Y2 23) Oligopoly - Kinked Demand Curve

Summary

This video delves into the concept of oligopoly, focusing on the kinked demand curve model to illustrate market characteristics and firm behavior. It explains how oligopolies, dominated by a few firms with differentiated products, exhibit interdependence and price rigidity, often resorting to non-price competition. The script uses real-world examples like the soft drink and car industries to clarify concepts and discusses the temptation towards collusion to achieve higher profits. Stay tuned for the next video on applying game theory to oligopoly behavior.

Takeaways

• 😀 Oligopoly is characterized by a few firms dominating the market, often with more than 70% collective market share.
• 🏭 These firms offer differentiated products and have the power to set prices due to high barriers to entry and exit, such as startup costs and brand loyalty.
• 🔄 Interdependence is a defining feature of oligopolies, where firms make decisions based on the actions and reactions of their rivals, leading to price rigidity.
• 💰 Profit maximization is not always the sole objective in oligopolies; firms may pursue other objectives that give them market control or monopoly power.
• 👀 The kinked demand curve model illustrates the interdependence of firms in an oligopoly and supports the idea of price rigidity.
• 📉 Raising prices above the market level can lead to a decrease in market share and total revenue due to other firms not following the price increase.
• 📈 Lowering prices may initially increase demand, but other firms' reactions can lead to a price war, reducing total revenue and leaving market share unchanged.
• 📊 The marginal revenue curve in the kinked demand model shows that firms can adjust to cost changes without altering their price, reinforcing price rigidity.
• 🌐 Real-life examples of oligopolies include the global soft drink industry, the car industry, OPEC, and various sectors in the UK such as supermarkets and airlines.
• 🤔 Despite the theoretical discouragement of price competition, firms may still engage in price wars or reduce prices to gain market share, as seen in the UK supermarket industry.
• 🤝 There is a strong temptation for oligopolistic firms to collude to avoid interdependence and fix prices for higher profits, akin to monopoly behavior.

Q & A

What is an oligopoly and what are its main characteristics?

An oligopoly is a market structure where a few firms dominate the market, typically characterized by a high concentration ratio with no more than seven firms holding around 70% market share. The main characteristics include differentiated goods, high barriers to entry and exit, interdependence among firms, price rigidity, and non-price competition.

What does 'interdependence' in the context of oligopoly mean?

Interdependence in an oligopoly means that firms do not make decisions independently. Instead, they consider the actions and potential reactions of their rival firms when making their own strategic moves.

Why do oligopolistic firms often experience price rigidity?

Price rigidity in oligopolies is due to the interdependence among firms. Changing prices, either by raising or lowering, can lead to a loss in market share or a decrease in total revenue, making it unattractive for firms to alter their prices.

What is the significance of the kinked demand curve model in understanding oligopoly behavior?

The kinked demand curve model illustrates the interdependence among oligopolistic firms and supports the conclusion of price rigidity. It shows that firms have different price elasticities of demand around the current market price, making it unwise for them to change their prices.

How does the kinked demand curve model explain the lack of price competition in oligopolies?

The model shows that if a firm raises its price, it moves onto a price elastic demand curve where other firms do not follow, leading to a loss in market share. Conversely, if a firm lowers its price, it moves onto a price inelastic demand curve where other firms may follow, leading to a price war and no significant gain in market share.

What are some real-life examples of oligopolies mentioned in the script?

Examples include the global soft drink industry with Coca-Cola and Pepsi, the global car industry, OPEC as a legal oligopoly, and in the UK, the supermarket industry, energy industry, supermarket fuel providers, and the bus and airline markets.

What is the role of non-price competition in oligopolistic markets?

In oligopolistic markets, where price competition is often limited due to price rigidity, non-price competition becomes prominent. This includes competition based on branding, advertising, product quality, and service quality.

How does the kinked demand curve model account for cost changes within an oligopoly?

The model suggests that as long as costs change within the vertical gap of the marginal revenue curve, a profit-maximizing oligopolist will continue to charge the same price, as the quantity demanded remains the same, thus not requiring a change in price.

What is the temptation for oligopolistic firms due to the challenges posed by interdependence?

Due to the challenges of interdependence, there is a strong temptation for oligopolistic firms to collude, which allows them to act like a monopoly, fix prices, and potentially make higher profits without worrying about rival reactions.

How does the script suggest that game theory can be used to map oligopoly behavior?

The script mentions that game theory will be used in the next video to map oligopoly behavior, suggesting that it is a useful tool for understanding the strategic interactions among firms in an oligopoly.

What are the two main conclusions drawn from the kinked demand curve model regarding oligopoly behavior?

The two main conclusions are that price competition in an oligopoly is limited due to the potential negative outcomes of price changes, and that non-price competition becomes more prevalent as firms seek to gain market share without altering their prices.