Question

How do firms in an oligopoly market structure set prices and output?

Answer 1

PRICE DETERMINATION UNDER OLIGOPOLY:

The price and output behaviour of the firms operating in oligopolistic or duopolistic market condition can be studied under two main heads:

1. Price and Output Determination under Duopoly:

(a) If an industry is composed of two giant firms each selling identical or homogenous products and having half of the total market, the price and output policy of each is likely to affect the other appreciably, therefore there is every likelihood of collusion between the two firms. The firms may agree on a price, or divide the total market, or assign quota, or merge themselves into one unit and form a monopoly or try to differentiate their products or accept the price fixed by the leader firm, etc.

(b) In case of perfect substitutes the two firms may be engaged in price competition. The firm having lower costs, better goodwill and clientele will drive the rival firm out of the market and then establish a monopoly.

(c) If the products of the duopolists are differentiated, each firm will have a close watch on the actions of its rival firms. The firm good quality product with lesser cost will earn abnormal profits. Each firm will fix the price of the commodity and expand output in accordance with the demand of the commodity in the market.

2. Price and Output Determination under Oligopoly:

(a) If an industry is composed of few firms each selling identical or homogenous products and having powerful influence on the total market, the price and output policy of each is likely to affect the other appreciably, therefore they will try to promote collusion.

(b) In case there is product differentiation, an oligopolist can raise or lower his price without any fear of losing customers or of immediate reactions from his rivals. However, keen rivalry among them may create condition of monopolistic competition.

There is no single theory which satisfactorily explains the oligopoly behaviour regarding price and output in the market. There are set of theories like Cournot Duopoly Model, Bertrand Duopoly Model, the Chamberlin Model, the Kinked Demand Curve Model, the Centralised Cartel Model, Price Leadership Model, etc., which have been developed on particular set of assumptions about the reaction of other firms to the action of the firm under study.