Price Determination Under Oligopoly

Submitted to:- Submitted By:-Dr. Vanita SumitAsst.prof. (14104024) MBA Deptt. finance

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Price Determination Under Oligopoly

In the words of Peter C.Dooley “ An Oligopoly is a market of only a few sellers, offering either homogenous or differentiated products.

Feature of oligopoly

A few sellers Lack of uniformity Homogenous or differentiated product Advertisement Element of monopoly Constant struggle or keen competition Uncertainty

Classification of oligopoly

1. On the basis of product differentiation2. On the basis of entry of firm3. On the basis of agreement4. On the basis of price leadership

Reasons For The Emergence Of Oligopoly

1. Large Capital2. Patent Rights3. Essential Factors4. Entrepreneurship5. Mergers 6. Economies of scale

Price Determination Under Oligopoly

• Independent Pricing• Collusive Pricing• Price Leadership

The Old Classical Models Of Oligopoly

There are only two sellers of a product , there exists Duopoly.

Following are the three classical models of duopoly type Oligopoly;-

The cournot’s Duopoly model. The Bertrand’s Duopoly model. The Edgeworth Duopoly model.

Cournot’s Duopoly model

Augustin cournot, a French economist, was the first to develop a formal duopoly model in 1838.To illustrate his model, Cournot assumed ;

a) Two firms, each owning an artesian mineral water well.

b) Both operate well their well at zero marginal cost.c) Both face a demand curve with constant negative

slope.d) Each seller act on the assumption that his competitor

will not react to his decision to change his output price.

Cournot Model Table

Period Firm ‘A’ Firm ’B’1 ½(1) = 1/2 ½(1/2) = 1/4

2 ½(1-1/4) = 3/8 ½(1-3/8) = 5/16

3 ½(1-5/16) = 11/32 ½(1-11/32) = 21/64

4 ½(1-21/64) = 43/128 ½(1-43/128) = 85/256

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- ------- -------

- ------- -------

N ½(1-1/3) = 1/3 ½(1-1/3) = 1/3

Criticism Of The Model

Cournot’s behavioral assumption is native to the extent that it implies that firms continue to make wrong calculations about the competitor's behavior.

The assumption of zero cost of production is totally unrealistic.

Total market at reach stage is assumed to be constant which is not the case in real life.

Bertrand’s Model Of Duopoly

Joseph Bertrand, a French mathematician developed his own model of duopoly in 1883.Bertrands model differs from cournot’s model in respect of his behavioural assumption. While cournot’s model, each seller assumes his rival’s output to remain constant, under Bertrand’s model.

Assumptions Of The Model

There are two competitive firms.Each firm is perfectly aware of the demand

curve.Each firm aims at maximization of its profit.Each firm acts on the assumption that its rival

will not change its price.

Criticism Of The Model

Bertrand’s model has been criticized on the same grounds of cournot’s model. Bertrand’s imficit behavioral assumption that firms never learn from their past experience seems to be unrealistic. If cost is assumed to be zero price will fluctuate between zero and upper limit of the price, instead of stabilizing at a point.

Edgeworth’s Duopoly model

Edgeworth developed his model of duopoly in 1897. Edgeworth’s model follows Bertrand’s assumption that each seller assumes his rival’s price, instead of his output, to remain costant.

“There will be an indeterminate tract through which the index of value will oscillate, or, rather will vibrate irregularly for an indefinite length of time.”

Assumptions Of The Model

Each seller continues to assume that his rival will never change his price even through they are proved repeatedly wrong. But according to Hotelling , Edgeworth’s model is definitely an improvement upon cournot’s model in that it assumes price, rather than output, to be the relevant decision variable for the sellers.

Price Determination In Non-Collusive Oligopoly

Each firm can follow an independence price and output policy on the basis of its judgment about the reactions of its rivals. If the firm are producing homogeneous products, it may lead to price war. Each firm has to fix the price at the competitive level.

The actual price may fall between the two limits; Upper limit of monopoly price, Lower limit of competitive price.

Price Rigidity – Sweezy’s kinky Demand Curves

A well known theory formulated to explain the rigidity of prices in oligopolistic market was advanced by Paul sweezy in 1939.

AssumptionsThe kinky demand curve is based on the following

assumptions;a) If one firm reduces its price other firms will also

reduce their prices.b) If one firm increases its price, other firms will

not follow price increase.c) There is an established prevailing price.d) The marginal cost curve will pass through the

dotted portion of the marginal revenue curve.

Criticism Of The Prices Rigidity

1. Does not explain price determination2. Wrong assumptions3. Ignores non price competition4. Ignores competitive reaction

Collusive oligopoly

It mean that the firm co-operate with each other in taking joint actions to keep their bargaining power stronger against the consumer.

“collusion denoted a situation in which to or more firm jointly set their prices or output, divide the market among them ,or make other business decisions.”

Assumption Of Price Determination Under Perfect Collusion

i. All the firms of the cartel are producing homogeneous product.

ii. The market demand for the product is the cartel’s demand.

iii. The demand at each possible price is known.iv. The marginal cost of all the firms is also known.v. There are three firms A,B,C in the industry.

Price Leadership Model

In the words of McConnel, “ price leadership is a means by which oligopolist can co-ordinate their price behavior without entering in out right collusion. Formal agreements and clandestine meeting are not involved. Rather a practice evolves where by the dominate firm usually the largest or the most efficient in the industry-initiates price change-and all other firms more or less automatically follow that price change.”

Strategy Of Price Leadership

The price leader will not change the frequently.

The price leader communicates the future change in prices to the whole industry.

The price leader does not necessarily choose the price which maximizes short run profits for the industry.