Oligopoly is a market situation in which there are a few firms selling homogeneous or differentiated products. It is difficult to pinpoint the number of firms in the oligopolist market. There may be three, four or five firms.
In-spite of these difficulties, two interrelated characteristics of oligopolistic pricing stand out:
(i) Oligopolistic prices tend to be inflexible or Sticky Price change less frequently in Oligopoly than they happen under other competitions like perfect, competition, monopoly and monopolistic competition.
(ii) When oligopolistic prices change, firms are likely to change their prices together they act in collusion in setting and changing prices.
Keeping these facts in mind, the price and output determination under oligopoly is in the following situations:
- Price Determination in Non-Collusive Oligopoly
In this case, each firm follows an independent price and output policy on the basis of its judgment about the reactions of his rivals. If the firms are producing homogeneous products, price war may occur. Each firm has to fix the price at the competitive level. On the contrary, in case of differentiated oligopoly, due to product differentiation, each firm has some monopoly control over the market and therefore charge near monopoly price.
Thus the actual price may fall between the two limits
(i) The Upper Limit of Monopoly Price and,
(ii) The Linear limit of Competitive Price.
Practically, there is every possibility to determine the exact price within these limits. However there may be the following possibilities:
(i) There may be complete price instability in the market which results in price war.
(ii) The price may settle down at intermediate level due to the working of the market forces.
(iii) The firm may accept the prevailing price and adjust itself according to prevailing price.
So long as the firm earns adequate profits at the prevailing price, it may not try to change it. Any effort to change it may create uncertainties in the market. A firm will stick to that price to avoid uncertainties. Thus the price tends to be rigid where oligopolist takes independent action.
Equilibrium under Collusion
The modern economists are of the view that independent price determination cannot exist for long in oligopoly. It leads to uncertainty and insecurity and to overcome them there is a tendency among oligopolists to act collectively by tacit collusion. In addition, the firms can gain the economics of production. All the firms in oligopoly tend to enlarge their size and lower their costs of production per unit and capture maximum share of the market.
Collusive oligopoly is a situation in which firms in a particular industry decide to join together as a single unit for the purpose of maximising their joint profits and to negotiate among themselves so as to share the market.
The former is known as:
(i) The joint profit maximization cartel and
(ii) The latter as the market-sharing cartel. There is another type of collusion, known as leadership, which is based on tacit agreements.
Under it, one firm acts as the price leader and fixes the price for the product while other firms follow it. Price leadership is of three types: low-cost firm, dominant firm, and barometric.