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.