Oligopoly

Characteristics

An agreement between firms to limit competition, increase monopoly power and increase profits.

Collusion

Collusive oligopoly - Cartels

Formal agreement between firms in an industry to take actions to limit competition
Objective: limit competition, increase monopoly power, increase in profits (joint profits)
Cartel members behave like a monopoly

At the profit maximizing level of output, where MC = MR, the cartel is producing at the output level with price Pe and quantity Qmax. At this level of output, the firm is making a profit of Pe * (a-b)

Obstacles to forming and maintaining a cartel

Tacit / informal collusion

Refers to co-operation that is implicit or understood between co-operating firms, without a formal agreement

Price Leadership

A dominant firm in the industry sets a price and initiates price changes, and other firms become price takers, accepting any prices set by the dominant firm. This could limit competition. Obstacles are similar as a formal collusion.

Non-collusive Oligopoly

Prices of oligopolistic firms tend to be sticky (price rigidities)
Where oligopolistic firms do not agree to fix price or collaborate in any ways
Kinked demand curve is the main characteristic of non-collusive oligopoly, the market output is determined by the kinked demand curve
Due to strategic behaviour, any decisions on price changes made by rival firms will affect other firms in the competition a lot

Suppose three different oligopolistic firms Nike, Puma, and Adidas are producing at the output level Z (kinked demand curve), with price P1 and quantity Q1

Using Nike’s point of view

*So therefore firms should not change their price, and they should remain selling at P1

Firms that do not collude are forced to take into account the actions of their rivals in making price decisions
Price stability is still existing even if the firms do not collude
Firms usually do not compete with each other on the basis of price

Advantage and Disadvantage of an Oligopoly