How price and output is determined under oligopoly

In oligopolistic industry, there are only a few big firms which control the supply of a commodity and each firm produces a significant portion of the market. They are, therefore, mutually interdependent. In other words, we say the behaviour of the firm directly affects and is affected by the action of the rival firms. The firms under oligopoly are motivated by two opposing forces, one force moves them to co-operate with one another so that the profit of each firm are maximized. The other force takes the away from the joint profit maximizing price and profit.

Under oligopoly the pricing theory is fundamentally the same with the difference that the larger the number of firms, the greater will be the differences in the marginal costs and more remote will be the possibility of collusion or agreement, whether taxeit or explicit. When they all deal in a standardized product and each is producing a considerable portion of total output, the price and output policy of each is likely to affect the other apprcialy but none can foretell precisely how. The price which will be fixed in oligopoly without product differentiation is thus inderminate.

In case there is a product differentiation monopoly agreement are even less likely. Since the products are not similar, any producer in oligopoly can raise or lower his price without any fear of losing customers or of immediate reactions from his rivals. Cut throat competition is unlikely. However keen rivalry among them may create conditions of monopolistic competition. The price in the long run may settle at a level between the monopoly price and that under cut throat competition.

It is often noticed that price under oligopoly is stable. It is neither much responsive to changes in demand nor to the changes in the supply. For instance if demand increases, no firm will venture to raise the price for fear that other firms may not raise the price and it may lose the market. Nor will it lower price for the fear that the other firms may also lower their price and deprive it of any initial advantage.

Similarly, changes in costs too, do not much affect price and output under oligopoly. For instance, if wages have gone down, each firm may like to reduce the price, but it is not sure if others too will not lower theirs. In competitive industry action of no single firm can affect the conditions in the industry, for the number of firms is very large. But under oligopoly the number of firms is very small and step taken by anyone firm is likely to produce some reaction on the others. As Tarshis remarks “Thus it is quite possible for demand and cost to change frequently and yet to produce no changes, or at any rate very few changes in price. Thus existence of oligopoly accounts for some of the price inflexibility that characterises our economy.

The oligopolists avoid experimenting with price changes. He knows that if he raises the price, he will lose his customers and if he lowers it, he will offend his rivals. He has a clientele of his own when there is product differentiation. Why shout he experiment? He is therefore content to leave price and output as they are.