Why do oligopolies suffer from price rigidity and interdependence? (15)
An oligopoly is where a few large firms have the majority of the market share. Oligopolies often suffer from price rigidity, which is when prices stay inflexible and sticky and can be demonstrated on a diagram called the kinked demand curve. They also often suffer from interdependence, which is where the actions from one firm will have an effect on the sales and revenue of other large firms in the market.
The Kinked Demand curve shows how oligopolies suffer from price rigidity, as this is where the firms will make most profit. If a firm were to raise their price to p1, none of the firms would follow and therefore would lose revenue from as decrease in output. If a firm was to decrease their prices however, this could cause a detrimental affect on the market. When the firm decreases their price, the other firms will have to compete with this, as they will all be losing revenue, much like the current supermarket economy. Aldi and Lidl have come in with low prices and thus have stolen much of the market revenue, causing the other firms to now start to match Aldi and Lidl’s prices in order to reclaim lost consumer spending on their products. A new firm will not undercut the current firms price due to the large barriers to entry and therefore they would suffer large losses to start with due to initial large costs.
Due to interdependence, 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. For example, an oligopoly considering a price reduction may wish to estimate the likelihood that competing firms would also lower their prices and possibly trigger a price war. Or if the firm is considering a price increase, it may want to know whether other firms will also...