4. Competition  (cont'd)

4.6 Oligopoly 

        Oligopoly satisfies the following conditions: 

  • a small number of producers; and, 

  • actions of a producer perceptible to rivals, i.e. interdependency of sellers whereby action of one results in reaction of others. 

In perfect competition and monopoly there exists a determinant solution to a firm's price and output decision-making. When there are only a few sellers, however, each firm recognizes that its best choice depends on choices made by rivals. There are dozens of alternative oligopoly pricing theories and some economists claim there is no determinant solution. In an oligopolistic market there is usually price stability because of the interdependence of sellers. Interdependence results in 'game playing' behavior whereby suppliers act like players in a game acting and reacting to the moves of their competitors. Competition tends to take place on a secondary level of: product differentiation; technological innovation; and, diversification, i.e. producing more than one commodity. In theory, oligopoly is considered inefficient because price is higher and quantity lower than under perfect competition. 


1. Cournot Solution 

 The Cournot Solution proposes that firms choose an output that will maximize profits assuming the output of rivals is fixed. The solution concludes that there is a determinant and stable price-quantity equilibrium that varies according to the number of sellers. In effect each firm makes assumptions about its rival's output that are tested in the market. Adjustment or reaction follows reaction until each firm successfully guesses the correct output of its rivals (M&Y 10th Fig 12.4; M&Y 11th Fig. 12.1; B&B Fig. 13.1; B&Z not displayed)


2. Sweezy Kinked Demand Curve Solution      

 The Sweezy solution postulates that oligopolists face two subjectively determined demand curves that assume:

  • rivals will maintain their prices; and, 

  • rivals will exactly match any price change. 

A key assumption is that rivals will choose the alternative least favorably to the initiator. If initiator raises p, rivals will not follow; if lowers price everyone follows. The result is p will be relative rigid in the face of moderate changes in cost or demand (figure not in text).


3. Other Solutions

There are a variety of models of oligopoly that attempt to establish the price/quantity relationship resulting in profit maximization.  These include:

i - The Nash Equilibrium (p. 384);

ii - The Stackelberg Model (p. 389);

iii - The Betrand Model (p. 392); and,

iv - Collusion & Cartel Models (p. 383).

What this means is that there is no 'determinant solution' for profit maximization under oligopoly.  Complicating matters is the fact that an oligopoly is usually accompanied by a large number of small fringe producers  called 'the competitive fringe'.  Whatever price the 'big boys' set, the fringe acts much like 'price-takers' but with a  latitude similar to monopolistic competitors, that is, they can enjoy some measure of product differentiation.  They also act like a pool for the potential 'creative destruction' (a term introduced by Joseph Schumpeter) of technological change.  For a current summary of the concept see: "Deconstructing Creative Destruction with Dick Foster" by David Berkowitz, eMarketeer, July 5, 2001).


4. Game Theory

The complexity of the oligopoly and the rich variety of possible 'profit maximizing' outcomes has led economics to 'spin off' a whole new field of thought called Game Theory (pp. 410 - 444).   Modern corporations and the military have adopted various conceptual outputs of this field.  Even the arts are involved in that actors are often hired by businesses, governments, the military and other institutions to 'role play' in games to hone the skills of various personnel.

The impact upon the general public is also significant.  "Everyone plays games!";  "winners & losers"; "positive and negative sum games".  In many ways the contemporary ethos or zeitgeist is game playing.  For a brief history please see:  AN OUTLINE OF THE HISTORY OF GAME THEORY by Paul Walker



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