"Even without a formal agreement firms in oligopolistic markets may be able to sustain a joint monopoly equilibrium. Discuss."

Authors Avatar

Gemma Thomas

Business Economics Essay

Term 2

“Even without a formal agreement firms in oligopolistic markets may be able to sustain a joint monopoly equilibrium. Discuss.”

To understand what the question is asking, a definition of an oligopolistic market is required before I will attempt to answer. An oligopolistic market is characterized by few firms and many buyers, there are a sufficiently small number of firms for interdependence to exist, meaning that each firms prospects depend on rivals as well as their own policies. This interdependence can lead to attempts at communication, coordination and collusion. All decisions made are strategic and rivals responses will have been taken into account. Each time a firm in an oligopolistic market adjusts either price or quantity, any revenue gain is at the expense of its competitors. The competitors whose profit margins are affected are likely to respond by altering their own price or quantity. From this we can understand why there is an incentive for firms to collude.

There are four important oligopoly models, the Cournot-Nash model, the Stackelberg model, the Bertrand model and the dominant firm price leadership model, each built upon different assumptions and result in different equilibrium outputs. I am going to examine each in turn, a discussion which mirrors that in Waldman and Jenson.

  • Cournot-Nash Model - considers a duopoly market with identical firms, facing identical costs and no product differentiation. Each firm believes that its competitor will always maintain its current output i.e. they assume that rivals will not react to changes they implement. Equilibrium is reached where each firm’s output is the best response to its rival’s output and where both firm’s output maintenance assumptions concerning the other are correct. It is a game of imperfect information because it is a simultaneous move game. This model has been used in the airline industry between American Airways and United Airlines.
  • Stackelberg Model – this model considers what would happen if the Cournot model is viewed as a two stage sequential game where the leader moves first and assumes that the follower will respond to the leaders quality decision by producing on its reaction function. So the leader will select a point on the followers reaction function that maximizes the leaders profits. This model was used in the US coffee roasting industry in the 1970’s
  • Bertrand Model – Firms take their competitor’s prices, rather than quantities, as fixed. With the absence of product differentiation price equals marginal cost (MC). This model is driven by the assumption that one of the firms can capture the entire market if it charges a lower price than its competitor. At MC neither firm has an incentive to reduce price. American Airlines has a policy of pricing close to MC on routes where it has competition, this shows us the models viability in the real world.
  • Dominant firm price leadership model – occur if one firm controls a large percentage of the industry’s output compared with several considerably smaller ‘fringe’ firms that supply the rest of the market demand. The dominant firm sets the industry price, and the fringe acts as price takers. If the fringe earns positive economic profits it is likely to expand and the dominant firm’s market share will decline over time. The major weakness of this model is that the dominant firm is passive, this model has been seen several times in recent years, but especially with Xerox in the low volume segment of the copier industry.
Join now!


For an oligopolistic market to remain so, there must be a reason for competitors to stay out, this could be due to firms not earning supernormal profits or due to high entry barriers. Positive profits will induce entry, which, will have the effect of increasing supply and decreasing price; this is detrimental for all firms in an industry. To prevent this firms will want to erect entry barriers. Bain defines entry barriers as “the extent to which in the long run, established firms can elevate their selling prices above the minimum average costs of production and distribution without inducing potential ...

This is a preview of the whole essay