Discuss how firms within an oligopolistic market compete in kinked demand curve

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Discuss how firms within an oligopolistic market compete.

An oligopolistic market is a market structure dominated by a few firms. One definition of an oligopoly, is a market where the five firms biggest firms have 50% or more of the market share. There are different ways firms in an oligopoly may compete.
Firstly, the kinked demand curve model suggests that prices will be stable because firms have little or no incentive to change prices. If a firm increased price, they would be uncompetitive and lose market share; therefore demand is price elastic for a price increase. If they cut prices, other firms follow suit and there is a price war; therefore, if they cut prices, demand will be price inelastic and they will have less revenue. Therefore, the best solution is to keep prices stable.

the kinked demand curve
the kinked demand curve

Because there is no incentive to change price, firms compete through non-price competition such as advertising, branding, after sales service and offering a better product. In other words firms try to sell goods through measures other than price.

Non-price competition is particularly important for markets where branding is important such as soft drinks, clothes and mobile phones. Firms will try hard to differentiate their products through extra features, good reputation and effective advertising campaigns.

However, the kinked demand curve has limitations. It doesn’t explain how prices were arrived at in the first place. In the real world, it doesn’t explain why prices in oligopoly do change. It is only one theoretical model to explain some behaviour under certain conditions.

Also, if firms seek to maximise market share rather than profit maximisation then they may compete by cutting prices. Although, this makes them less profit, some firms may see increasing market share as the most important long-term objective. If demand is price inelastic, cutting prices will lead to lower revenue, however a firm may feel it is worth it.

This is because cutting prices leads to increased market share, and it may enable a reduction in competition in the long term. Also with higher output they may be able to benefit from economies of scale and get rid of surplus stock. However, price wars are often selective (e.g. supermarkets cutting certain products) or short term. Also, shareholders often prefer profits and dividends to growth maximisations.

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