a) Explain why oligopolies tend to engage in non-price competition (10)

Oligopoly refers to a type of market structure characterised by a small number of dominant firms. Because each of them are large and controls a significant proportion of the market, they are able to exert huge influence in the market, resulting in interdependent pricing and non price policies.

There are 2 types of oligopoly; collusive and competitive.

Collusive oligopoly could tacitly or formally set prices. In tacit collusion, firms follow a price leadership model. They are likely to follow the price of a market leader, and hence, firms pricings are interdependent on one another. In this case, they are not likely to drop prices to incite competition, prices tend to increase together with one another in the markets.

Gas stations and telecommunications tend to exhibit such properties since they produce very similar products.
Instead, they engage in non-price techniques like branding, advertising, and product differentiation.

In formal collusion, cartels tend to set pricings based on the group’s MC and MR. They formally decide pricing and output and allocate them to different firms production. OPEC for example, practices such formal collusion. Since each firm has a predetermined pricing and output, there is no price competition and they tend to engage in non-price.

kinked demand curve

Competitive oligopoly tend to experience price rigidity as explained by kinked demand curve.

In such industries, prices are rigid at the kink, P. Firms are unlikely to raise price because the demand is elastic above P, this means that other firms are not likely to match price increase, and the initial firm will suffer a loss as consumers start to switch.

They are not likely to drop prices as well, because the demand is inelastic below P. Rival firms will match price drops, eroding any increase in revenue for the existing firm.

Firms are likely to all retain pricing at P, since firms who have similar MC in the disjointed MR region, will all have the same profit maximising price.

Hence, prices are rigid in this industry, and are sticky downwards. Such firms has rigid pricing and compete using non-price alternatives.

For example, soft drinks industries. Firms retain pricing and instead compete on differentiation such as Diet coke, vanilla Coke, and Pepsi max.


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