hello and welcome back to our discussion on oligopoly we have looked at possible oligopolistic
uh decision making process through game theory and uh in this module we are going to look
at pricing in case of oligopoly so if oligopolistic uh firm behaviour is ruled uh majorly by the
moves and actions of the rivals then how do the oligopolistic firms decide what prices
to charge and what output to produce so uh so there are certain implications of
the prisoners dilemma on pricing so we have seen already with lot of examples that because
the prisoners dilemma exists that is the dilemma whether to collude whether to trust the other
players and uh stick to the agreement or whether to go by ones own self interest uh this is
the dilemma that all the firms are facing and that is the reason that uh pricing choices
uh could be different .
so what are the implications of this dilemma on pricing in case of a oligopoly firm first
is the kinked demand curve so summarizing implications of the prisoners dilemma is the
first thing is the kinked demand curve which we uh looked at a few modules back so the
demand is kinked at the currently prevailing price and is elastic above this price and
inelastic below so the demand is kinked at the currently prevailing
price because here is the dilemma for the firms whether to change the price or not and
we have seen that the firms uh they know that if they would like to increase the price the
other firms are probably not going to follow suit in that case this particular firm is
going to lose lose all its customers to the other firms
Hence the demand curve is flat or highly elastic above this price that is if the price is to
be increased the laws of demand for this firm is going to be really huge but on the other
hand if the firm is to reduce the price then it knows that probably it is not going to
uh get a huge increase in output or a huge increase in demand for its product because
other firms are also going to follow suit in this uh in uh reducing the price and hence
the impact on quantity or the impact the output effect that we say that when there is a price
decline the output is going to increase that does not happen and the firm kind of
uh faces a inelastic demand curve below this price so its all uh but but uh one thing which
needs to be kept in mind is the firm faces this kinked demand curve because it perceives
the actions of its rivals in this way the firm perceives that the rivals are probably
not probably not going to increase the price if it increases the price and the other firms
are probably going to reduce the price if the firm reduces its price
so acting on this speculation uh the the firm kind of faces a kinked demand curve so this
kinked demand curve results in a price rigidity we have seen that the kinked demand curve
has a marginal revenue curve which has a break in the in between so it has a break where
the kinked happens and in this break and in this range we have shown through diagram shown
through theoretical modeling that if the marginal cost fluctuates within that range if the marginal
cost is to go up in that range the firm is probably not going to increase its price
so the firm is sticky or rigid about changing its price for a certain range of costs its
probably going to take the cost on itself and not pass it on to the uh consumers for
the fear that it is going to lose its consumers to the other firms so this is called price
rigidity which the producers are reluctant to change prices even if costs or demand changes
another 2 more things that can happen because of prisoners dilemma on pricing so since all
the firms are acting with this prisoners dilemma in oligopolistic setup it is possible for
the firms to go for tacit collusion so that is possible uh and 2 examples are one is price
signaling and other is called the price leadership so basically as we have been repeatedly saying
uh while discussing oligopoly that uh the oligopolistic firm keeps a watch on the price
movements of its rivals but at the same time uh explicitly colluding
with the firms and deciding on a monopoly output and monopoly price is not a proof by
law so they cannot do that and it is obviously not uh legally enforceable also but there
are situations where the firms signal to each other that i would so although the firms are
firms fear the uh fear that they are going to lose consumers when the price uh when they
increase the price yet they would like to signal to its to their uh to the other competitors
in the market that i am going to increase the price and uh so do you
so this is the kind of price signaling so the firms might uh feel that if i increase
the price it is possible for the firms to increase their other firms to increase their
price as well so this is called price signaling where it is a implicit collusion where a firm
initiates a price rise with the hope that the other firm will follow suit
so this is a this is a very common phenomena in a oligopolistic market structure and it
happens uh its its a kind of tacit agreement and price signaling can happen in a lot of
ways say for example in the airlines industry uh it may happen that uh one of the airlines
is contemplating a rise in its prices in one of the routes and it raises the price but
keeps a watch on the other competitors if they are following suit
now one uh possibility is that the other firms emboldened by the price rise of this one firm
is by price rise of one of its competitors they also increase their price so if they
increase their price so the objective of the first firm increasing their increasing uh
its price is uh fulfilled now what happens if the other firms do not increase their price
so usually what happens in case of the airlines
uh industry they are going to try this price increase during the say weekend so during
the weekend when the when the fare fares are low they are going to try this and if they
see that the other uh uh competitors in the market are not increasing their price they
will immediately come back to the uh lower their price and come back to the original
price now then again in the following weekend it
will again increase the price so that is a very clear signal to the competitors that
you have to increase your price otherwise i may go for deep discounting and actually
i may end up getting your uh uh customers so this is this is the kind of price signaling
which happens in the market but one thing that needs to be kept in mind here is price
signaling is not always about uh illegal collusion or the firms going for monopoly pricing
uh it could have a economic rationale behind it say for example this has been very uh citing
the example of professor george hay of institute of competition law where uh he says he cites
the example of 2 petrol pumps say imagine that there are 2 petrol pumps on a highway
and there are no uh petrol pumps for miles altogether so all the cars and vehicles which
are passing through the highway they are dependent on only these 2 petrol pumps so it is a oligopolistic
market in this entire locality so for quite a few kilometers these are the
2 uh 2 petrol pumps in the market the only 2 petrol pumps in the market who are splitting
the market between themselves so now imagine that each of the petrol pumps is charging
a uh price of say 68 rupees per litre of petrol now one of the petrol pumps now each of the
firms they know each of the petrol pumps obviously they are splitting the market they are in
the same region same locality so their cost structures are also probably the same and
they are just splitting the market between themselves so may be the equal number of customers
are almost going to each of the uh petrol pumps
now they know each of the firms each of the pumps they know that they could act as a monopoly
if they uh would if they want to because in that entire area there is no other petrol
pump and the uh all the cars are completely dependent on these two
so one of the petrol pumps knows that it is possible to charge a price of 72 rupees per
litre of petrol instead of 68 and it would really like to do so because it knows that
if i increase the price to this much we can i can have monopoly profit and uh basically
and if the other pump also follows the same price then both the firms together we are
going to get a monopoly profit and we are going to split the uh number of customers
equally amongst ourselves But there is no way it can communicate this
directly to the other pump That is illegal it cannot do do that so what it does is it
goes for price signaling in the market in the sense that it is going to increase its
price uh on its own without uh making any uh without informing or sitting face to face
with the other pump and deciding on the price it just takes the chance to increase its price
now isnt it risky yes it is risky for this firm for this pump say lets call this pump
a now it is risky for pump a because as soon as it increases the price it will lose a whole
lot of vehicles who will immediately go to pump b if pump b continues to charge 68 instead
of 72 as the pump a is charging so that is a huge risk that pump a is taking
now from the point of view of pump B it is very similar to the pepsi and coke example
that we took now what are the choices in front of pump b now pump b knows that if it does
not follow the rise in price by pump a so for a brief period probably for 5 days it
is going to get the major of the vehicles on the highway
but after that probably the other pump is going to go back to its lower price of 68
will continue to charge the lower price will continue to charge the same price as uh pump
b and they will go back to earning the profit that they were earning earlier so and the
other option to pump b is to since a has already raised its price let me also raise my price
and it knows in that case it is going to get a monopoly profit which will be higher than
the profit that it was earning earlier so in that case both a and b continue to earn
a higher profit for all the periods to come in the first case where pump b decides not
to raise its price it earns a higher profit only for a very brief period so in that case
it makes sense for pump b to raise its price also and both the firms have been able to
raise their price successfully and continue to earn a higher profit
so this is where this is a form of price signaling where actually firm a or the petrol pump a
has not communicated anything to the other pump it has acted on its own taken a chance
taken a risk acted on its own and the other pump just followed it so this is a price signaling
that can happen in the market another form of uh tacit collusion is price leadership
price leadership one of the firms acts as the price leader and announces price changes
and the other firms follow so what happens in the case of a kinked demand curve we said
that there is a range between in range where the firms are wary of changing the price although
the costs may increase or the demand may have come down so they are reluctant to increase
the price so they fear increasing the price but it is
not always clear to the firms where exactly is the end of the kink or end of the break
in the marginal revenue and where it is safe to increase the price and the other firms
are going to increase the price so in that case in a industry or in a market what usually
happens is the firms basically follow a price leader
they basically follow a price leader so if one of the firms has increased its price so
everyone follows suit because they know that the situations are such that it makes sense
to increase the price and for one thing in case of price leadership in most circumstances
the unless it is a very aggressive uh uh price leader or a very aggressive uh firm which
has decided to cut prices to emerge as the dominant player in the market in most other
situations the firms are going to increase the price only when the costs have increased
or demand has gone down and which is going to probably affect the entire industry as
a whole in the entire market as a whole and that is where one firm is going to take the
initiative of increasing the price and the other firms basically follow
so one typical example is in the uh case of the banks banks have this prime lending rate
a prime lending rate is the rate which the banks charge to their uh the most established
biggest corporate clients now this prime lending rate is dependent on the money market in movements
in the money market of the economy and is dependent on all the rates of interest in
the all the rates of interest are basically correlated to this uh rate of interest in
the uh in in banking now the banks again since they could oligopolistic
uh banks few banks who are lending it is possible that they would be reluctant to change this
lending prime lending rate because they dont want to lose these big corporate uh customers
so there could be a price leader who understand understands the changes in the money market
and knows that uh the the rates are going to be high for some periods to come because
of changes in the economy and it takes initiatives to increase this lending rate and all the
other banks follow so this is a example of price leadership .
now to talk a little more in details price leadership can be of 3 types one is the dominant
price leadership now dominant price leadership happens when uh there is one single large
firm in the market it is a dominant player in the market and it basically its almost
like a monopoly uh may not be a monopoly but its almost like a monopoly and it it is its
a very big uh firm and since its a big firm catering to it has economies of scale and
uh probably since its a big firm which has emerged as a dominant player it has uh better
and more more efficient cost conditions and it decides its prices on the basis of its
own cost and uh demand in the market and the price that it charges since it is the dominant
player in the market since its a one large firm in this market and the price that it
charges the other firms just have to follow this price because uh it this big firm is
catering to the major part of the market so the firm the price that this firm is charging
the other smaller firms have to follow this price and adjust their output and uh output
accordingly because the other firms are just catering to the residual demand in this market
but this is a dominant price leadership and the price leader here almost acts as a monopoly
and it does not is it is not concerned about the cost or demand conditions of the other
smaller firms in the market so it is almost acting like a monopoly and it is not behaving
like a it probably does not have any prisoners dilemma so it is not going to consider the
actions or reactions of the other firms in the industry and it is just going to change
its price depending on its own cost conditions and demand and other firms are going to just
follow suit and they are behaving like a oligopolistic um like oligopolistic firm
the second kind of price leadership is barometric price leadership now barometric price leadership
can happen when there is a barometer firm what do we mean by barometer firm basically
this is a firm which probably gauges the changes in individual demand and cost first in the
market it is the first to understand changes in demand and cost conditions in the market
and uh hence it basically changes the price and probably the other firms have accepted
the role of this so this barometric price leadership this barometer
firm may not be a dominant player in the firm it may not a very large firm in the market
yet it is possible for it to behave as the price leader because probably it has a history
of judging the movements in the market judging the movements of demand and cost in the market
better than the other firms in the market and the other firms basically uh trust the
price movement the price the price set by this firm and they also follow suit
so barometric price leadership is another form of price uh leadership and uh third is
the aggressive price leadership now in case of aggressive price leadership it is possible
for a small firm a small entrant in the uh market also to go for aggressive pricing that
is it tries to establish its foothold in the market and accordingly it charges a very low
price a competitive price and uh other firms are forced to follow it because otherwise
their uh their customers are going to be taken away by this very aggressive uh pricing policy
of this firm so that is a aggressive price leadership which
can also happen in a market so so these are the different ways in which uh pricing could
be influenced in a in a oligopolistic market framework and some of it is allowed by law
because they are going by their economic rational of setting a price but collusion any explicit
collusion amongst the firms to behave as a monopoly is not approved by law and that is
something which the firms cannot do they cannot do this and that is the reason
that uh basically uh collusion or cartel formation they are uh intrinsically they are unsustainable
they they cannot sustain for long because uh the firms do not trust each other and there
they eventually at least one of the firms they it uh goes by self interest and breaks
the agreement which leads to breaking of the entire cartel thank you