Question

Two characteristics of oligopoly pricing that have frequently been observed are that

Select one:

A. oligopolists tend to practice a lot of price discrimination, and there tends to be a wide variance in oligopoly pricing.

B. oligopolistic firms' prices tend to fluctuate a lot, and these prices tend to move together with each other.

C. oligopolistic firms' prices tend to fluctuate a lot, and there tends to be a wide variance in oligopoly pricing.

D. oligopolistic prices tend to be "sticky" or inflexible, and when the firms do change their prices, they tend to do so together.

Answer 1

Oligopoly industry exhibits a greater degree of price rigidity or inflexibility. In other words in an oligopoly market the prices remain sticky or inflexible and there is no tendency on the part of the oligopolists to change the price of the commodity they trade even though the economic conditions are changing. The reason of this price rigidity or inflexibility can be explained with the kinked demand curve hypothesis developed by Paul M Sweezy. Take the case of an oligopoly market without product differentiation. When a firm raises its price, all its customers would leave it. The reason is that if an oligopoly firm raises its price, the other firms in the industry will not follow the price increase. Then the firm loses most of its customers. So the demand curve facing the Oligopoly firm will be perfectly elastic in such a situation.

On the other hand, when an oligopoly firm lowers its price, the other firms in the industry will match the price reduction. Thus the price reducing firm cannot get greater share in the market by price reduction. Thus the demand curve facing an oligopoly firm is highly elastic for price increase and less elastic for price reduction. Thus because of reaction of the rival firms to defeat the price increase and decrease, an oligopoly firm will have no tendency to increase or decrease its price. Therefore the prices remain sticky or inflexible under this market condition.

Again there are other reasons of price rigidity or inflexibility in price. They are formation of cartel or collusive oligopoly.

Because of the inconvenience to set prices independently there exists some form of understanding among the oligopoly firms in a particular industry. This understanding of agreement among the firms may be ether tacit of formal. A formal agreement is made after consultation and discussion and the firms agree to observe a certain common rules regarding the price and output determination. The firms may make written agreement too and impose penalties on those who violate the rules. Since formal agreement or cartel is illegal in many countries the oligopoly enters into a tacit agreement. Such tacit agreement among the oligopoly leads to the creation of collusive oligopoly.

The collusive oligopoly exists in the form of price leadership. Various types of price leadership exist in an oligopoly industry. They are:

1. Price leadership by a low cost firm.

Under the price leadership by a low cost firm, the low cost firm sets a lower price than the profit maximizing price of the high cost firms. The price leader has to ensure that the price which the firm sets must yields some profits to the high cost firms also.

2. Price leadership by the dominant firm.

The second type of price leadership is the price leadership by a dominant firm. Here the firm or firms which produce a very large proportion of the total supply of the industry estimates its own or their own demand curve and fixes a price and others follow it.

3. Barometric price leadership.

The third category of price leadership is a barometric price leadership. Under this an old, experienced, largest or most respected firm assumes the role of a custodian and it fixes the price by protecting the interest of all.

4. Exploitive or aggressive price leadership.

The fourth category of price leadership an exploitative or aggressive price leadership. Under this a very large or dominant firm establishes it leadership by following aggressive price policies and compel the other firms to follow it.

All the above situations of uncertainty in price and the collusion between the firms make the price more rigid or inflexible in a monopoly market.

Answer: D. Oligopolistic prices tend to be sticky or inflexible, and when the firms do change their prices, they tend to do so together.