What do mutual interdependence and uncertainty mean with respect to oligopoly? Why are they special characteristics of oligopoly? One of the key characteristics of oligopoly is interdependence. Any change in the price and other economic factors by a firm will also bring about a change in the pricing policy of the rivals, as competition is limited. Apart from taking into account the demand for its products or cost of the products, oligopoly firms also consider the reactions of other rival firms to changes in their price and output policies. However, mutual interdependence often creates uncertainty for all the firms. Hence, the demand curve of an oligopolistic firm losses its determinateness. Why is it difficult to employ formal economic analysis to explain the prices charged by and the outputs of oligopolists? There is no single model describing the operation of an oligopolistic market.[7] The variety and complexity of the models is because you can have two to 10 firms competing on the basis of price, quantity, technological innovations, marketing, advertising and reputation. Fortunately, there are a series of simplified models that attempt to describe market behavior under certain circumstances. Some of the better-known models are the dominant firm model, the Cournot-Nash model, the Bertrand model and the kinked demand model. Explain what the kinked demand curve is, its most important characteristics, the assumptions upon which it is based, and the kind of marginal revenue curve to which it gives rise. How can the kinked demand curve be used to explain why oligopoly prices are relatively inflexible? Under what conditions will oligopolists acting independently raise or lower their prices even though their demand curves may be kinked? "Kinked" demand curves and traditional demand curves are similar in that they are both downward-sloping. They are distinguished by a hypothesized convex bend with a discontinuity at the bend - the "kink." Therefore, the first derivative at that point is undefined and leads to a jump discontinuity in the marginal revenue curve.
Classical economic theory assumes that a profit-maximizing producer with some market power (either due to oligopoly or monopolistic competition) will set marginal costs equal to marginal revenue. This idea can be envisioned graphically by the intersection of an upward-sloping marginal cost curve and a downward-sloping marginal revenue curve (because the more one sells, the lower the price must be, so the less a producer earns per unit). In classical theory, any change in the marginal cost structure (how much it costs to make each additional unit) or the marginal revenue structure (how much people will pay for each additional unit) will be immediately reflected in a new price and/or quantity sold of the item. This result does not occur if a "kink" exists. Because of this jump discontinuity in the marginal revenue curve, marginal costs could change without necessarily changing the price or quantity. Why do oligopolists find it advantageous to collude? What are the obstacles of collusion? Colluding is good for the oligopolic firms as it means they can raise their prices without losing customers to the rivals, so they earn more profit. The number of firms: As the number of firms in an industry increases, it is more difficult to successfully organize, collude and communicate. Cost and demand differences between firms: If costs vary significantly between firms, it may be impossible to establish a price at which to fix output. Cheating: There is considerable incentive to cheat on collusion agreements; although lowering prices might trigger price wars, in the short term the defecting firm may gain considerably. This phenomenon is frequently referred to as "chiseling". Potential entry: New firms may enter the industry, establishing a new baseline price and eliminating collusion (though anti-dumping laws and tariffs can