An oligopolistic market refers to a market that is dominated by a few firms, each possessing a significant market share. What are the assumptions for an oligopoly? There are four assumptions for an oligopoly firm. There are few sellers and many buyers, high barriers to entry, imperfect information and either homogeneous or differentiated product. There is mutual interdependence or rivalry between firms in an oligopolistic market, which leads to strategic, game theoretic behaviour of firms. Mutual interdependence or rivalry refers to a situation where a firm has to consider the reactions of its competitors when making its decisions, in which it might make strategic, game theoretic pricing and output decisions. This economics essay thus attempts to explain how mutual interdependence or rivalry affects a firm’s price and output decisions, and how collusion and advertising affect a firm’s decisions.
Oligopolies tend to have sticky prices that are rigid and are often unchanged. In an oligopoly, when a firm lowers its price, it will draw a significant number of customers away from its rivals. These rival firms are unlikely to sit back and do nothing but will instead lower their prices in response to avoid losing a big portion of their sales.
However, should a firm raise its price, it will instead lose much of its customers to its rivals. Since its rivals benefit by not reacting they will probably not raise their price in response. Based on such observations, oligopoly pricing behavior based on the kinked demand curve was derived, showing price rigidity.
An oligopoly firm will only alter its price if its marginal costs change substantially, and if the marginal costs fall significantly there could be a price war - an oligopoly will decide rationally that it could lower prices, increase output, and thus put some rivals out of business.
[Insert a diagram on oligopoly’s kinked demand curve model - showing a price war]
There are other factors affecting the decision of price and output by oligopolistic firm. For instance, collusion may affect the oligopolistic market and help make it become a monopoly market.
Collusion refers to the act of firms jointly determining the price or output. There are two types of collusion, namely explicit collusion and tacit collusion. Collusion can be explicit where firms formally gather to fix prices or output. A formal collusion oligopoly is called a cartel. Tacit collusion could still occur as firms cooperate informally by following a price leader. Both explicit and tacit collusion can work like a monopoly market which can control output and set the price.
JC Economics Essays - H2, H3 Economics essays - tutor's comments: This economics essay deals with oligopolies, strategic behaviour, and pricing and output decisions of firms, with a simple hint of game theory, assuming that firms are rational and thus make rational decisions. Game theory is an important mathematical tool that can help in general economics analysis, but specifically, especially for H3 examinations, undergraduate economics courses, and economics in general. However, there was very little depth of game theory in this economics paper. There are many important elements of this economics essay which make it worth many marks and a rather good examination grade. However, the usual questions for improvement still apply: how could you make this essay answer better? Could examples have been used? Always try to answer the question, and think of how you could make your answers better when dealing with economics questions.