Oligopoly or Oligopolistic Market

In an oligopoly, there are even fewer firms compared to monopolistic competition, and there are higher barriers to entry. The players need to keep an eye on each other’s strategy. If one firm changes its prices, you can expect the same move from other firms as well. The firms are interdependent and one firm’s actions will have an impact on the other firm’s demand curve as well. The oligopolies can be described using the following models:

  1. Kinked Demand Curve Model
  2. Cournot Duopoly Model
  3. Nash Equilibrium Model
  4. Stackelberg Dominant Firm Model

Kinked Demand Curve Model

According to this model, each firm in the oligopoly believes that if it raises its price, its competitors will not follow, but if it lowers its price all of its competitors will follow. The following graph shows the kinked demand curve model. According to each firm, the demand for its product has a kink at the current price (P) and quantity (Q).

If prices are greater than P, then increasing the price by a small amount leads to a large decrease in quantity sold. If price is less than P, large price cuts lead to low increases in the quantity sold. If competitors also lower prices, then there is no advantage to cutting prices.

Demand is relatively elastic above the kink. This is because the prices of all other firms remain unchanged.

Demand is relatively inelastic below the kink because if the firm shown in the figure changes its prices, all other firms’ prices will also change.

Firms produce at the point where MR = MC. This model states that price and quantity are not very sensitive to small cost changes.

The kink in the demand curve means that the MR curve is discontinuous at the current quantity. This is shown by gap in the figure below.

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