HASNAIN SHAH

MB-12-47

Group members

Naeem shahid
MB-12-31

M.Arslan
MB-12-37

H.M.Saleem
MB-12-41

Junaid Afzal
MB-12-45

OLIGOPOLY AND FIRM

ARCHITECTURE

Oligopoly
The form of market organization in
which there
are few sellers of a homogeneous or
differentiated
product.
If there are only two sellers duopoly.
If the product is homogeneous pure
oligopoly.
If product is differentiated
differentiated
oligopoly.
Entry into oligopoly is possible but not
easy. That

Oligopoly
Most prevalent form of market
organization in
manufacturing sector of industrial nations.
Examples are automobiles, primary
aluminum,
steel, electrical equipment,
telecommunication,
durable equipment, airlines, cigarettes and
soaps.
Oligopoly also exists when transportation
costs
limit the market area.

Oligopoly
Since there are only a few firms in
the
industry, the action of each firm will
affect
other firms in the industry and vice
versa.
Example when Pepsi mounted a
major
advertising campaign, Coca-cola
responded by
having major advertising campaign of
its own.

Oligopoly
Before making any decision, an
oligopolistic must consider a few things:
Possible reaction of competitors in
deciding
its pricing policies,
The degree of product differentiation to
introduce,
The level of advertising to undertake,
The amount of service to provide.
Since they are interdependence,
decision
making is much more complex under

Sources of Oligopoly
Economies of scale.
May operate over sufficiently large
range of
output that only a few firms supplying the
entire
market.
Large capital investment required.
Specialized input required to enter the
industry,
which acts as natural barrier to entry.
Patented production processes.
No other firm can produce the

Sources of Oligopoly
Brand loyalty.
Loyal following of customers based on
product quality and service that new firm
cannot match.
Control of a raw material or resource.
Control of entire supply of raw material
required in the production of the product.

Sources of Oligopoly
Government franchise.
Form a barrier for entry in the long run.
Without restriction, other firm can enter the
industry and it could not remain as
oligopolistic.
Limit pricing.
Existing firm charge a price low enough to
discourage entry into the industry. They
sacrifice short-run profits in order to
maximize long-run profits.

Oligopoly Models
Some most important models the
Cournot model, the kinked demand curve
model, cartel arrangements and the price
leadership model.
each model focuses on one particular
aspect of oligopoly but overlooks other.
Thus, they have limited applicability and
are more or less unrealistic.

SWEEZYS KINKED DEMAND

CURVE
MODEL OF OLIGOPOLY
Assumptions:
1. If a firm raises prices, other firms wont
follow and the firm loses a lot of business.
So demand is very responsive or elastic to
price increases.
2. If a firm lowers prices, other firms follow
and the firm doesnt gain much business.
So demand is fairly unresponsive or inelastic
to price decreases.

THE KINKED DEMAND CURVE

$
P*

D
Q*

quantity

MR CURVE FOR THE TOP PART OF THE

DEMAND CURVE
$
D
P*
MR

Q*

quantity

DRAWING MR CURVE FOR THE

BOTTOM PART OF THE DEMAND
CURVE
$
P*
MR
D
Q*

quantity

MR CURVE FOR THE BOTTOM

PART OF THE DEMAND CURVE
$
P*
MR
D
Q*

quantity

THE KINKED DEMAND CURVE

AND THE MR CURVE
$
P*
MR
D
Q*

quantity

THE MC CURVE INTERSECTS THE MR CURVE

IN THE VERTICAL SEGMENT.
$
MC
P*
MR
D
Q*

quantity

THE ATC CURVE CAN BE ADDED TO THE GRAPH. TO

SHOW POSITIVE PROFITS, PART OF ATC CURVE MUST
LIE UNDER PART OF THE DEMAND CURVE.

MC

P*

ATC

D
Q* MR

quantit
y

THE ATC* VALUE CAN BE FOUND

ON THE ATC CURVE ABOVE Q*.
$

MC

P*
ATC*

ATC

D
Q* MR

quantity

TC = ATC . Q
$

MC

P*
ATC*

ATC

D
Q* MR

quantity

TR = P . Q
$

MC

P*
ATC*

ATC

D
Q* MR

quantit
y

PROFIT = TR - TC
$
P*
ATC*

MC

ATC

profit

D
Q* MR

quantity

TO SHOW A FIRM WITH A LOSS,

THE ATC CURVE MUST BE ENTIRELY
ABOVE THE DEMAND CURVE.
ATC
$
ATC*
AVC
MC
loss
P*

D
Q* MR

quantity

TO SHOW A FIRM BREAKING EVEN, THE

ATC CURVE MUST BE TANGENT TO THE
DEMAND CURVE AT THE KINK.

MC

ATC*= P*

ATC

D
Q* MR

quantity

Cartel Arrangement
Two types of cartels
Market-Sharing Cartel Collusion to divide
up markets. Gives each member the
exclusive
right to operate in a particular geographical
area.
Centralized Cartel Formal agreement
among member firms to set a monopoly
price
and restrict output. It determines how profits
are to be shared. Incentive to cheat.

Price Leadership
Firm that is recognized as price leader
initiates price change, followed by other firms
in the industry.
Price leader is usually the largest or
dominant firm. It could also be the low-cost
firm or any other firm (called barometric firm),
recognized as barometer of changes in
industry demand and cost conditions
warranting a price change.
An orderly price change is then
accomplished by
other firms following the leader.

Price Leadership
In dominant-firm price leadership model, the
dominant firm sets product price that maximizes
its total profits, allowing the followers to sell all
they want at that price.
The follower firms behave as perfect competitors
or price takers, and the dominant firm acts as
residual monopolistic supplier of the product.
Example of price leadership is in automobile
industry. With one firm sets certain incentive, i.e.
cash rebate, other firms soon follows in a matters
of days.
The role of price leader can also shift from one
firm to another over time.

Porters Strategic Framework

Developed by Michael Porter, Harvard
University Business School conceptual
framework for identifying the five structural
determinants of the intensity of
competition
and of the profitability of firms in
oligopolistic industries.
The threat from substitute products.
The threat of entry.
The bargaining power of buyers.
The bargaining power of suppliers.
The intensity of rivalry among existing
competitors.

Porters Strategic Framework

Firm tend to earn higher than average industry
profits
if it does not face much threat from substitute
products
if it does not face threat from entry of potential
competitors
if buyers and suppliers do not exert much market
power
if there is low intensity of rivalry and competition
among
existing firms.
The greater the differentiation and uniqueness of
the
product and the greater the brand loyalty for firm's
product, the higher is the markup that the firm can

Porters Strategic Framework

Profitability of a firm is also affected by bargaining
power of buyers
and suppliers. The smaller concentration (and market
power) of
buyers and sellers, the higher is the profitability of the
firm. Tesco
can squeeze lowest price from its suppliers, thus can
sell at lower
price than it competitors but earn higher profit. It sells
to
unorganized consumers with little individual market
power.
Oligopolists profit depends on intensity of rivalry with
other firms.

Efficiency Implications of
Oligopoly
In short run, just as in other forms of market
structure, an oligopolist can earn a profit,
break
even or incur a loss.
Even if incurring a loss, it pays for an
oligopolist to
continue to produce in the short run as long as
P>
AVC.
In long run oligopolist will leave the industry
unless
it can earn a profit or break even by

Efficiency Implications of
Oligopoly
In long run oligopoly may lead to harmful
effects:
As in monopoly, price exceeds LAC so profits
in
oligopolistic market can persist in long run
because of
restricted entry.
Oligopolist usually do not produce at lowest
point on
their LAC curve as perfectly competitive firms
do.

Efficiency Implications of
Oligopoly
On positive side:
For technological reasons, many product
(automobiles, steel, etc.) could not possibly
be
produced under perfect competition (the
cost will
be prohibitive).
Oligopolists spend much of their profits on
R & D,
which leads to much faster technological
advance
and higher standards of living.

Sales Maximization Model

Proposed by William Baumol.
Managers of modern corporations seek to
maximize sales, after ensuring that an
adequate rate of return has been earned,
rather
than to maximize profits.
Larger firms may feel more secure, get
better
deal in the purchase of input and lower
rates
of borrowing money and have better image
with consumers, employees and suppliers.

Sales Maximization Model

There is strong correlation between
executives salaries and sales, but not
between
sales and profits.
Sales maximization model is particularly
relevant in oligopolistic markets.
Sales (or total revenue, TR) will be at a
maximum when the firm produces a
quantity that sets marginal revenue equal
to
zero (MR = 0).