1) Oligopoly is when a particular market is controlled by a small group of firms. For example supermarkets, there are three (there usually exist three companies) companies which dominate the market, Wong and Metro, Santa Isabel and Plaza Vea, and Tottus. The main assumptions that economists make when talking about a situation of Oligopoly are various; three or four large companies dominate the industry, but small companies do exist (smaller companies in the recent example would be for example “Arakaki”, a sole trader company); firms are interdependent, al will watch what the competitors do and act accordingly (when Wong created the “Bonus” card, it did not even passed a week when Santa Isabel created the “Más Más” card); the existence of the kinked demand curve (which we will see what it is on question b);
there are barriers to entry, this means it is difficult for other firms to enter the industry; non price competition, as companies cannot compete by prices, therefore they have to compete with the service they offer (for example the “Bonus” and the “Más Más” cards); the oligopoly must be collusive (collusion), this means when the companies, which dominate, work together to maintain very high prices at the expense of the consumer (for example Umbro and Adidas, sell football shirts at very high prices, as a Manchester United shirt costs approximately $50), companies which work together to maintain high prices should be fined, as it is illegal. Advertising is also essential to maintain a high profit and market share, and also something very important, which is to develop brand loyalty (for example, once I began to buy “Sony” electro domestics, I begin to have a brand loyalty, as I never had a single problem with them).
2) The causes of price stability (when prices are stable, without any change) existing in a situation of Oligopoly are two. The first reason is due to the shapes of the Demand curve (AR). Putting an example of gasoline stations, if there are three companies in this market (Shell, Texaco and Mobil), and if one company, for example shell, decides to increase its prices, no other company will follow, and its sales will decrease by a lot (there will be no incentive for companies to increase prices as consumers have other companies to buy gasoline from, therefore it is elastic as there has been a small change in price but a big change in demand).
A company will also not lower its prices because all other companies in the industry will do the same (as
people will go to where prices are lower), and there will be very few benefits, also profits will decrease, as sales increase by only a small amount (there has been a big change in price but a small change in demand, therefore inelastic). Firms will leave the price unchanged, and the firms will have to use other objects to compete with each other, this includes product differentiation through advertising and innovation. The price elasticity of demand looks at the responsiveness of QD to a change in price.
It is better for companies to therefore use the same price and find other ways of increasing their sales, for example to use non price competition in order to increase sales. “The solution concludes that there is a determinant and stable price-quantity equilibrium that varies according to the number of sellers. In effect each firm makes assumptions about its rival’s output. Adjustment or reaction follows reaction until each firm successfully guesses the correct output of its rivals”.
The second reason of price stability in Oligopoly is, if a company maximises its profits where MC=MR, therefore the point where this two curves cross will give us the price and the quantity the company should provide. The marginal revenue curve is not continuous, as it has a very big gap in it, this is called the “Region of Indeterminacy”, and the MC curve can pass through any part of this region, this gap in the MR curve, allows MC to vary without affecting either final price or quantity. For prices to change, costs would need to rise above MC”.