Question

What are the characteristics of an oligopoly? Using the concept of duopoly and the price leadership model, discuss demand and pricing strategies in an oligopolistic market structure.

Answer 1

Below are the characteristics of the oligopoly:

- Small number of large firms: the oligopolist industry is dominated by the small number of large firms. For example, the market for Cars.

- Identical or Differentiated product: The firms in the oligopolist set-up sells either homogenous or differentiated product in the market.

- existence of barriers to entry of new firms.

- Mutual Interdependence amongst the firms: firms in the market face high competition and their actions are inter dependent on each other. For example, a price cut by on firm faces quick action by all other firms.

- Tension between Cooperation and Self- Interest: if all the firms in the market restrict their output, price increase dramatically and some of the firms have incentive to cheat and deviate from the equilibrium position.

- Kinked Market Demand curve

price strategies and demand strategies:

The price that is set by the single firm is not only dependent upon the quantity demanded of its own product but also depends upon the demand for other firm's product. Each firms takes into account the best responses of all other firms and then make output and pricing decisions.

In an oligopoly, some firms enjoy cost advantage and make pricing decision. These firms are called price leaders. Once, these firms decide their price, other firms in the market will decide their own strategy to maximize their profits.

The firms in the market can play simultaneously (known as Cournot game) or can play sequentially (known as Stackelberg Game)

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