Oligopoly and Kinked Demand Curve Paul M Sweezy in 1939 suggested that the ordinary concept of a demand curve

is inapplicable to oligopoly. The assumption that everything else would remain unchanged if an oligopoly changed their price was unrealistic. Oligopoly is therefore more complicated than other models of monopoly or perfect competition and there are several methods used to model oligopoly. An oligopoly is a market form in which a market or industry is dominated by a small number of sellers (oligopolists). Because there are few sellers, each oligopolist is likely to be aware of the actions of the others. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolists needs to take into account the likely responses of the other market participants. Oligopoly is a common market form. As a quantitative description of oligopoly, the fourfirm concentration ratio is often utilized. This measure expresses the market share of the four largest firms in an industry as a percentage. For example, as of fourth quarter 2008, Verizon, AT&T, Sprint, and T-Mobile together control 89% of the US cellular phone market. Oligopolistic competition can give rise to a wide range of different outcomes. In some situations, the firms may employ restrictive trade practices (collusion, market sharing etc.) to raise prices and restrict production in much the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a cartel. A primary example of such a cartel is OPEC which has a profound influence on the international price of oil. Firms often collude in an attempt to stabilize unstable markets, so as to reduce the risks inherent in these markets for investment and product development.There are legal restrictions on such collusion in most countries. There does not have to be a formal agreement for collusion to take place (although for the act to be illegal there must be actual communication between companies)for example, in some industries there may be an acknowledged market leader which informally sets prices to which other producers respond, known as price leadership. In other situations, competition between sellers in an oligopoly can be fierce, with relatively low prices and high production. This could lead to an efficient outcome approaching perfect competition. The competition in an oligopoly can be greater when there are more firms in an industry than if, for example, the firms were only regionally based and did not compete directly with each other. Characteristics Profit maximisation conditions: An oligopoly maximizes profits by producing where marginal revenue equals marginal costs. Ability to set price: Oligopolies are price setters rather than price takers. Entry and exit: Barriers to entry are high.[2] The most important barriers are economies of scale, patents, access to expensive and complex technology, and

strategic actions by incumbent firms designed to discourage or destroy nascent firms. Additional sources of barriers to entry often result from government regulation favoring existing firms making it difficult for new firms to enter the market.[3] Number of firms: "Few" a "handful" of sellers.[2] There are so few firms that the actions of one firm can influence the actions of the other firms.[4] Long run profits: Oligopolies can retain long run abnormal profits. High barriers of entry prevent sideline firms from entering market to capture excess profits. Product differentiation: Product may be homogeneous (steel) or differentiated (automobiles).[3] Perfect knowledge: Assumptions about perfect knowledge vary but the knowledge of various economic factors can be generally described as selective. Oligopolies have perfect knowledge of their own cost and demand functions but their inter-firm information may be incomplete. Buyers have only imperfect knowledge as to price,[2] cost and product quality. Interdependence: The distinctive feature of an oligopoly is interdependence. [5] Oligopolies are typically composed of a few large firms. Each firm is so large that its actions affect market conditions. Therefore the competing firms will be aware of a firm's market actions and will respond appropriately. This means that in contemplating a market action, a firm must take into consideration the possible reactions of all competing firms and the firm's countermoves Non-Price Competition: Oligopolies tend to compete on terms other than price. Loyalty schemes, advertisement, and product differentiation are all examples of non-price competition.

Kinked Demand Curve Under Oligopoly A demand curve with two distinct segments which have different elasticities that join to form a corner or kink. The primary use of the kinked-demand curve is to explain price rigidity in oligopoly. The two segments are: (1) a relatively more elastic segment for price increases and (2) a relatively less elastic segment for price decreases. The relative elasticities of these two segments is based on the interdependent decision-making of oligopolistic firms. The kinked-demand curve is a demand curve comprised of two segments, one that is relatively more elastic, which results if a firm increases its price, and the other that is relatively less elastic, which results if a firm decreases its price. These two segments are joined at a corner or "kink." This demand curve is used to provide insight into why oligopoly markets tend to keep prices relatively constant. The more elasticity segment of the kinked demand curve exists because other firms in the industry are unlikely to match price increases of an oligopolistic firm. The result is a loss of market share and big decreases in quantity demand. The less elasticity segment of the kinked demand curve exists because other firms in the industry are very likely to match price decreases of an oligopolistic firm. The result is no gain in market share and relative small increases in quantity demanded.

An oligopolist faces a downward sloping demand curve but the elasticity may depend on the reaction of rivals to changes in price and output. Assuming that firms are attempting to maintain a high level of profits and their market share it may be the case that: (a) rivals will not follow a price increase by one firm - therefore demand will be relatively elastic and a rise in price would lead to a fall in the total revenue of the firm (b) rivals are more likely to match a price fall by one firm to avoid a loss of market share. If this happens demand will be more inelastic and a fall in price will also lead to a fall in total revenue.

The kink in the demand curve at price P and output Q means that there is a discontinuity in the firm's marginal revenue curve. If we assume that the marginal cost curve in is cutting the MR curve then the firm is maximizing profits at this point.

In the bottom diagram, we see that a rise in marginal costs will not necessarily lead to higher prices providing that the new MC curve (MC2) cuts the MR curve at the same

output. The kinked demand curve theory suggests that there will be price stickiness in these markets and that firms will rely more on non-price competition to boost sales, revenue and profits.

REAL WORLD EXAMPLE The competition within the pharmaceutical industry can be best described as Sweezy Oligopoly. There are relatively few companies that serve many customers and each produces differentiated products. Furthermore, each firm can be certain that a rival will respond with a price reduction not a price increase and there are barriers for entry. Newly patented pharmaceutical products that are the first in class are monopolies; this is short lived however. First in class pharmaceutical products have the highest cost of attrition. Since there are high profits this attracts other firms to develop and market generic drugs and as the number of entries into market increases the firms experience decreasing profits. The Sweezy model has a high analytical value. It is useful for explaining price stability in competitive, non-collusive oligopolies. It is a simple graphic way of illustrating why changing conditions of demand and costs in non-collusive oligopolies are often observed to have no effect on output and price. The model also has high teaching value. It demonstrates the key relationship between demand elasticity and marginal revenue in a managerial decision making context. Specifically, it reveals that price lethargy over time in a non-collusive oligopoly may have a sound rational foundation. ISSUES WITH THE MODEL

There are a few problems with the kinked demand curve model; one is that it fails to explain oligopolies behavior consistently. The second is that is provides no explanation of how any actual price, like P, is established in the first place. Nevertheless, the Sweezy model shows how a firms belief of their rival firms reactions can play a big part in the strategic pricing decisions. 2. Keynes General Theory of Income and Employment or Explain the following concepts Effective Demand and Aggregate Demand Keynes General Theory of Employment :Keynes offered this theory in 1936. Keynes explained in this theory that employment depends upon the income. If the standard of national income is higher then rate of employment will also be higher. On the other hand if the level of national income is lower then the level of employment will also be lower. The equilibrium level of income and employment will be that where aggregate demand is equal to the aggregate supply. ASSUMPTION : 1. It has been assumed that period taken is short run. 2. There is no change in the amount of capital. 3. There is no change in technology and efficiency of labour. 4. There is no foreign trade. 5. There is no government interference. 6. The propensity to consume is stable. 7. There should be no change in the methods of production. 8. There should be no change in a distribution of wealth. 9. Employment is the function of the income. Keynes proved this fact that supply can not create its own demand, and there is no tendency of the economy towards full employment. If at any time aggregate demand falls, then unemployment takes places and if aggregate demand increases then inflation takes place. As regards the question of national income and employment determination it is determined by the aggregate supply and aggregate demand. AGGREGATE SUPPLY :According to Keynes aggregate supply is equal to national income at market price. In other words national income is equal to the price of goods and services produced in the country.The national income is divided into three parts, consumption saving and taxes. So Aggregate supply = National income = Consumption + Savings + Taxes or AS = Y = C + S + T

In the above Figure real national income is measured along OX axis and expected revenue along OY. This 45 degree curve "OS" shows the aggregate supply. It explains that which minimum revenue should be received to the producers and they may be able to produce a particular amount of goods and services and may be able to provide employment to the workers. AGGREGATE DEMAND :Aggregate demand is the amount of consumption and amount of investment expenditure at each level of income. There are two components of aggregate demand. 1. Consumption expenditure ( C ). 2. Investment expenditure ( I ). Aggregate demand can be expressed as Y = C + I Consumption Expenditure :It depends upon the size of national income. If the size of national income is greater then greater amount will be spent on consumption. In other words the marginal propensity to consume is grater then the gap between consumption and income is small and the level of employment will be high. Investment Expenditure :The investment expenditure depends upon the following two factors : 1. Marginal Efficiency of Capital 2. Current Rate of Interest If the marginal efficiency of capital is lower than the rate of interest, the demand for investment will be low. The aggregate demand curve rises upward from left to right. EFFECTIVE DEMAND :According to Keynes the level of income and employment is determined at a point there aggregate demand curve intersect aggregate supply curve. Now by the following diagram we can explain it :

Explanation :- In the above diagram income is measured along OX-axis and consumption and investment along OY. OS curve shows the aggregate supply (45 degree) or C + S line. C + I is the aggregate demand curve. Aggregate demand and supply curves intersect each other at the point "M". M is the point of effective demand and OP is the equilibrium level of national income. If we assume that national income is greater than OP in that situation new equilibrium point will be F. If total expenditure fall short then the aggregate supply, the producer will also reduce the production. Further income and employment will also reduce and again equilibrium will be M. CRITICISM :1. In the under developed countries there are so many other factors which are responsible for unemployment, like over population and lack of skill. 2. Perfect competition is not found in real world. 3. In the long run its chances of success are limited. 4. It is not applicable in socialistic economy. 5. This theory was produced by the depression of 1930 and it is not applicable in ordinary economic condition.