Explain the features of oligopoly market. Examine and illustrate why there is a kink in the demand curve in an oligopoly market? How does kink demand curve explain price rigidity in oligopoly? (50 marks)
Oligopoly markets comprise small firms which are generally mutually exclusive. Each firm in an oligopoly market considers the expected reaction that other firms will have. Oligopoly term is made of two Greek words, Oleg’s which means a few and Pollen means to sell. Therefore, oligopoly describes a situation whereby there are a few firms involved in selling activities. The form of competition described in oligopoly markets is such that there are few firms involved in the competition. The few firms in the market either produce homogeneous products or close substitute goods. However, the products are not perfect substitutes. As there is no strict border line between many and few, oligopoly market structure is often thought of as having between two firms to ten firms (Agarwala, 2008). There are various characteristics associated with the oligopoly market structure.
The first feature is the interdependence trait. This typically means that oligopolistic firms exhibit interdependent tendencies in their decision making process. The fact that there are a few competitors means that a slight change in price as well as products’ unique characteristics can profound impact on the profitability of rival firms. Therefore, an action by one firm is often followed by retaliation by other firms in the oligopoly market. The decisions made by an individual firm thus focus on both the prevailing market demand as well as the actions by other firms in the market. An individual firm in an oligopoly market cannot afford to operate in total disregard of the actions by other rival firms in the industry. This is an indication of a high level of interdependence among the few firms in oligopoly market structure.
Another important characteristic of oligopoly market structure is the level of relevance attributed to selling costs and advertising. Firms in oligopolistic market structure often undertake very aggressive advertising. The firms in oligopoly market also defensive weapons that are used to gain a larger share of the market as well as experience a maximization of sales in the market. To fulfill such profit maximization goals through increased sales, it is common for firms in oligopoly market structure to undertake extensive advertising and numerous other promotion techniques. To this end, promotion and advertising are important components of oligopoly market structure. Indeed, a firm under oligopoly market considers expenditure in advertising and product promotion as an integral life-blood of such a firm’s existence.
Oligopoly markets also comprise of firms with tendencies of group behavior. This based on the extensive levels of interdependence among firms in oligopoly market structure. Oligopoly markets also exhibit indeterminateness of the demand curve. In particular, this characteristic originates from the interdependence nature of oligopolistic firms. When there is a mutual interdependence among the firms in the marker, there is typically a high level of uncertainty for all the firms in the market. The existence of mutual interdependence in the market leads to the creation of uncertainty for all the firms. Consequently, no individual firm is in a position to predict the effect of price-output decision adopted by other firms. Additionally, a firm cannot hope that other rival firms will maintain the prices upon changing individual prices. This characteristic erodes the determinateness aspect of the demand curve for firms in oligopolistic markets (Arnold, 2006). Therefore, the demand curve for firms in oligopolistic markets is well known and relates to the numerous quantities of product able to be sold at diverse levels of prices with unknown quantity and uncertain demand curve.
The other characteristic of oligopolistic market has to do with the elements of monopoly depicted by this form of market structure. Firms in oligopolistic market depict some reasonable levels of monopoly status. Basically, firms in oligopolistic markets undertake intense product differentiation thus imposing control on a large portion of the market through production of differentiated products. Therefore, the firm acts as a monopolist in the determination of price and output for the products sold. Furthermore, oligopolistic market structure boasts of price rigidity. There is price rigidity for firms in oligopolistic markets. A price cut by one firm leads to retaliation by other firms immediately. Therefore, price wars exist among the different firms. The outcome of such retaliatory activities for the firms is a condition of price-rigidity.
The use of the kinked-demand curve in oligopoly markets explains the level of price rigidity in oligopoly markets. The kind has two segments which depict a more elastic segment with price increases while the other segment represents a relatively less elastic part for price decreases. The relative elasticity of the two parts of the kink depends on the level of interdependent decisions of the firms under consideration. The existence of the more elastic segment is brought about by existence of other firms in the industry which are likely to retaliate after increases in price for oligopolistic firm. This leads to erosion of market share as well as massive decreases in the quantities demanded. The part of less elasticity in the kinked-demand curve portrays the likely of other firms to match any price decreases by a firm in oligopolistic market. This eventually leads to no gain in terms of market share. Furthermore, there is a minimal increases in quantity demanded.
Due to the existence of uncertainties in the oligopoly market, businesses undertake measures to prevent such occurrence through various ways. Collusion is one such method adopted by firms in oligopolistic markets. The desire by each of the firms in oligopolistic markets to know the actions of each other in advance on certain occurrences encourages collusion among firms in oligopoly markets. The firms often get together and make agreements aimed at protecting themselves from each other. Collusion leads to the creation of cartels sometimes leading to powerful firms.