Explain how interdependence and uncertainty affect the behavior of firms in the oligopolistic market

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Explain how interdependence and uncertainty affect the behavior of firms in the oligopolistic market

An oligopoly is a market dominated by a few producers. In this economic model is a high level of market concentration, which measures the extent to which an industry is dominated by a few leading firms. This term is used when the top five firms in the market have more than 60% of the total market shares. An example of an oligopolistic market is the petrol market in the UK.

There are a few assumptions, which are relatively high barriers to entry, so firms can enter the market but won’t gain enough market shares to have any significant effect on prices and output.                                                                                                                                                    Another assumption is product branding, which mostly leads to loyalty from consumers to the branded products – this makes the price fairly inelastic.                                                                            Then there is the non-price competition such as advertising, which is one of the competitive strategies.                                                                                                                                                                          At last the inter-dependent decision-making plays a major part in the oligopoly concept. Here the firms take into account the reactions of the rival firms to any change in price, output and non-price competition. This means that the firms have to predict each other’s decisions and reactions to any circumstances in the market in order to be more competitive.

The oligopoly concept is best defined as the complex behaviour of the firms inside the market. There is no single theory of price and output under conditions of oligopoly. Hereby are meant price wars, where oligopolists may choose to produce and price much with the consequence of a highly competitive industry or they will act together in cartels to become sort of monopoly.

It exists a concept called duopoly, which is also a form of oligopoly. Here there are in the purest form only two firms, which control all of the market shares, but it is more commonly known as two firms colluding together in order to dominate the market with their significant market shares. Examples are Coca-Cola and Pepsi or Sotheby’s and Christie’s.                                   In these markets entry barriers are high and based on brand loyalty, product differentiation and huge research economies of scale.

In the kinked demand curve model below is assumed that businesses might face a dual demand curve for its product, dependent on the likely reactions of other firms to change their price or another variable. Oligopolies are mainly looking to protect and maintain their market shares, so as the change in price makes a significant change on the price elasticity, the firms have to predict precisely what is going to happen when they either rise or cut their prices.

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The kinked demand curve model states that businesses might reach stable profit maximising equilibrium at price P and output Q with a small incentive to alter prices. Furthermore the model predicts the periods of relative price stability under an oligopoly with businesses focusing non-price competition to increase their supernormal profits.                                                 Even in this model price wars can occur, so that a firm gets an advantage in the short term over the other firms ...

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