Chapter 26, Problem 26.1LO

To determine

Key characteristics of Oligopoly market.

Concept Introduction:

Oligopoly Market: An oligopoly market structure is a market where a few firms sell similar but differentiated products. But the special feature is that only a few firms hold the major market share. Oligopoly market is said to be highly concentrated. They dominate the pricing strategy. They are the market leaders. Others are the followers.

Explanation of Solution

Key characteristics of a Oligopoly Market

• Few firms: There are a few firms in an oligopoly market. Oligopoly industry is dominated by a few large firms. The market share of these few firms is relatively large as compared to the market size. Thus these few firms have a substantial control over the market.

• High Barrier of entry or exit: It is not easy for any firm to enter or exit this industry. The barrier of entry or exit is high. Barriers are created in forms of patents and copyrights, government restrictions or huge start up costs. Because of high barriers, firms cannot easily enter or exit the market. Thus the existing firms have a huge control on the market.

• Interdependence: The firms are highly interdependent. One firm’s decisions depends on another firm. As a group of firms have a substantial share of the market, so the decision of each firm have an impact on the rival firm. It provokes a countermove from the rival.

• Differentiated Product: The firms sell differentiated products which are similar to each other but not identical. They are not perfect substitutes. Each product is slightly different from each other. This is known as product differentiation. Each firm in monopolistic markets claims their product to be exclusive from the other. This gives them slight monopoly power and so they have a negatively sloped demand curve. Products are generally differentiated based on three categories.

1. Physical differences
2. Perceived differences
3. Differences in supports services

• Advertisement: It is a big instrument in the hand of an oligopoly firm. They use it as a tool against the rival firm. An oligopoly firm under oligopoly does aggressive advertising with the objective of taking into custody a large part of the market.

• Group Behavior: They may have a formal or informal group of firms. They have one firm as the leader firm and others as the followers. They form the group by a formal agreement between the groups of producers, to control the price of the product. The goal of the group is to maximize collective profit.

• Price Rigidity: Oligopoly firms have to stick to their own price. If one firm tries to reduce their price, the rival firm may respond by an even higher reduction in the price level. On the other hand, if a firm tries to increase its price, the rival firm may not respond to it at all.

• Kinky demand curve: Because of the stickiness of the price, the oligopolists are faced with kinked demand curve. Actually the oligopoly firm faces two demand curves. A relatively inelastic demand curve for low prices and a relatively elastic demand curve for the high prices. So the demand curve for the firm will have a kink at the intersection point of the two curves. If the firm tries to increase the price above the equilibrium level, the other firms will not follow. So the firm will face an elastic demand curve. When the price is reduced below equilibrium level, other firms will follow and thus faces a relatively inelastic demand curve.