CHAPTER_15

CHAPTER_15 - CHAPTER 15: OLIGOPOLY What Is Oligopoly?...

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CHAPTER 15: OLIGOPOLY What Is Oligopoly? Oligopoly is a market structure in which Natural or legal barriers prevent the entry of new firms. A small number of firms compete. Barriers to Entry Either natural or legal barriers to entry can create oligopoly. Figure 15.1 shows two oligopoly situations. In part (a), there is a natural duopoly —a market with two firms. In part (b), there is a natural oligopoly market with three firms. A legal oligopoly might arise even where the demand and costs leave room for a larger number of firms. Small Number of Firms Because an oligopoly market has a small number of firms, the firms are interdependent and face a temptation to cooperate. Interdependence: With a small number of firms, each firm’s profit depends on every firm’s actions. Cartel : A cartel and is an illegal group of firms acting together to limit output, raise price, and increase profit. Firms in oligopoly face the temptation to form a cartel, but aside from being illegal, cartels often break down. Two Traditional Oligopoly Models The Kinked Demand Curve Model In the kinked demand curve model of oligopoly, each firm believes that if it raises its price, its competitors will not follow, but if it lowers its price all of its competitors will follow. Figure 15.2 shows the kinked demand curve model. The firm believes that the demand for its product has a kink at the current price and quantity.
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Above the kink, demand is relatively elastic because all other firm’s prices remain unchanged. Below the kink, demand is relatively inelastic because all other firm’s prices change in line with the price of the firm shown in the figure. The kink in the demand curve means that the MR curve is discontinuous at the current quantity—shown by that gap AB in the figure The next diagram helps to envisage why the kink in the demand curve puts a break in the marginal revenue curve. Fluctuations in MC that remain within the discontinuous portion of the MR curve leave the profit-maximizing quantity and price unchanged. For example, if costs increased so that the
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This note was uploaded on 12/31/2011 for the course ECON 101 taught by Professor Vanderwaal during the Fall '08 term at Waterloo.

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CHAPTER_15 - CHAPTER 15: OLIGOPOLY What Is Oligopoly?...

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