Oligopoly is a market structure characterized by a small number of large firms dominating the industry. It lies between the extreme market structures of perfect competition (many small firms) and monopoly (one firm). Here are some features of oligopoly, as well as explanations of the kinked demand curve, cartels, and price leadership:
Features of Oligopoly:
- Few Large Firms: In an oligopoly, there are only a few firms that dominate the market. These firms have a significant market share and exert substantial control over the industry.
- Interdependence: Oligopolistic firms are interdependent, meaning that their decisions and actions are influenced by the behavior of other firms in the industry. They closely monitor and respond to their competitors’ actions, such as pricing and advertising strategies.
- Barriers to Entry: Oligopolies often have high barriers to entry, making it difficult for new firms to enter the market and compete with the existing players. These barriers can include economies of scale, patents, brand loyalty, and significant capital requirements.
- Product Differentiation: Oligopolistic firms may engage in product differentiation to distinguish their products or services from those of their competitors. This strategy aims to create brand loyalty and reduce direct competition.
Kinked Demand Curve:
The kinked demand curve is a model used to explain the behavior of oligopolistic firms in response to changes in price. It suggests that firms in an oligopoly face a demand curve with a kink or discontinuity at the current price level.
The kinked demand curve model assumes that if a firm raises its price above the current level, other firms will not follow suit, fearing a loss in market share and reduced sales volume. As a result, the firm’s demand becomes highly elastic, meaning that a small increase in price will lead to a significant decrease in demand.
Conversely, if a firm lowers its price below the current level, the model assumes that other firms will also lower their prices to match the decrease. In this case, the firm’s demand becomes inelastic, meaning that a decrease in price will result in a relatively small increase in demand.
The kinked demand curve suggests that oligopolistic firms have an incentive to maintain price stability, as deviating from the current price may lead to unfavorable reactions from competitors and a loss in market share.
Cartels:
Cartels occur when oligopolistic firms collude to act as a single entity and coordinate their actions to maximize joint profits. Cartels typically involve agreements among firms to fix prices, restrict output, allocate market share, or engage in other anti-competitive practices.
The purpose of a cartel is to eliminate or minimize competition among its members, thereby exerting greater control over the market. Cartels often violate antitrust laws as they restrict consumer choice, inflate prices, and harm overall market efficiency.
Price Leadership:
Price leadership is a strategy observed in some oligopolistic markets where one firm, often the dominant or largest firm, sets the price and other firms in the industry follow suit. The price leader is typically chosen based on factors such as market share, reputation, or cost structure.
Under price leadership, the leading firm initiates price changes, and other firms adjust their prices accordingly. This strategy helps maintain price stability and reduces the potential for price wars or disruptive competition within the industry. Price leadership can be either explicit (through agreements) or implicit (through observation and response).
It’s worth noting that while cartels involve explicit collusion, price leadership does not necessarily involve collusion or anti-competitive behavior. It can arise from market dynamics and the rational responses of firms to market conditions. However, antitrust authorities closely monitor price leadership arrangements to ensure they do not lead to anti-competitive practices or harm consumer welfare.