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A kinked demand curve

The graph shows a kinked demand curve can result based on how an ologopoly expands or reduces output and how other firms react to these changes.
Consider a member firm in an oligopoly cartel that is supposed to produce a quantity of 10,000 and sell at a price of $500. The other members of the cartel can encourage this firm to honor its commitments by acting so that the firm faces a kinked demand curve. If the oligopolist attempts to expand output and reduce price slightly, other firms also cut prices immediately—so if the firm expands output to 11,000, the price per unit falls dramatically, to $300. On the other side, if the oligopoly attempts to raise its price, other firms will not do so, so if the firm raises its price to $550, its sales decline sharply to 5,000. Thus, the members of a cartel can discipline each other to stick to the pre-agreed levels of quantity and price through a strategy of matching all price cuts but not matching any price increases.

Many real-world oligopolies, prodded by economic changes, legal and political pressures, and the egos of their top executives, go through episodes of cooperation and competition. If oligopolies could sustain cooperation with each other on output and pricing, they could earn profits as if they were a single monopoly. However, each firm in an oligopoly has an incentive to produce more and grab a bigger share of the overall market; when firms start behaving in this way, the market outcome in terms of prices and quantity can be similar to that of a highly competitive market.

Tradeoffs of imperfect competition

Monopolistic competition is probably the single most common market structure in the U.S. economy. It provides powerful incentives for innovation, as firms seek to earn profits in the short run, while entry assures that firms do not earn economic profits in the long run. However, monopolistically competitive firms do not produce at the lowest point on their average cost curves. In addition, the endless search to impress consumers through product differentiation may lead to excessive social expenses on advertising and marketing.

Oligopoly is probably the second most common market structure. When oligopolies result from patented innovations or from taking advantage of economies of scale to produce at low average cost, they may provide considerable benefit to consumers. Oligopolies are often buffeted by significant barriers to entry, which enable the oligopolists to earn sustained profits over long periods of time. Oligopolists also do not typically produce at the minimum of their average cost curves. When they lack vibrant competition, they may lack incentives to provide innovative products and high-quality service.

The task of public policy with regard to competition is to sort through these multiple realities, attempting to encourage behavior that is beneficial to the broader society and to discourage behavior that only adds to the profits of a few large companies, with no corresponding benefit to consumers. Monopoly and Antitrust Policy discusses the delicate judgments that go into this task.

The temptation to defy the law

Oligopolistic firms have been called “cats in a bag,” as this chapter mentioned. The French detergent makers chose to “cozy up” with each other. The result? An uneasy and tenuous relationship. When the Wall Street Journal reported on the matter, it wrote: “According to a statement a Henkel manager made to the [French anti-trust] commission, the detergent makers wanted ‘to limit the intensity of the competition between them and clean up the market.’ Nevertheless, by the early 1990s, a price war had broken out among them.” During the soap executives’ meetings, which sometimes lasted more than four hours, complex pricing structures were established. “One [soap]executive recalled ‘chaotic’ meetings as each side tried to work out how the other had bent the rules.” Like many cartels, the soap cartel disintegrated due to the very strong temptation for each member to maximize its own individual profits.

How did this soap opera end? After an investigation, French antitrust authorities fined Colgate-Palmolive, Henkel, and Proctor&Gamble a total of €361 million ($484 million). A similar fate befell the icemakers. Bagged ice is a commodity, a perfect substitute, generally sold in 7- or 22-pound bags. No one cares what label is on the bag. By agreeing to carve up the ice market, control broad geographic swaths of territory, and set prices, the icemakers moved from perfect competition to a monopoly model. After the agreements, each firm was the sole supplier of bagged ice to a region; there were profits in both the long run and the short run. According to the courts: “These companies illegally conspired to manipulate the marketplace.” Fines totaled about $600,000—a steep fine considering a bag of ice sells for under $3 in most parts of the United States.

Even though it is illegal in many parts of the world for firms to set prices and carve up a market, the temptation to earn higher profits makes it extremely tempting to defy the law.

Key concepts and summary

An oligopoly is a situation where a few firms sell most or all of the goods in a market. 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.

The prisoner’s dilemma is an example of game theory. It shows how, in certain situations, all sides can benefit from cooperative behavior rather than self-interested behavior. However, the challenge for the parties is to find ways to encourage cooperative behavior.

Problems

Mary and Raj are the only two growers who provide organically grown corn to a local grocery store. They know that if they cooperated and produced less corn, they could raise the price of the corn. If they work independently, they will each earn $100. If they decide to work together and both lower their output, they can each earn $150. If one person lowers output and the other does not, the person who lowers output will earn $0 and the other person will capture the entire market and will earn $200. [link] represents the choices available to Mary and Raj. What is the best choice for Raj if he is sure that Mary will cooperate? If Mary thinks Raj will cheat, what should Mary do and why? What is the prisoner’s dilemma result? What is the preferred choice if they could ensure cooperation? A = Work independently; B = Cooperate and Lower Output. (Each results entry lists Raj’s earnings first, and Mary's earnings second.)

Mary
A B
Raj A ($100, $100) ($200, $0)
B ($0, $200) ($150, $150)

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Jane and Bill are apprehended for a bank robbery. They are taken into separate rooms and questioned by the police about their involvement in the crime. The police tell them each that if they confess and turn the other person in, they will receive a lighter sentence. If they both confess, they will be each be sentenced to 30 years. If neither confesses, they will each receive a 20-year sentence. If only one confesses, the confessor will receive 15 years and the one who stayed silent will receive 35 years. [link] below represents the choices available to Jane and Bill. If Jane trusts Bill to stay silent, what should she do? If Jane thinks that Bill will confess, what should she do? Does Jane have a dominant strategy? Does Bill have a dominant strategy? A = Confess; B = Stay Silent. (Each results entry lists Jane’s sentence first (in years), and Bill's sentence second.)

Jane
A B
Bill A (30, 30) (15, 35)
B (35, 15) (20, 20)

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References

The United States Department of Justice. “Antitrust Division.” Accessed October 17, 2013. http://www.justice.gov/atr/.

eMarketer.com. 2014. “Total US Ad Spending to See Largest Increase Since 2004: Mobile advertising leads growth; will surpass radio, magazines and newspapers this year. Accessed March 12, 2015. http://www.emarketer.com/Article/Total-US-Ad-Spending-See-Largest-Increase-Since-2004/1010982.

Federal Trade Commission. “About the Federal Trade Commission.” Accessed October 17, 2013. http://www.ftc.gov/ftc/about.shtm.

Questions & Answers

What is the difference between inferior goods and complementary goods
Bernard Reply
inferior goods are goods whose demand reduces as consumers income increases
rivan
while complementary goods are goods which are jointly demand
rivan
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Bernard
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rivan
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rivan Reply
The Market equilibrium quantity is___ tons of bolts, the socailly optimal quantity of bolt production is ____ tons
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Mohamud Reply
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Brandon Reply
scarcity is the stage at which your end becomes greater than your want.
Caasianebok
what is marginal rate of transformation
Peter Reply
difference between individual demand and market demand with illustrations.
kwagala Reply
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kwagala
Is the total amount of goods and services that all consumers are willing and able to purchase...
Istar
market demad business
zahid
What is the different between demand and supply?
Mohamud Reply
Demand is a natural phenomenon by a person who wants a certain commodity , u can say The ablity to buy a certain commodity at a certain price is called demand
Wardan
supply is point of view from Supplier of certain commodity
Wardan
Thnks wardan sheikh
Mohamud
u can get help from Law of Demand which is When a price of certain commodity increases it's quantity demanded decreases and when the price of certain commodity decreases it's quantity demanded increases and vice versa
Wardan
and to understand supply u can understand by the help of law of supply which is when a price of certain commodity increases it's quantity supplies also increases and when price of certain commodity decreases it's quantity supplies also decreases and vice versa
Wardan
Hope u got the answer
Wardan
hi
Christian
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Victory
what is point?
Asmatullah
pls it's quantity supplied not quantity supplies. tanx
PETER
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Ruchi
Ruchi Shukla it's a big topic which contains several parts , u can understand a market where there are number of employees (skilled and semiskilled )
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kivumbi
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Destiny
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Destiny Abekah the cause Is fun ahahahaha
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impact of transport and communication for economic help me
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What is the formula for calculating elasticity
Destiny Reply
Change in Quantity/Change in price
Abdul
ok
Destiny
E=%∆ in Q/ %∆ in P
ashafa
what mean elasticity
Jimcaale
change in quantity divided by change in price
mukhtaar
ok
Abdul
price elasticity = Q2-Q1/Q2+Q1/2/ P2-P1/P2+P1/2
Wardan
second formula is change in q / change in p × Q(original)/ p (original)
Wardan
Elasticity is just a measurement of change influenced by change in price , income
Wardan
change quantity /change in price
Ayaan
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Muhammad
change in price change in quality
Muhammad
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Godwin
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Saratu
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Destiny
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Destiny
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demand changes when the price of the commodies in the market increaaes
Destiny
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Destiny
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Saratu
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Destiny
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XORO Reply
Price elasticity demand
Saratu
price elasticity supply
Saratu
What are the uses of stastitics in economic and business?
Mohamud Reply
Statistics helps in analysing various economic problems such as inflation, unemployment etc by looking at numbers, trends over the years.
Samuel
it also helps in summarising mass data like income, consumption etc into measures like per capita income and per capita consumptions which are more explanatory of how an economy is performing.
Samuel
Statistics is a data interpretation tool used for collecting, classifying and analyzing data. It is an indispensable tool for an economist to understand various business and economic problems and formulate policies to tackle with them.
Samuel
good answer
Destiny
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Shekwonudiza Reply
What is margin?
Crahmaan
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Wardan Reply
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Leela
i would like to know about GST rather
JNUI
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JNUI
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JNUI
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JNUI
Gst is an essential Tax to boost up National income
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Wardan
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Wardan
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Wardan
the central Government is responsible for such error to not be so prudent under those policies which are applied
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deductive and inductive
Mianosama
deductive and inductive are the parts of micro economics
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What are the key elements to consider when defining economics
Samuel
scarcity, means and end
Balogun
Samuel it is defined as study of house hold Management and money matters .
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scarcity is defined as the point where demand is greater than supply
Wardan
Use scarcity,means and end in your definition
Samuel
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Samuel
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Criminologist
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Wardan
consider a market (where there are buyers and sellers ) situation , Let's make it funny to make u understand more easy that due to some political issues It is announced by the government that every store will be closed tomorrow , the citizens who are intelligent enough to predict consequences for it
Wardan
They will start buying more and more and due to those political issue some stores were closed and few were opened so at this point the demand for product or commodity (which people are willing to buy from stores) is greater than supply
Wardan
What is GDP
XORO

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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