Price Determination Under Oligopoly
An Oligopoly market condition exists between two of the most extreme market conditions; i.e. perfect competition Market and Monopoly Market. An Oligopoly market is a type of market condition where there are two-three firms that dominate the market for a certain type of good or service. In this type of market condition, there are few companies, and the marketing decisions of each company affect the other. Hence, it can be said that in an oligopoly market, the marketing decisions of the competing firms are interdependent. Here, interdependence can be seen in any kind of decision, say pricing. When one company changes the price of its product or service, the effect of the change can be seen in the pricing of products and services of other companies.
Price and Output Determination Under Oligopoly
Price and Output
A determination under the Oligopoly market can be studied under two heads; One when there is a duopoly and one when there are a few firms. Here, we will discuss the price determination under Oligopoly in both the conditions:
When There is Duopoly
If in a sector there are only two companies that dominate the market, then such a condition is called duopoly. In such a market condition if, both the firms have identical products, they are likely to form a collaboration and make a joint profit. If in case the products of both the firms are a perfect substitute, then the firm with a lower cost, better goodwill and better client interaction will attract more customers. This will force the other company to lose business.
On the other hand, when the offerings of both the companies are differentiated, then each one has to keep a close watch on the other. In this kind of situation.
A firm with better quality products and the lesser price will earn abnormal profits.
When There is Oligopoly
In case there are more than two firms in a sector, and each one is considered a key player in that sector, then such a market is called oligopoly market. If all the firms produce the same products, then they will always promote collusion. This collaboration will help them earn profit jointly and would cause no harm to the other. On the other hand, if the products of all the firms are different, then they can lower or increase the price without any fear of losing a share in the market.
Theories on Price and Output Determination
No single theory can explain how the price is determined under Oligopoly. Several theories suggest various ways on how the price determination under oligopoly is done. Here we will discuss the important theories of price and output determination.
Cournot’s Model
According to Cournot, Each firm in a duopolist market thinks that instead of its action and effect on the market, The other firm will keep on producing the products. The Cournot model suggests that the most profitable pricing is when a firm’s output is two-third of its competitor’s output, and the price is also two-third.
Stackelberg Model
Under Stackelberg’s model, a leader and follower relationship is formed. The firm with good brand equity is called the leader, and the one with lower brand equity is called the follower. The leader decides the price and quality of the commodity, and then the follower observes the leader and decides the price, to maintain its market share.
Bertrand Model
Bertrand model can be explained when there exists a symmetry in the industry, i.e. there are firms which are equal in size and operations. The Bertrand model suggests that the firms set a low price until the price matches the cost of production. This is done to dominate the market.
Edgeworth Model
The Edgeworth Model suggests that each firm in a duopoly market thinks that his competitor will charge the same price, so it changes its price to make a greater profit. This thinking of the firm keeps the price war continued.
Explanation of Price and Output Determination Under Oligopoly
Under the oligopoly market, the number of firms varies.
Sometimes there are 2-3 firms, and sometimes there are 7-10 firms.
The commodities produced under the oligopoly market may or may not be homogenous.
Sometimes it so happens that firms consult each other before fixing the price of the commodities, to save each other from losses.
A firm can never be sure of its rivals' reaction to its decisions.
Determination of Price and Output In Oligopoly
There are various types of markets that exist and oligopoly is one of them. Oligopoly markets are mostly dominated by suppliers on a small scale. These are oligopoly markets that are found across the world in many sectors. Some of the oligopoly markets are competitive whereas some are not that significant. The authorities for the competition are called upon to supervise the coordinated actions as well as if there is low competition. Oligopoly markets can exist between the extreme conditions of a market which is either a perfect competition market or a monopoly market. It is the market where three are two or three firms that dominate the market for a good or service. Marketing decisions of each company and other companies affect one another thus; the oligopoly marketing decisions are interdependent in an oligopoly market. Interdependence can be any decision e.g. pricing of a particular product or service. This, in turn, will affect all the pricing of products and services of the other companies associated with a company.
Price and Output Determination in Oligopoly
There are two conditions under which the price and output determination in an oligopoly can be done. They are:
In the case of duopoly
In the case of fewer firms
In the case of duopoly, which means two companies that dominate the market in a sector and the firms have similar products. In such cases, the two firms or companies will form a collaboration with each other and have a joint profit. The firm which provides products with lower prices will attract more people and have better client associations. This can cause losses to the other company. On the other hand, if the companies have slightly different products, the firm which provides products of better quality with a low price will gain large profits.
In the case of fewer firms, each company is an essential player in that sector. Here, the collaboration will help both the companies and there won’t be a loss for either of them. When the products of the companies are different then they may increase or decrease the pricing without having the fear of losing shares in the market.
FAQs on Price and Output Determination Under Oligopoly
1. Is price and output indeterminate under oligopoly?
Price and output determination under oligopoly are often considered indeterminate due to the complex interplay between a few dominant firms. Unlike perfect competition or monopoly, oligopolists must constantly anticipate the reactions of their rivals, making stable predictions difficult. The main reason for this indeterminateness is the uncertainty regarding how competitors will respond to price or output changes. While economic models like the kinked demand curve try to explain this phenomenon, no single theory universally predicts prices and outputs in oligopoly markets. As a result, equilibrium can fluctuate unless firms explicitly agree on strategies, as in collusive arrangements. Oligopoly thus creates a market environment where price and output remain uncertain and are heavily influenced by strategic interactions between firms.
2. What are the pricing strategies under oligopoly?
Oligopoly firms use several pricing strategies to balance competition and cooperation with rivals. Because each firm's decisions affect and are affected by others, they often rely on sophisticated methods to set prices. Common pricing strategies under oligopoly include:
- Price leadership – One dominant firm sets the price, and others follow.
- Collusive pricing – Firms make agreements, either formal or tacit, to fix prices or limit output.
- Kinked demand curve pricing – Firms keep prices rigid, fearing loss of market share if they change prices.
- Non-price competition – Firms compete on product features, advertising, or after-sales service rather than price.
3. How is price determined in a collusive oligopoly?
In a collusive oligopoly, major firms cooperate to fix prices or limit output, acting like a monopoly. They may form cartels or enter tacit agreements to maximize joint profits rather than compete aggressively. Typically, the group collectively decides on the industry price and allocates output quotas to each member based on capacity or market share. This approach eliminates price wars and stabilizes the market. However, such collusion is often illegal or regulated in many countries due to its potential to harm consumers by keeping prices artificially high. Thus, under collusion, price determination is coordinated rather than competitive, leading to higher prices and restricted output compared to more competitive market structures.
4. What are the three main models of oligopoly pricing and output?
Several models help explain pricing and output decisions in oligopoly markets. The three main models are:
- Kinked Demand Curve Model – Assumes firms believe rivals will match price decreases but not increases, leading to price rigidity.
- Price Leadership Model – One dominant firm sets the price, and other firms follow the leader’s pricing decisions.
- Collusive (Cartel) Model – Firms cooperate to decide on price and output collectively, maximizing joint profits like a monopoly.
5. Why is price rigidity common under oligopoly?
Price rigidity is a notable feature of oligopoly markets, meaning prices tend to remain stable even if demand or costs change. This occurs because firms fear triggering undesirable competitive responses if they raise or lower prices. For example, cutting prices might lead to a price war, harming all competitors, while increasing prices could cause customers to switch to rivals. The kinked demand curve theory explains that demand is less elastic above the current price and more elastic below it, discouraging changes. As a result, oligopoly prices often show ‘stickiness’ and remain steady for long periods. Firms instead shift focus to non-price competition to attract customers without altering prices.
6. How does interdependence affect price and output determination in oligopoly?
Interdependence is a key characteristic of oligopoly markets, where each firm’s actions directly impact its rivals. When deciding on price and output, an oligopolist must forecast how competitors will react. This mutual awareness leads to strategic decision-making, often resulting in cautious or coordinated moves rather than aggressive competition. Interdependence can cause uncertainty, leading to price stability or sometimes collusion. Firms may avoid price changes, fearing retaliation or loss of market share. Therefore, interdependence complicates price and output setting, making outcomes unpredictable compared to more competitive markets.
7. How do non-price factors influence output under oligopoly?
Non-price factors play a significant role in output determination under oligopoly. Since price wars can be damaging, firms often compete through product differentiation, advertising, or improved services. These strategies can increase demand for a firm's product without changing its price. For example, aggressive marketing or innovation may allow a firm to expand its market share and increase output. Non-price competition thus offers a way for oligopolists to grow and attract customers while avoiding the risks associated with frequent price changes. Such factors can also lead to higher brand loyalty and longer-term market stability.
8. What is the kinked demand curve theory in oligopoly?
The kinked demand curve theory is a model used to explain price stability in oligopoly markets. According to this theory, an individual firm faces a demand curve that has a 'kink' at the current price level. If the firm raises prices, rivals are unlikely to follow, leading to a significant loss of customers. Conversely, if it lowers prices, competitors usually match the decrease, resulting in only a small gain in market share. This creates a situation where there is little incentive to change prices, leading to price ‘stickiness.’ The kinked demand curve thus helps explain why oligopoly prices can remain stable despite fluctuations in cost or demand.
