Oil and gas well drilling costs were cut through technology in the mid-2010s. For example, an oligopoly considering a price reduction may wish to estimate the likelihood that competing firms would also lower their prices and possibly trigger a ruinous price war. With Threat of Entry: Suppose there is a constant threat of entry into the oligopolistic industry. This can be known by drawing a horizontal straight line from point R towards the Y-axis. Firm C in figure 10. As a result, all purely self-interested prisoners would betray each other, resulting in a two year prison sentence for both.
A cartel is an agreement among competing firms to collude in order to attain higher profits. Sales do not always occur at list prices. An oligopolistic firm tries to differentiate its product from that of its rivals in order to raise the demand for its product and to make its demand curve less elastic. But an oligopoly usually exhibits the following features: 1. In case there is threat of entry of new firms, low price will be fixed. It will be seen in Fig.
For example, if products are heavily promoted and producers have a number of existing successful brands, it will be very costly and difficult for new firms to establish their own new brand in an oligopoly market. Oligopolies have also arisen in heavily-regulated markets such as wireless communications: in some areas only two or three providers are licensed to operate. The small firm can fix a slightly differ price if products are differentiated. Product differentiation: Product may be homogeneous steel or differentiated automobiles. At this stage other firms in the industry will follow the price.
In case their cost curves differ, their market shares will also differ. But when there are cost differences between the firms as is generally the case, the cartel price will be fixed by bargaining between the firms. So the demand curve facing an oligopolists looses its definiteness and as well as its own significance. As a result it is illegal to operate the cartel in many countries. Tacit collusion is when firms abide to the price that has been set by a recognized leader. However, when costs of member-firms are different, the different quotas for various firms will be fixed and therefore their market shares will differ. The seller does not worry about how other sellers will react, because either the seller is negligibly small, or already a monopoly.
Thus, the cartel does not necessarily divide the market equally among its members. Instead, firm need to measure the effect that the response of each competitors will have on them. The barometric price leader may not be the dominant firm with the lowest cost or even the largest firm in the industry. Oligopoly is a market structure in which there are a few firms producing a product. If Coca-Cola reduces their prices, Pepsi may follow to ensure they do not lose market share. The supply of dominant firm on this price is zero.
Cartel agreements with more than about twenty partners are difficult to reach, and break down easily once reached. However, this outcome is not Pareto-optimal. In the long run, there are a number of difficulties faced by a cartel which tend to break it down. Advertising and Promotion : The main purpose of advertising and promotion is to shift the demand curve for the product upward to the right. This will force the cartel to break down. This will ultimately lead to the breaking up of the market sharing agreement. This stickiness of the price often leads to the breakdown of the cartel when some members defect from it.
Cost curves of the two firms are identical. The other firms may invent and produce cheaper substitutes which may be accepted by consumers. Thus, the cartel will earn positive economic profits equal to the area of the rectangle, with a base equal to the monopoly quantity and a height equal to the difference between price on the demand above the monopoly quantity and average cost, as shown in the following figure. What will the collective profits be of all firms in the industry? Interdependence: The distinctive feature of an oligopoly is interdependence. Game theory has found widespread applications in the social sciences, as well as in business, law, and military strategy. When a cartel works on the basis of the intentions of its members, it acts like a single monopolist firm that maximises total industry profits.
Oligopolies are often buffeted by significant barriers to entry, which enable the oligopolists to earn sustained profits over long periods of time. A cartel is formed when firms jointly fix prices and outputs with a view to maximising total industry profits. For example, firms may need to reach a certain minimum size before they are able to spend enough on advertising and marketing to create a recognizable brand name. With only a few firms in the market, the action of one firm is likely to affect the others. Non-price Competition refers to the efforts on the part of one oligopolistic firm to increase its sales by some means other than a price reduction. Market-Sharing Cartel : Another type of perfect collusion in an oligopolistic market is found in practice which relates to market-sharing by the member firms of a cartel. References The United States Department of Justice.