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Price and output decisions in an oligopolistic market

This can be explained by kinked demand curve hypothesis.
Price, in many oligopolistic industries, remains sticky and inflexible for a long time. The explanation for this price rigidity under oligopoly is the kinked demand curve hypothesis given by an American economist, Paul Sweezy.
If a large percentage of sales are from 4 largest firms it’s an oligopoly.
Examples: Automobiles, steel, etc
  • If an industry is composed of few firms each selling identical or homogenous products and having powerful influence on the total market, the price and output policy of each is likely to affect the other appreciably, therefore they will try to promote collusion.
  • ƒIn case there is product differentiation, an oligopolistic can raise or lower his price without any fear of losing customers or of immediate reactions from his rivals. However, keen rivalry among them may create condition of monopolistic competition.
Kinked Demand Curve: It is the bending in the demand curve as a result of decrease in the price of the competitors to match each others. A kinked demand curve has a ‘kink’ at point K as shown in the following diagram:
Description: 21467.png
Each oligopolistic believes that if he lowers the price, his rivals will also lower their prices. Thus, the upper portion of the demand curve is price elastic. If he increases the price, the rivals will not and therefore, he will lose customers. This explains the inelastic lower portion of the demand curve. Each oligopolistic will thus adhere to the prevailing price seeing no gain in changing it and a kink will be formed at the prevailing price.
Here the prices are determined in the following way:
  • Interdependent pricing: here sometimes the firms ignore interdependence. When it disappears demand curve facing the oligopoly becomes determinate.
  • ƒPrice wars: Here the firms are able to predict the counter moves of their rivals. This is how price war starts in determining price.
  • ƒPrice leadership: Here all the firms accept one firm as a leader and others follows it in setting the price. The leadership will come from dominant firm.

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