Lecture 12 - Theory of Oligopoly | Microeconomics- Interaction between individual buyer-seller PDF Download

 Page 1


Theory of Oligopoly                                                             1 
 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
Subject: Microeconomics 
Lesson:Theory of Oligopoly 
Lesson Developer: Bidyadhar Majhi 
College/ Department:Shyamlal College, University of Delhi 
  
Page 2


Theory of Oligopoly                                                             1 
 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
Subject: Microeconomics 
Lesson:Theory of Oligopoly 
Lesson Developer: Bidyadhar Majhi 
College/ Department:Shyamlal College, University of Delhi 
  
Theory of Oligopoly                                                             2 
 
Institute of Lifelong Learning, University of Delhi 
Contents 
1. Learning Outcomes 
2. Introduction 
3. Forms of Oligopoly  
4. Features of Oligopoly 
5. Causes of Emergence of Oligopoly  
6. Cooperative And Competitive Behaviour Under Oligopoly 
7. Price And Output Determination Under Oligopoly 
   7.1  Price Rigidities under Oligopoly - Kinked Demand Curve Model of Sweezy 
 7.2 Cournot  Duopoly Model 
8. Application of Game Theory to Oligopoly  
9. Regulation Of Oligopoly 
10. Review Points 
11. Questions for Practice 
12. Suggested Readings 
 
1. Learning Outcomes 
 
The objective of the present chapter is to acquaint the readers about:  
  
? The meaning and definition of oligopoly market 
? Different forms of oligopoly 
? Features of oligopoly market 
? Causes of emergence of oligopoly 
? Cooperative and competitive behaviour under oligopoly 
? Price and output determination under oligopoly 
? Price rigidities under oligopoly - kinked demand curve model of Sweezy 
? Cournot model  
? Application of game theory to oligopoly 
? Prisoners dilemma  
? Regulation of oligopoly 
 
2. Introduction 
 
In previous few chapters we discussed about two forms of market that is perfect 
competition and imperfect competition including monopoly and monopolistic 
competition. In fact, perfect competition and monopoly are two extreme forms of 
market which are hardly seen in real life.  Of course, the monopolistic competition 
is a real life market situation where elements of both the perfect competition and 
monopoly co-exists; firms compete with each other in the market because of 
substitute nature of the products produced by them and enjoys monopoly power 
because of brand name associated with their own products. However, in the present 
chapter our focus is to highlight another real life market situation known as 
‘oligopoly’.  
Page 3


Theory of Oligopoly                                                             1 
 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
Subject: Microeconomics 
Lesson:Theory of Oligopoly 
Lesson Developer: Bidyadhar Majhi 
College/ Department:Shyamlal College, University of Delhi 
  
Theory of Oligopoly                                                             2 
 
Institute of Lifelong Learning, University of Delhi 
Contents 
1. Learning Outcomes 
2. Introduction 
3. Forms of Oligopoly  
4. Features of Oligopoly 
5. Causes of Emergence of Oligopoly  
6. Cooperative And Competitive Behaviour Under Oligopoly 
7. Price And Output Determination Under Oligopoly 
   7.1  Price Rigidities under Oligopoly - Kinked Demand Curve Model of Sweezy 
 7.2 Cournot  Duopoly Model 
8. Application of Game Theory to Oligopoly  
9. Regulation Of Oligopoly 
10. Review Points 
11. Questions for Practice 
12. Suggested Readings 
 
1. Learning Outcomes 
 
The objective of the present chapter is to acquaint the readers about:  
  
? The meaning and definition of oligopoly market 
? Different forms of oligopoly 
? Features of oligopoly market 
? Causes of emergence of oligopoly 
? Cooperative and competitive behaviour under oligopoly 
? Price and output determination under oligopoly 
? Price rigidities under oligopoly - kinked demand curve model of Sweezy 
? Cournot model  
? Application of game theory to oligopoly 
? Prisoners dilemma  
? Regulation of oligopoly 
 
2. Introduction 
 
In previous few chapters we discussed about two forms of market that is perfect 
competition and imperfect competition including monopoly and monopolistic 
competition. In fact, perfect competition and monopoly are two extreme forms of 
market which are hardly seen in real life.  Of course, the monopolistic competition 
is a real life market situation where elements of both the perfect competition and 
monopoly co-exists; firms compete with each other in the market because of 
substitute nature of the products produced by them and enjoys monopoly power 
because of brand name associated with their own products. However, in the present 
chapter our focus is to highlight another real life market situation known as 
‘oligopoly’.  
Theory of Oligopoly                                                             3 
 
Institute of Lifelong Learning, University of Delhi 
Oligopoly is a form of market wherein the number of sellers of a 
product are very few, may be two or few more. In case the 
number of sellers in the market is just two then such form of 
market is called ‘duopoly’. In case of oligopoly, firms have market 
power to set price of their products however, due to existence of 
inter-firm rivalry firms cannot decide the market demand of their 
products and therefore the market demand curve. An oligopoly 
market is characterized by either product differentiation or 
product homogeneity and high degree of interdependence among 
the competitors. In this form of market price and output decision of a firm may be 
dependent on its competitors or may be independent.  Because of the presence of 
few firms in the industry each firm know that its competitors will respond quickly in 
either way to any move by it on price and output change. Therefore, a prudent firm 
while taking price output decision must take into consideration the possible reactions 
of its rival firms. High market concentration i.e., proportion of total market share 
control by a given number of firms, is another prime feature of an oligopoly market. 
Economists often believe that if an industry is characterized by high concentration 
ratio it is an oligopoly market. 
  
Thus, an oligopoly market is dominated by a small numbers of large firms and there 
exist fierce competition among them. There may be many small firms operate in an 
oligopoly market. In case products produced by the firms in an oligopoly market is 
homogenous, it is referred as pure oligopoly like steel producers in India and if 
firms produce differentiated product it is a case of impure oligopoly like market for 
cars.  
 
Note the Fundamental Difference between Oligopoly and Monopolistic Competition 
 
The fundamental difference between an oligopoly market and monopolist competitive market is that  
under monopolistic competition there are large number of firms produces differentiated products 
whereas under oligopoly a few firms, may even two in case of duopoly, produces products which 
may be homogeneous or differentiated. 
 
3. Forms of Oligopoly  
 
Based on the nature of product produced, entry condition, collusion among the 
firms, etc., oligopoly may be classified differently. Following are the different forms 
of oligopoly: 
 
i) Pure/Perfect and Imperfect/Differentiated Oligopoly: This classification 
has been made on the basis of the nature of product produced under oligopoly. 
In pure oligopoly firm produces homogeneous products whereas in case of 
differentiated oligopoly products produced by the firms are different but are 
close substitute to each other. Steel, tyre, petroleum oil, cement industries, 
airline industry etc., in India are the examples of pure oligopoly whereas soft 
Concentration 
Ratio 
 
It is the 
proportion of total 
market share 
control by a given 
number of firms in 
an oligopoly 
market. 
Page 4


Theory of Oligopoly                                                             1 
 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
Subject: Microeconomics 
Lesson:Theory of Oligopoly 
Lesson Developer: Bidyadhar Majhi 
College/ Department:Shyamlal College, University of Delhi 
  
Theory of Oligopoly                                                             2 
 
Institute of Lifelong Learning, University of Delhi 
Contents 
1. Learning Outcomes 
2. Introduction 
3. Forms of Oligopoly  
4. Features of Oligopoly 
5. Causes of Emergence of Oligopoly  
6. Cooperative And Competitive Behaviour Under Oligopoly 
7. Price And Output Determination Under Oligopoly 
   7.1  Price Rigidities under Oligopoly - Kinked Demand Curve Model of Sweezy 
 7.2 Cournot  Duopoly Model 
8. Application of Game Theory to Oligopoly  
9. Regulation Of Oligopoly 
10. Review Points 
11. Questions for Practice 
12. Suggested Readings 
 
1. Learning Outcomes 
 
The objective of the present chapter is to acquaint the readers about:  
  
? The meaning and definition of oligopoly market 
? Different forms of oligopoly 
? Features of oligopoly market 
? Causes of emergence of oligopoly 
? Cooperative and competitive behaviour under oligopoly 
? Price and output determination under oligopoly 
? Price rigidities under oligopoly - kinked demand curve model of Sweezy 
? Cournot model  
? Application of game theory to oligopoly 
? Prisoners dilemma  
? Regulation of oligopoly 
 
2. Introduction 
 
In previous few chapters we discussed about two forms of market that is perfect 
competition and imperfect competition including monopoly and monopolistic 
competition. In fact, perfect competition and monopoly are two extreme forms of 
market which are hardly seen in real life.  Of course, the monopolistic competition 
is a real life market situation where elements of both the perfect competition and 
monopoly co-exists; firms compete with each other in the market because of 
substitute nature of the products produced by them and enjoys monopoly power 
because of brand name associated with their own products. However, in the present 
chapter our focus is to highlight another real life market situation known as 
‘oligopoly’.  
Theory of Oligopoly                                                             3 
 
Institute of Lifelong Learning, University of Delhi 
Oligopoly is a form of market wherein the number of sellers of a 
product are very few, may be two or few more. In case the 
number of sellers in the market is just two then such form of 
market is called ‘duopoly’. In case of oligopoly, firms have market 
power to set price of their products however, due to existence of 
inter-firm rivalry firms cannot decide the market demand of their 
products and therefore the market demand curve. An oligopoly 
market is characterized by either product differentiation or 
product homogeneity and high degree of interdependence among 
the competitors. In this form of market price and output decision of a firm may be 
dependent on its competitors or may be independent.  Because of the presence of 
few firms in the industry each firm know that its competitors will respond quickly in 
either way to any move by it on price and output change. Therefore, a prudent firm 
while taking price output decision must take into consideration the possible reactions 
of its rival firms. High market concentration i.e., proportion of total market share 
control by a given number of firms, is another prime feature of an oligopoly market. 
Economists often believe that if an industry is characterized by high concentration 
ratio it is an oligopoly market. 
  
Thus, an oligopoly market is dominated by a small numbers of large firms and there 
exist fierce competition among them. There may be many small firms operate in an 
oligopoly market. In case products produced by the firms in an oligopoly market is 
homogenous, it is referred as pure oligopoly like steel producers in India and if 
firms produce differentiated product it is a case of impure oligopoly like market for 
cars.  
 
Note the Fundamental Difference between Oligopoly and Monopolistic Competition 
 
The fundamental difference between an oligopoly market and monopolist competitive market is that  
under monopolistic competition there are large number of firms produces differentiated products 
whereas under oligopoly a few firms, may even two in case of duopoly, produces products which 
may be homogeneous or differentiated. 
 
3. Forms of Oligopoly  
 
Based on the nature of product produced, entry condition, collusion among the 
firms, etc., oligopoly may be classified differently. Following are the different forms 
of oligopoly: 
 
i) Pure/Perfect and Imperfect/Differentiated Oligopoly: This classification 
has been made on the basis of the nature of product produced under oligopoly. 
In pure oligopoly firm produces homogeneous products whereas in case of 
differentiated oligopoly products produced by the firms are different but are 
close substitute to each other. Steel, tyre, petroleum oil, cement industries, 
airline industry etc., in India are the examples of pure oligopoly whereas soft 
Concentration 
Ratio 
 
It is the 
proportion of total 
market share 
control by a given 
number of firms in 
an oligopoly 
market. 
Theory of Oligopoly                                                             4 
 
Institute of Lifelong Learning, University of Delhi 
drinks, car industries, etc., are the examples of imperfect/differentiated 
oligopoly.  
 
ii) Collusive and Non Collusive Oligopoly: This 
classification of oligopoly is based on the existence or non-
existence of agreements among the firms operating under 
oligopoly. If firms are in collusion in fixing the price of the 
product it is a case of collusive oligopoly. Whereas in case 
of non collusive oligopoly firms take independent decision 
with regards to the determination of price of the products. 
Thus, in collusive oligopoly the scope of price competition 
among the firms does not exist whereas in case non collusive oligopoly firms 
take independent decision and compete with each other to determine price of 
their products.   
iii) Open and Closed Oligopoly: As the name suggests in case of open oligopoly 
there is full possibility of entry of new firms into the industry. On the contrary 
there is complete restriction to the new firms to enter into the industry in case 
of closed oligopoly. Barriers to entry in such market may be technological, legal 
or natural. It may be due to ownership of raw materials of strategic importance, 
exclusive knowledge of techniques of production, natural advantages in terms of 
abundant availability of mineral resources, etc.  
iv) Partial and Full Oligopoly: This classification of oligopoly is based on the 
existence or non-existence of a dominant firm in the industry. In case of 
oligopoly market where a single firm enjoys dominant position over its 
competitors and acts as a leader in fixing the price of the product it is a case of 
partial oligopoly. In other words partial oligopoly is characterized by presence of 
dominant firm in the industry who is the price leader. In case of full oligopoly no 
firm enjoys dominant position in the market and act as the price leader.  
 
 
4. Features of Oligopoly 
 
Following are the main characteristics/features of oligopoly market: 
 
i) Few Sellers and Large Number of Buyers: An oligopoly market is 
characterized by few sellers of a product and large number of buyers in the 
market. The number of sellers may be two or little more than that. There may be 
small number of large firms operate in such market. Because of this concentration 
ratio in an oligopoly market is high.  
Forms of Oligopoly 
 
i) Perfect and 
imperfect oligopoly. 
ii) Collusive and non 
collusive oligopoly. 
iii) Open and closed 
oligopoly. 
iv) Partial and full 
oligopoly 
Page 5


Theory of Oligopoly                                                             1 
 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
 
 
Subject: Microeconomics 
Lesson:Theory of Oligopoly 
Lesson Developer: Bidyadhar Majhi 
College/ Department:Shyamlal College, University of Delhi 
  
Theory of Oligopoly                                                             2 
 
Institute of Lifelong Learning, University of Delhi 
Contents 
1. Learning Outcomes 
2. Introduction 
3. Forms of Oligopoly  
4. Features of Oligopoly 
5. Causes of Emergence of Oligopoly  
6. Cooperative And Competitive Behaviour Under Oligopoly 
7. Price And Output Determination Under Oligopoly 
   7.1  Price Rigidities under Oligopoly - Kinked Demand Curve Model of Sweezy 
 7.2 Cournot  Duopoly Model 
8. Application of Game Theory to Oligopoly  
9. Regulation Of Oligopoly 
10. Review Points 
11. Questions for Practice 
12. Suggested Readings 
 
1. Learning Outcomes 
 
The objective of the present chapter is to acquaint the readers about:  
  
? The meaning and definition of oligopoly market 
? Different forms of oligopoly 
? Features of oligopoly market 
? Causes of emergence of oligopoly 
? Cooperative and competitive behaviour under oligopoly 
? Price and output determination under oligopoly 
? Price rigidities under oligopoly - kinked demand curve model of Sweezy 
? Cournot model  
? Application of game theory to oligopoly 
? Prisoners dilemma  
? Regulation of oligopoly 
 
2. Introduction 
 
In previous few chapters we discussed about two forms of market that is perfect 
competition and imperfect competition including monopoly and monopolistic 
competition. In fact, perfect competition and monopoly are two extreme forms of 
market which are hardly seen in real life.  Of course, the monopolistic competition 
is a real life market situation where elements of both the perfect competition and 
monopoly co-exists; firms compete with each other in the market because of 
substitute nature of the products produced by them and enjoys monopoly power 
because of brand name associated with their own products. However, in the present 
chapter our focus is to highlight another real life market situation known as 
‘oligopoly’.  
Theory of Oligopoly                                                             3 
 
Institute of Lifelong Learning, University of Delhi 
Oligopoly is a form of market wherein the number of sellers of a 
product are very few, may be two or few more. In case the 
number of sellers in the market is just two then such form of 
market is called ‘duopoly’. In case of oligopoly, firms have market 
power to set price of their products however, due to existence of 
inter-firm rivalry firms cannot decide the market demand of their 
products and therefore the market demand curve. An oligopoly 
market is characterized by either product differentiation or 
product homogeneity and high degree of interdependence among 
the competitors. In this form of market price and output decision of a firm may be 
dependent on its competitors or may be independent.  Because of the presence of 
few firms in the industry each firm know that its competitors will respond quickly in 
either way to any move by it on price and output change. Therefore, a prudent firm 
while taking price output decision must take into consideration the possible reactions 
of its rival firms. High market concentration i.e., proportion of total market share 
control by a given number of firms, is another prime feature of an oligopoly market. 
Economists often believe that if an industry is characterized by high concentration 
ratio it is an oligopoly market. 
  
Thus, an oligopoly market is dominated by a small numbers of large firms and there 
exist fierce competition among them. There may be many small firms operate in an 
oligopoly market. In case products produced by the firms in an oligopoly market is 
homogenous, it is referred as pure oligopoly like steel producers in India and if 
firms produce differentiated product it is a case of impure oligopoly like market for 
cars.  
 
Note the Fundamental Difference between Oligopoly and Monopolistic Competition 
 
The fundamental difference between an oligopoly market and monopolist competitive market is that  
under monopolistic competition there are large number of firms produces differentiated products 
whereas under oligopoly a few firms, may even two in case of duopoly, produces products which 
may be homogeneous or differentiated. 
 
3. Forms of Oligopoly  
 
Based on the nature of product produced, entry condition, collusion among the 
firms, etc., oligopoly may be classified differently. Following are the different forms 
of oligopoly: 
 
i) Pure/Perfect and Imperfect/Differentiated Oligopoly: This classification 
has been made on the basis of the nature of product produced under oligopoly. 
In pure oligopoly firm produces homogeneous products whereas in case of 
differentiated oligopoly products produced by the firms are different but are 
close substitute to each other. Steel, tyre, petroleum oil, cement industries, 
airline industry etc., in India are the examples of pure oligopoly whereas soft 
Concentration 
Ratio 
 
It is the 
proportion of total 
market share 
control by a given 
number of firms in 
an oligopoly 
market. 
Theory of Oligopoly                                                             4 
 
Institute of Lifelong Learning, University of Delhi 
drinks, car industries, etc., are the examples of imperfect/differentiated 
oligopoly.  
 
ii) Collusive and Non Collusive Oligopoly: This 
classification of oligopoly is based on the existence or non-
existence of agreements among the firms operating under 
oligopoly. If firms are in collusion in fixing the price of the 
product it is a case of collusive oligopoly. Whereas in case 
of non collusive oligopoly firms take independent decision 
with regards to the determination of price of the products. 
Thus, in collusive oligopoly the scope of price competition 
among the firms does not exist whereas in case non collusive oligopoly firms 
take independent decision and compete with each other to determine price of 
their products.   
iii) Open and Closed Oligopoly: As the name suggests in case of open oligopoly 
there is full possibility of entry of new firms into the industry. On the contrary 
there is complete restriction to the new firms to enter into the industry in case 
of closed oligopoly. Barriers to entry in such market may be technological, legal 
or natural. It may be due to ownership of raw materials of strategic importance, 
exclusive knowledge of techniques of production, natural advantages in terms of 
abundant availability of mineral resources, etc.  
iv) Partial and Full Oligopoly: This classification of oligopoly is based on the 
existence or non-existence of a dominant firm in the industry. In case of 
oligopoly market where a single firm enjoys dominant position over its 
competitors and acts as a leader in fixing the price of the product it is a case of 
partial oligopoly. In other words partial oligopoly is characterized by presence of 
dominant firm in the industry who is the price leader. In case of full oligopoly no 
firm enjoys dominant position in the market and act as the price leader.  
 
 
4. Features of Oligopoly 
 
Following are the main characteristics/features of oligopoly market: 
 
i) Few Sellers and Large Number of Buyers: An oligopoly market is 
characterized by few sellers of a product and large number of buyers in the 
market. The number of sellers may be two or little more than that. There may be 
small number of large firms operate in such market. Because of this concentration 
ratio in an oligopoly market is high.  
Forms of Oligopoly 
 
i) Perfect and 
imperfect oligopoly. 
ii) Collusive and non 
collusive oligopoly. 
iii) Open and closed 
oligopoly. 
iv) Partial and full 
oligopoly 
Theory of Oligopoly                                                             5 
 
Institute of Lifelong Learning, University of Delhi 
ii) Products are Homogenous or Differentiated: 
Products produced by the firms in the oligopoly 
market may be homogenous or differentiated. In 
case products are homogenous it is a case of pure 
or perfect oligopoly and if products are 
differentiated it is a case of imperfect oligopoly. For 
example, there are few firms in airline services in 
India which is homogenous whereas there are few 
firms producing cars in India which are 
differentiated. But, both the car and the airline 
industry are the example of oligopoly market.    
iii) Mutual Interdependence among the Firms: In 
an oligopoly market firms are mutually 
interdependent with regards to their price and output decisions. Due to market 
power of the firm under oligopoly it can set price of its product but, while taking 
such decision it has to take into consideration the possible reaction of its rival 
firms.  It is so because when a firm reduces the price of its product the rival firms 
may follow the same whereas in case the firm raises the price the rival firms may 
not follow the same.  
iv) Advertisement Cost: Because of presence of competitors in the market an 
oligopoly firm incurs huge expenditure on advertisement. Existence of high cross 
elasticity of demand of the products produced under oligopoly market and price 
rigidities, a firm can push up its sells only through advertisement. Thus, 
advertisement expenditure is an important component of the total cost of an 
oligopolist. Whereas firms under perfect competition and monopoly are not to incur 
any expenditure on advertisement. 
v) Existence of Price Rigidities: Price rigidity under oligopoly refers to a situation 
when a firm is not able to change the price structure of its products. It so happens 
because the firm would like to avoid price competition among its rival firms. For 
example, if an oligopolist reduces its price then its rivals will also reduce their 
prices thus, it would not be a prudent decision on the part of oligopolist. On the 
contrary if it raises the prices of its product then its rival firms will not raise the 
prices with a view to capture the market demand arise out of increase in the price 
by it. 
vi) Fierce Competition: Competition among the firms under oligopoly market is 
very high because of presence of small number of large sellers. If one firm 
changes its price or output decision then it will immediately affect the price and 
output decision of its rival firms. It is because of this every firm keeps a close 
watch on the action of its rival firms and accordingly take reactive measures. This 
kind of keen competition is unique in an oligopoly market.  
vii) Some Restriction to New Firms to Enter into the Industry:  In oligopoly 
market there are some barriers for the new firms to enter into the industry. 
Features of Oligopoly 
 
i) Few sellers and large number of 
buyers. 
ii) Products are homogenous or 
differentiated. 
iii) High mutual interdependence 
among the firms. 
iv) Advertisement cost. 
v) Existence of price rigidities. 
vi) Fierce competition. 
vii) Some restriction to new firms to 
enter into the industry. 
viii) Presence of monopoly element. 
ix) Uncertainty. 
x) Strategic behaviour.