Overview
This lecture explains the characteristics, pricing, output, and profit potential of oligopoly market structure, highlighting the complexity from interdependent decision-making and the kinked demand curve.
Oligopoly Characteristics
- Oligopoly is defined by a small number of sellers, each able to influence the market.
- Products in an oligopoly can be identical (like oil) or differentiated (like cars).
- High barriers to entry exist, making it difficult for new competitors to join.
- Firms are mutually interdependent, meaning each firm's actions affect all others in the market.
Pricing, Output, and Profit in Oligopoly
- Oligopoly results in higher prices than perfect competition, but lower than monopoly.
- Firms can maintain profits in the long run due to barriers to entry.
- Profit potential exists, but is less than that of a monopoly.
Kinked Demand Curve and Firm Behavior
- The demand curve is kinked because firm behavior differs for price increases and decreases.
- If a firm raises price, rivals do not follow, causing elastic demand and a large loss of customers.
- If a firm lowers price, rivals match the decrease, causing inelastic demand and little gain in sales.
- The kinked demand curve creates a marginal revenue curve with a discontinuity.
Profit Maximization in Oligopoly
- Firms maximize profit where marginal revenue (MR) equals marginal cost (MC).
- Marginal cost curve looks the same as in other market structures.
- The firm chooses output (Q*) where MR=MC and uses the demand curve to set the highest price consumers will pay for Q*.
- Short-run profits can be made, lost, or the firm can break even.
- In the long run, entry barriers allow some profits to persist, though they may erode if new rivals enter.
Comparison to Other Market Structures
- Oligopoly profits are sustainable but generally lower than monopoly profits.
- Profits are protected by entry barriers but can be reduced by eventual new entry.
Key Terms & Definitions
- Oligopoly — a market structure with a small number of firms, high entry barriers, and interdependent decision-making.
- Kinked Demand Curve — a demand curve showing elastic demand for price increases and inelastic demand for price decreases.
- Marginal Revenue (MR) — the additional revenue from selling one more unit of output.
- Marginal Cost (MC) — the additional cost of producing one more unit of output.
- Barriers to Entry — obstacles that make it difficult for new firms to enter a market.
Action Items / Next Steps
- Prepare to study collusion, mergers, and antitrust in the next lecture.