Question

1. What distinguishes oligopoly from monopoly competition? Explain how price leadership might evolve and function in an oligopolistic industry.

Answer 1

Monopoly competition and oligopoly both leads the imperfect competition in the market. Monopoly competition means single firm who produces goods which has no close substitute. On the other hand in oligopoly competition, there is small number of relatively large firms which produce similar but slightly differentiate products. In both competitions, there are significant barriers to entry in the market.

In monopoly, firm charges relatively high price because there is no competition, on the other hand in oligopoly firms charge moderate price due to the presence of competition. But in both case price is higher than perfect competition.

Price leadership in oligopoly competition

In some cases, firms under oligopoly are not involved in collusion. Rather one of them is a dominant organization which is called price leader. This price leadership is effective when

a) The number of organizations is small

b) Entry is restricted

c) products are homogeneous

d) Demand is less elastic or inelastic

e) Firms have similar cost curves

Suppose there are two firms A and B. A has a lower cost of production (MCa) and B has a higher cost of production (MCb)/ They are producing an identical product thus both the firms are facing same demand curve.

DD is the market demand curve. As MCb>MCa so MCa is drawn below MCb. Both the firm maximizes profit at MR=MC. At this point output of A is QA and price are charged P and output of B is QB and price is charged P'. In this case price of the firm, B is higher but as the product is homogeneous so both firms will charge the same price. In this case organization, A is the price leader and B is the follower. Both the firm will produce same output QA and charge same price P, however profit earned by organization B is lower than that of A as it has to produce at price P which is less than the profit-maximizing price of organization B.