How do Firms Behave in oligopoly Video Lecture | SSC CGL Tier 2 - Study Material, Online Tests, Previous Year

We've reached our final, and our most complex,
market structure: Oligopoly.
Do you remember the characteristics from the
overview in Episode 25?
In an oligopoly, you would find only a small
number of sellers, that is, few enough so
that any individual seller can affect the
market, and the firm's actions will have an
impact on all the other sellers.
The product can be either the same, like oil,
or differentiated, like automobiles, and there
are fairly high barriers to entry.
TIME TO THINK: having seen the other market
structures, you should be able to make some
predictions about the implications of the
oligopoly characteristics.
What will prices and output look like?
What is the potential for profit?
As you'd expect, the oligopoly market structure
will result in a higher price than either
competitive market, although not so high as
a monopoly, and will be able to maintain some
profit, if it exists, into the long run because
of the barriers to entry.
At the beginning of this video I said that
the oligopoly is the most complex market structure.
Well that's because the actions of any one
firm will have an impact on all of the other
players in the market.
This mutual interdependence among firms means
that each firm keeps an eye on everyone else,
trying not only to anticipate moves but also
to have their own reaction plan in place.
Will the other guy raise his price?
Lower his price?
If he makes a move, what will I do?
You can see the increased complexity of this
market just by looking at the oligopolistic
firm's demand -- a kinked demand curve.
We've never encountered a demand curve that
looks like this before so, what gives?
Well, this demand is effectively composed
of two different demand curves, because the
game-playing behavior, if you will, of the
firms in this industry will change depending
on whether the firm is implementing a price
increase, or a price decrease.
When the oligopolistic firm goes to increase
its price, the rivals will not follow; they
will let that one firm increase its price,
and then they will gain the customers as buyers
are driven away by the initiating firm's higher
prices.
What this means for the firm is that, if it
raises its price, and no other producer follows
suit, then the initiating firm will see a
large decrease in quantity demanded, i.e.,
the demand is more elastic when the firm attempts
to increase its price.
Well, what if the firm lowers its price?
The rivals are aware that they could lose
substantial market share if they do not follow
along and lower their prices as well, but
what happens if everyone lowers prices?
The firm that initiated the price decrease
would see very little change in quantity demanded
because, for the most part, customers stay
where they are; that is, the demand faced
by the firm is inelastic when there is a price
decrease.
So if the firm raises price, no rivals follow,
it loses a lot of customers, and the demand
is elastic; but if it lowers its price, everyone
follows, and not much is gained by that firm
in terms of sales, or you have inelastic demand.
This will also result in a very unusual marginal
revenue curve.
Think about the marginal revenue that would
be associated with the more elastic price
increase scenario.
Then, consider the marginal revenue that would
be associated with the more inelastic price
decrease demand.
The marginal revenue associated with a kinked
demand curve would look like this:
It's important at this point to be confident
in what you know about a firm's profit-maximizing
behavior.
Is this the weirdest-looking demand/marginal
revenue graph you've ever seen?
Sure.
Can you still figure out the profit-maximizing
output?
Definitely.
You have the profit-maximizing rule burned
into your brain by now, don't you?
All you need is the output where marginal
revenue equals marginal cost.
Marginal cost looks the same regardless of
the market structure, so you just add it to
the oligopolistic firm's demand diagram.
You can find Q*, the output where marginal
revenue equals marginal cost, and then use
the demand curve to determine the highest
price the firm can get the consumers to pay
for those Q* units.
From here, the analysis is the same as any
other market structure.
In the short run, the firm could make money,
lose money, or break even depending on the
position of the average cost curves.
If the firm makes money in the short run,
the barriers to entry help to protect these
profits, even in the long run.
Remember, in an oligopoly market structure
it is difficult, but not impossible, to enter
the market, so there may be some loss of profit
to new rivals over time.
If the firm loses money in the short run,
it will exit the industry in the long run,
leaving behind more customers for the rival
firms.
So, in the end, how does the oligopoly compare
to the other market structures?
As expected the oligopolistic firm can maintain
profit into the long run, but the profits
earned aren't quite as high as the monopoly
could earn.
In the next episode, weÕll see what happens
when the firms of an oligopoly get together
and attempt to act like a single large firm
-- a monopoly -- in order to boost their profits.
NEXT TIME: Collusion, mergers and antitrust.
TRANSCRIPT00(MICRO) EPISODE 30: OLIGOPOLY