Answer to Question #103322 in Macroeconomics for Nhlamulo

Question

Draw the graph facing an oligopoly market and briefly explain why it's shape is like that.

Answer 1

Oligopoly

One of the most common models of imperfect competition is oligopoly. The following symptoms are typical for her:

• a small number of firms in the industry;
• production of both homogeneous and differentiated products;
• high level of concentration of production;
• the interdependence of all firms in the market when setting prices.

Thus, oligopoly is a market structure when the number of firms in the industry is small, and they are all interdependent in the implementation of pricing policies. The main reasons for the formation of an oligopoly largely coincide with the reasons for the existence of a pure monopoly. In an oligopoly, each of the few large firms knows that if it reduces the price to expand sales, other firms will have to do the same to maintain their market share. As a result, each company, ceteris paribus, will remain the same share of sales with a decrease in profit. Therefore, price competition is disadvantageous for all firms operating in an oligopoly.To explain this situation, a model of a broken demand curve for oligopolist products is used. This model is built on the assumption that there are several large independent firms in the industry that have approximately the same market share of a certain type of product and do not implement an agreed pricing policy. Suppose that at present the price of the products of one of these firms is equal to P_o, and the volume of output is Q_o (point O). It should be explained how the demand schedule for the products of this oligopolist will change with a decrease and increase in the price of their products, based on the behavior of other firms.

The following important conclusions follow from the broken demand curve:

1. Any change in price by an oligopolist has negative consequences for him. If he raises the price, he will lose a significant part of customers in the market (the demand schedule for OD₂ is highly elastic). If it reduces the price, then its sales will increase slightly, and possibly a decrease in gross revenue (the demand curve OD₁ is characterized by low elasticity). So, in fig. it can be seen that the gross revenue TR when the price decreases below the Po level at first slightly increases with an increase in production volume from Q_o to Q₁ (while marginal revenue MR₁> 0), and then with output Q> ​​Q₁ it will decrease (marginal revenue becomes negative: MR₁ < 0). In this regard, there is relative price stability in the conditions of an oligopoly.

2. Comparative price stability in an oligopoly not based on collusion, is also associated with the consequences of changes in the marginal costs of MS in the unusual form of the marginal revenue schedule MR. The gap in the schedule of marginal revenue, due to the broken demand curve of the oligopolist, means that significant changes in marginal costs within certain limits will not affect the choice of the optimal volume of production and price. So, in fig. any change in marginal cost in the range from MC₁ to MC₂ (in the CB segment) will not lead to a change in the optimal production volume and price, since in this interval MR = MC for the same output Q_o and the previous price P_o. The consequence of the disadvantage of price competition for all oligopolists is their implementation of a conspiracy among themselves in setting prices and dividing the market. Thus, oligopolists, controlling the price, in determining the optimal volume of production and prices act similarly to the monopolist. At the same time, various pricing methods can be used depending on the characteristics of the oligopoly. In the event that firms in the conditions of an oligopoly produce homogeneous products and have approximately the same costs, then in accordance with the MR = MS rule they will choose the optimal production volume and charge the same price.

In those oligopolistic sectors where there is one of the largest and most efficient firms and several small enterprises, a large firm can act as a price leader. Small firms will be forced to change prices after a large firm sets the price. In conditions of an oligopoly where differentiated products are produced, the “cost + cape” pricing method is usually used. At the same time, to set the price, a cape in the amount of a certain percentage (20%, 30%, etc.) is added to the average cost of production per unit of output for the planned volume of sales. The economic consequences of an oligopoly are similar to a pure monopoly.An oligopoly can even more fully realize its negative consequences in the economy than a pure monopoly. This is due to the fact that the monopoly is always subject to state regulation, and the oligopoly, in the absence of state control, can fully use its market power. At the same time, in the conditions of an oligopoly, not one, but several firms operate, which creates opportunities for using non-price forms of competition, updating and improving product quality.