish

to compete on price, reckoning that it is the strongest firm

in the market.