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Oligopoly

Oligopoly. An oligopoly occurs when there are a few large dominant firms, large firms are interdependent and there are significant entry/exit barriers.

Examples of oligopolies include banking, supermarkets, car manufacturers and OPEC.

Assumptions

⦁ A few large firms dominate the market. Many small firms may also exist but with no market power.

⦁ Large firms are interdependent, their actions affect each other.

⦁ There are significant entry barriers.

Kinked Demand Curve

Large firms face a kinked demand curve because of interdependence. Assume firms produce close substitutes. If a firm raises its price, it loses a lot of sales to rivals who do not raise their prices, so demand is elastic above P*. If a firm lowers its price, it only gains a few sales as its rivals also lower their prices to keep their market share, so demand is inelastic below P*.

A firm maximizes profit at Q* and charges a price P*. Because of the kinked demand curve, marginal revenue is discontinuous, if costs rise or fall slightly price will not change so prices are rigid.

Non-Price Competition

Because prices are rigid firms must engage in non-price competition. For example:

⦁ Branding: Brand image/loyalty makes demand more inelastic and attracts new consumers as the good seems unique.

⦁ Advertising: Create a brand image and inform consumers of the benefits of the firm’s good.

⦁ Innovation: A firm could invest in Research and Development (R&D) to develop new and better products for consumers and gain a competitive advantage over rivals.

⦁ Quality: Better quality than rival goods.

⦁ Loyalty Cards: Incentivizes consumers to keep shopping with a specific firm to gain rewards.

⦁ Longer Opening Hours: Convenience for consumers.

⦁ In-Store Services: Crèche, Post-Office, chemist etc. makes it convenient for consumers.

⦁ Banking and Financial Services: Convenience for consumers as everything is in one place.

⦁ Internet Shopping: Allows consumers to shop at home.

⦁ After-Sales Services: Incentivizes consumers to return to that firm.

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