Price and Output Determination Under Oligopoly

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 affects 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 Determination under 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 number of 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, the 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 is the price 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 of it 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.

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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. 

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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.

FAQs (Frequently Asked Questions)

Q1. What are the Characteristics of Oligopoly Market?

Ans. The characteristics of Oligopoly Market are as follows:

The oligopoly market consists of a few firms, and these firms dominate the market. All firms in the industry in an oligopoly market are interdependent as one firm’s action affects the decision of the other. In an oligopoly market, the firms earn the most profit, and they try to restrict the entry of any new player into the industry to save their market share. The firms and the owners of the firm in an oligopoly market always try to predict the decisions of their rivals. This helps them to form policies to tackle any kind of change that can cause harm to them. 

Q2. What are the Causes of Oligopoly?

Ans. Numerous reasons cause an oligopoly market condition. Here we have mentioned some of the reasons, and they are;

When the production capacity of a few firms is large, and they invest heavily in production. They implement new ways of production and have advanced machinery. They produce the products at a lower cost and dominate the market. On the other hand, the firms which are small and have outdated machinery are thrown out of the industry. This creates an oligopoly market. The second reason is that the entry of new players in an oligopoly market is barred by the dominating firms to retain their share in the market. 

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