We've reached our final, and our most complex, market structure: Oligopoly.
Do you remember the characteristics from the overview in Episode 25?
In an oligopoly, you would find only a small number of sellers, that is, few enough so
that any individual seller can affect the market, and the firm's actions will have an
impact on all the other sellers.
The product can be either the same, like oil, or differentiated, like automobiles, and there
are fairly high barriers to entry.
TIME TO THINK: having seen the other market structures, you should be able to make some
predictions about the implications of the oligopoly characteristics.
What will prices and output look like?
What is the potential for profit?
As you'd expect, the oligopoly market structure will result in a higher price than either
competitive market, although not so high as a monopoly, and will be able to maintain some
profit, if it exists, into the long run because of the barriers to entry.
At the beginning of this video I said that the oligopoly is the most complex market structure.
Well that's because the actions of any one firm will have an impact on all of the other
players in the market.
This mutual interdependence among firms means that each firm keeps an eye on everyone else,
trying not only to anticipate moves but also to have their own reaction plan in place.
Will the other guy raise his price?
Lower his price?
If he makes a move, what will I do?
You can see the increased complexity of this market just by looking at the oligopolistic
firm's demand -- a kinked demand curve.
We've never encountered a demand curve that looks like this before so, what gives?
Well, this demand is effectively composed of two different demand curves, because the
game-playing behavior, if you will, of the firms in this industry will change depending
on whether the firm is implementing a price increase, or a price decrease.
When the oligopolistic firm goes to increase its price, the rivals will not follow; they
will let that one firm increase its price, and then they will gain the customers as buyers
are driven away by the initiating firm's higher prices.
What this means for the firm is that, if it raises its price, and no other producer follows
suit, then the initiating firm will see a large decrease in quantity demanded, i.e.,
the demand is more elastic when the firm attempts to increase its price.
Well, what if the firm lowers its price?
The rivals are aware that they could lose substantial market share if they do not follow
along and lower their prices as well, but what happens if everyone lowers prices?
The firm that initiated the price decrease would see very little change in quantity demanded
because, for the most part, customers stay where they are; that is, the demand faced
by the firm is inelastic when there is a price decrease.
So if the firm raises price, no rivals follow, it loses a lot of customers, and the demand
is elastic; but if it lowers its price, everyone follows, and not much is gained by that firm
in terms of sales, or you have inelastic demand.
This will also result in a very unusual marginal revenue curve.
Think about the marginal revenue that would be associated with the more elastic price
increase scenario.
Then, consider the marginal revenue that would be associated with the more inelastic price
decrease demand.
The marginal revenue associated with a kinked demand curve would look like this:
It's important at this point to be confident in what you know about a firm's profit-maximizing
behavior.
Is this the weirdest-looking demand/marginal revenue graph you've ever seen?
Sure.
Can you still figure out the profit-maximizing output?
Definitely.
You have the profit-maximizing rule burned into your brain by now, don't you?
All you need is the output where marginal revenue equals marginal cost.
Marginal cost looks the same regardless of the market structure, so you just add it to
the oligopolistic firm's demand diagram.
You can find Q*, the output where marginal revenue equals marginal cost, and then use
the demand curve to determine the highest price the firm can get the consumers to pay
for those Q* units.
From here, the analysis is the same as any other market structure.
In the short run, the firm could make money, lose money, or break even depending on the
position of the average cost curves.
If the firm makes money in the short run, the barriers to entry help to protect these
profits, even in the long run.
Remember, in an oligopoly market structure it is difficult, but not impossible, to enter
the market, so there may be some loss of profit to new rivals over time.
If the firm loses money in the short run, it will exit the industry in the long run,
leaving behind more customers for the rival firms.
So, in the end, how does the oligopoly compare to the other market structures?
As expected the oligopolistic firm can maintain profit into the long run, but the profits
earned aren't quite as high as the monopoly could earn.
In the next episode, weÕll see what happens when the firms of an oligopoly get together
and attempt to act like a single large firm -- a monopoly -- in order to boost their profits.
NEXT TIME: Collusion, mergers and antitrust.
TRANSCRIPT00(MICRO) EPISODE 30: OLIGOPOLY