How does an oligopolist set prices and maximize profits?
The oligopolist maximizes profits by equating marginal revenue with marginal cost, which results in an equilibrium output of Q units and an equilibrium price of P. The oligopolist faces a kinked‐demand curve because of competition from other oligopolists in the market.
An oligopolist cannot assume that its competitors will not change their price and/or output if it changes. Price change by one firm will be followed by other competitors, which will change the demand conditions facing this firm. Therefore, demand curve for any firm is not fixed like other markets.
They would set quantity at the point where marginal revenue equals marginal cost, and set price at the corresponding point on the demand curve. Compare the quantity and price of an oligopoly with those of a monopoly.
By making consumers aware of product differences, sellers exert some control over price. In an oligopoly, a few sellers supply a sizable portion of products in the market. They exert some control over price, but because their products are similar, when one company lowers prices, the others follow.
Prices in an oligopolistic firm
Prices fluctuate less in an oligopolistic market than in a perfectly competitive market due to the varying degree of barriers to entry in the respective market. In an oligopoly, there are high barriers to entry.
Oligopolists earn their highest profits if they can band together as a cartel and act like a monopolist by reducing output and raising price. Since each member of the oligopoly can benefit individually from expanding output, such collusion often breaks down—especially since explicit collusion is illegal.
Oligopolies can be criticised on a number of obvious grounds, including:
- High concentration reduces consumer choice.
- Cartel-like behaviour reduces competition and can lead to higher prices and reduced output.
An oligopoly is a market characterized by a small number of firms who realize they are interdependent in their pricing and output policies. The number of firms is small enough to give each firm some market power.
(a) P = SMC: The total profits of a firm become maximum at the output where marginal cost is equal to marginal revenue. Under perfect competition a firm is to sell all the units of its output at the same market price. For this reason market price becomes equal to a firm's marginal revenue in this type of market.
There are 4 Pricing Methods that can help you put a price on what you sell: replacement cost, market comparison, discounted cash flow/net present value, and value comparison.
What are the techniques of setting a price?
- Mark-up Pricing Method: This is the most commonly used method. ...
- Perceived-value pricing Method: Perceived-value pricing is a market-oriented method for setting the price. ...
- Going-rate Pricing Method: ...
- Sealed-bid Pricing Method: ...
- Target Return Pricing: ...
- Break-even Analysis Method:
Oligopolies are price setters rather than prices takers. High barriers to entry and exit. The most important barriers are government licenses, economies of scale, patents, access to expensive and complex technology, and strategic actions by incumbent firms designed to discourage or destroy nascent firms.
There are 3 basic theories about oligopolistic pricing: kinked-demand theory, or non-collusive oligopoly, the cartel model, and the price leadership model.
The government sets prices to ensure that specific goods and services are sold fairly to every citizen. Price controls on goods can be set by two types: price ceiling and price floor. It forms a bracket where one is the maximum price and the other is the minimum price.
This competition of sellers against sellers and buyers against buyers determines the price of the product. It's called supply and demand. The price is the measure of how scarce one product is compared to all other products and all incomes.
Oligopolies set prices through leadership of one firm or cartels. In both cases the prices are higher than in a market with perfect competition. The firms often do not compete on price but rather choose to compete on alternative parameters such as product quality.
The market power of an oligopoly is such that it bars entry to new firms, limiting competition, and is generally bad for consumers because it causes higher prices.
In an oligopoly market when the price of a commodity is decreased the competitors response by decreasing the price of their brand so as to exist in the market, whereas when the price increases there is no response by the competitors.
There is limited competition in an oligopoly, which makes the prices sticky. In other words, the prices in an oligopoly are inflexible because the few producers in the market have informally agreed upon a specific price point so as to sustain competition.
An oligopoly can earn positive economic profit in the short run. This can only occur when the oligopoly decreases the price of the products while the competitors retain their set price. The positive profit margin depends on the purchasing power of the consumers.
What are the 4 characteristics of oligopoly?
- Firms are interdependent.
- Product differentiation.
- High barriers to entry.
- Costs and Expenses.
- Supply and Demand.
- Consumer Perceptions.
Determinants of Price in Marketing
The Utility and Demand. The extent of Competition in the market. Government and Legal Regulations. Pricing Objectives.
- Few Sellers and Many Buyers. There are few firms. ...
- Homogeneous or Differentiated Products. Products may be either homogeneous or differentiated. ...
- Restricted Entry. Entry into the industry is legally free. ...
- There is Perfect Knowledge or Information about the Market. ...
The market price of an asset or service is determined by the forces of supply and demand. The price at which quantity supplied equals quantity demanded is the market price. The market price is used to calculate consumer and economic surplus.
- Provide the service first, then build the model around it. ...
- Evaluate your competition. ...
- Be results oriented. ...
- Look to your customers. ...
- Determine cost analysis and supply/demand. ...
- Keep it simple. ...
- Determine the value and ROI.
In a monopoly, the price is set above marginal cost and the firm earns a positive economic profit. Perfect competition produces an equilibrium in which the price and quantity of a good is economically efficient.
Cost-Based Pricing. Value-Based Pricing. Competition-Based Pricing.
- Step 1: Selecting the pricing objective. ...
- Step 2: Determining demand. ...
- Step 3: Estimating costs – ensuring profits. ...
- Step 4: Analysing Competitors' Costs, Prices, and Offers. ...
- Step 5: Choosing your pricing method. ...
- Step 6: Determining the final price.
- Market research. ...
- Value. ...
- Cost of goods. ...
- Labor. ...
- Distribution. ...
- Economies of scale.
What are the two factors to consider when setting prices?
- Competitors – a huge impact on pricing decisions. ...
- Costs – a business cannot ignore the cost of production or buying a product when it comes to setting a selling price.
A monopolist is considered to be a price maker, and can set the price of the product that it sells. However, the monopolist is constrained by consumer willingness and ability to purchase the good, also called demand.
Under it, one firm acts as the price leader and fixes the price for the product while other firms follow it. Price leadership is of three types: low-cost firm, dominant firm, and barometric.
Three important factors are whether the buyers perceive the product offers value, how many buyers there are, and how sensitive they are to changes in price.
Price control is an economic policy imposed by governments that set minimums (floors) and maximums (ceilings) for the prices of goods and services in order to make them more affordable for consumers.
A price setter is an entity that has the ability to set its own prices, because its products are sufficiently differentiated from those of competitors. A firm is better able to set prices when it has a significant amount of market share and follows a clear pricing strategy.
Costs determine the floor for the price that the business can charge. Thus, cost-based pricing sets the price based on the costs of production, distribution and also selling the product.
Price ceilings and price floors are the two types of price controls. They do the opposite thing, as their names suggest. A price ceiling puts a limit on the most you have to pay or that you can charge for something—it sets a maximum cost, keeping prices from rising above a certain level.
When it comes to setting the price of the product, then it involves two parties; the marketing team and production staff. However, the marketing team comprises of company's management, top executives, and marketing staff. They consider how the product would play out in the market.
Profit maximisation is a process business firms undergo to ensure the best output and price levels are achieved in order to maximise its returns. Influential factors such as sale price, production cost and output levels are adjusted by the firm as a way of realising its profit goals.
Where do oligopolies maximize profit?
The profit maximizing point for colluding oligopolies is found where MR=MC, where price is Pc, just as in a monopoly. Because of cutthroat competition, oligopolies may instead act as perfect competitors, moving the profit maximizing point to where demand and MC intersect, just as in perfect competition.
The kinked-demand curve explains why firms in an oligopoly resist changes to price. If one of them raises the price, then it will lose market share to the others. If it lowers its price, then the other firms will match the lower price, causing all the firms to earn less profit.
Oligopolists maximize profit overall when they cooperate and form an artificial monopoly.
When competing, oligopolists prefer non-price competition in order to avoid price wars. A price reduction may achieve strategic benefits, such as gaining market share, or deterring entry, but the danger is that rivals will simply reduce their prices in response.
Price leadership occurs when a leading firm in a given industry is able to exert enough influence in the sector that it can effectively determine the price of goods or services for the entire market. This type of firm is sometimes referred to as the price leader.
Golden rule of profit maximization. The firm maximizes profit by producing where marginal cost equals marginal revenue.
Why do markets dominated by oligopolies result in high prices for the consumer? Oligopolies often compete on a non-price basis, which is expensive. The costs are passed on to consumers.
- Few sellers. There are just several sellers who control all or most of the sales in the industry.
- Barriers to entry. It is difficult to enter an oligopoly industry and compete as a small start-up company. ...
- Interdependence. ...
- National advertising.
Oligopoly characteristics include high barriers to new entry, price-setting ability, the interdependence of firms, maximized revenues, product differentiation, and non-price competition.
Oligopolies are price makers. Fewer suppliers in the market offer sellers a higher power to control the price of their products. The sellers are the price setters but are under the control of a single firm. The oligopolists enjoy the pricing power provided by the lack of competition in the market.
How an oligopolist determines its price level based on cartel theory?
The cartel members choose their combined output at the level where their combined marginal revenue equals their combined marginal cost. The cartel price is determined by market demand curve at the level of output chosen by the cartel.
By controlling prices, oligopolies are able to raise their barriers to entry and protect themselves from new potential entrants into the market. This is quite important, as new firms may offer much lower prices and thus jeopardize the longevity of the colluding firms' profits.
Firms in an oligopoly set prices, whether collectively—in a cartel—or under the leadership of one firm, rather than taking prices from the market. Profit margins are thus higher than they would be in a more competitive market.
The best illustration of an oligopoly is the automobile industry. An oligopoly is a market with imperfect competition in which a few major businesses dominate the industry as the automobiles industry dominates numerous others by providing identical goods and services.
OPEC is the best example of oligopoly.