When oligopolists follow each others pricing decisions, consumer demand for each oligopolist's product will become less elastic or less sensitive to changes in price because each oligopolist is matching the price changes of its competitors. There is hardly any disposition to lower the price when there is decline in demand or in costs, but the price may be raised in response to increased demand or to rising cost. Example: Coke and Pepsi, same price and same range of products. There is little incentive to raise or lower price. Hitch on the other hand. The price is reduced to below cost price, a definite loss leader, so that the competitor cannot cope.
Helps organizations to increase their performance ii. Collusion Model-The Cartel : In oligopolistic market situations, organizations are indulged in high competition with each other, which may lead to price wars. The greater the difference in the two elasticities, the greater the length of the discontinuity. It follows from the above discussion that the larger the difference between e, and e 2, i. The increase in quantity demanded for Pepsi itself would be modest. If one of the three firms put their price up to 90p a litre, what would happen next? Product that appeals , Price difficult to vary significantly , Promotion advertising, marketing, etc. When there is a rise in cost of industry an oligopolist can reasonably expect that his increase in price will be followed by the others in the industry.
Price competition is frequently seen in the. The dotted red lines help to explain. Psychological pricing suggests in the real world firms seek to set prices which are psychologically attractive to customers. The kinked demand curve model makes a prediction that a business might reach a stable profit-maximising equilibrium at price P1 and output Q1 and have little incentive to alter prices. In particular, you can see where and why point C starts where it does.
Sweezy on the one hand and Profs. Firms with established brands can easily charge a premium on their products. Other features of oligopoly will be covered in the next sub-section. Readers Question: To what extent does the kinked demand curve model explain price rigidity in oligopoly? This is because when under oligopoly products are differentiated, it is unlikely that when a firm raises its price, all customers would leave it because some customers are intimately attached to it due to product differentiation. This is why advertising is so important. In recent years, it appears that the quality newspaper market is a good example.
Fourth, in the model under discussion, the firm may not have to change the price of its product, even if its cost of production rises. The competitive reaction pattern assumed by the kinked demand curve oligopoly theory is as follows: Each oligopolist believes that if he lowers the price below the prevailing level, his competitors will follow him and will accordingly lower their prices, whereas if he raises the price above the prevailing level, his competitors will not follow his increase in price. First, it does not explain how the oligopolist finds the kinked point in its market demand curve. The other two firms know this is going to happen following the price cut, so they match the price cut see price wars later. More recently, we have seen firms diversify to attract custom supermarkets offering banking and insurance services and some have even started to offer shopping 'on-line' using the Internet. This is demand curve for Oligopolistic competition, in which there are less than 10 producers and there are huge number of consumers. When the price is likely to change and when it is likely to remain inflexible in the face of changing costs and demand conditions is explained below: 1 Decline in Costs: When the cost of production declines, the price is more likely to remain stable.
The big problem, of course, is the fact that it is tempting for a member of the cartel to cheat! If the dominant firm keeps prices stable, other firms are reluctant to change. Stigler also asserts that the model is unnecessary because already included allowances for short-run sticky prices due to collusion, menu costs, and regulatory or bureaucratic inefficiencies in markets. Basically, it is where one firm cuts its price, the others follow and perhaps cut theirs by a little bit more, and so on. On the other hand, under oligopoly without product differentiation, when a firm raises its price, all its customers would leave it so that demand curve facing an oligopolist producing homogeneous product may be perfectly elastic. This would result in producing the kinked demand curve.
Why the Kink in the Demand Curve? From what has been said above, it is easy to see why an oligopolist confronting a kinked demand curve will have no incentive to raise its price or to lower it. In other words, cartel can be defined as a group of organizations that together make pricing and output decisions. His primary opposition is summarized in a Working Paper out of the Economics Department by seminal authors Elmore, Kautz, Walls et al. Our analysis shows that whether we use kinked demand curve of the type postulated by Sweezy, or Hall and Hitch prices are unlikely to be stable during the boom periods. Therefore, for a price cut, demand is price inelastic.
Often prices appear to be relatively stable in oligopolistic markets. In such a case, the organization that has raised its prices would lose some part of its market share. However, firms may wish to maximise other objectives such as creating goodwill amongst stakeholders. Limit and predatory pricing Limit pricing is where the firms in oligopoly try to set a price that limits the entry of new firms into the industry. Therefore, price and output would remain stable. It would be able to maximise profit if it, like the previous case, sells of output at the price of p 1.