There is no general theory which can explain pricing and output decisions in all kinds of oligopoly situations.
Thus, it is said that price and output under oligopoly is indeterminate. It is due to interdependence of other firms and absence of well defined goods.
However, the price of a commodity is determined by its demand and supply. In monopoly and competition, firms make decisions and take action without considering how these actions will affect other firms and how, in turn, other firm’s reactions will affect them. Thus they have definite demand (Revenue) curves.
“In a perfectly competitive model, each firm ignores the reaction of other firms because each firm can sell all that it wants at the going market price. In the pure monopoly model, the monopolist does not have to worry about the reaction of rivals since by definition there are none.” Prof. Miller
In case of oligopoly, there is interdependence of the firms. Hence the decisions of a firm will affect the other firms which in turn will react in a way that affects the initial firm. This causes uncertainty. Thus it is difficult to take decision of the demand curve of an oligopolist.
We cannot use the downward sloping curve as oligopolist is not a monopolist. We cannot use a horizontal demand curve because the oligopolist is not a perfect competitor. We can simply make an assumption about the interaction among the oligopolists there is a new model of price determination under oligopoly. The inability of an oligopolist. So firm to predict with certainty the reaction of its rivals makes it virtually impossible to estimate the demand and marginal revenue data faced by an oligopolist. So without such data, firms cannot determine their profit maximising price and output.
For the indeterminate price and output under oligopoly, reasons are as following:
1. Conflicting Behaviour:
In oligopoly due to interdependence, different behaviour becomes possible. According to Prof. Baumol, “Under the circumstances a very wide variety of behaviour patterns becomes possible. Rivals may decide to get together and co-operate in the pursuit of their objectives so far as the law allows, or, at the other extreme they may try to fight each other to the death.” Even if they enter into agreement it may last or it may break down. And the agreements may follow a wide variety of pattern.” There is not a single model of analysing price-output determination under oligopoly.
2. Indeterminate Demand Curve:
Another cause of indeterminateness of price and output in oligopoly is indeterminate demand curve. We know that each firm closely watches the actions of other firms because the actions of one can dramatically affect the others. Due to the interdependence, an oligopolitic firms cannot have a definite demand curve since it keeps shifting in response to the reactions of rivals. Prof. Baumol has observed, “The firm’s attempts to outguess one another are then likely to lead to interplay of anticipated strategies and counter strategies which are tangled beyond hope of direct analysis.” In this way, actions and reactions of rival firms make the demand curve indeterminate.
3. Profit Maximisation is Not the Only Motive:
The motive of profit maximisation as followed by firms in perfect competition and monopoly enables the firms to have a determinate solution to the price-output problem. At the same time, in oligopoly the firms may have other motives like sales maximisation, security maximisation etc. The variety of motives also contributes to the indeterminateness of price and output considerably.
4. Different Institutional Arrangements:
The industries exhibiting oligopolistic organisation differ widely in their institutional arrangements for different firms. In practice, there may be as ‘many varieties of arrangement as the number of industries.’ As William Fellner has observed that, there is a strong tendency towards some kind of understanding or collusion among the few firms under oligopoly.
There may be tacit or gentleman’s agreement among them to follow particular policies; firms may decide to follow a dominant or low cost leader firm; and many others. In short, the institutional arrangement of the oligopolistic industry will depend on many factors.
(i) The stage of development of the industry will determine entrepreneur’s knowledge of market conditions, the probable reactions to be expected from rival enterprises and in general, the intensity of competition.
(ii) It depends upon the relative sizes of various firms in the industry and the motivation of those in controls-whether; they are ambitious to expand their shares of the market, or are content to let sleeping dogs lie.
(iii) The existence or lack of price leadership has also to be taken into account.
5. Oligopolistic Interdependence:
The most outstanding factor that differentiates an oligopoly from monopolistic competition is the interdependence between various firms in their decision making. Every firm under oligopoly knows that at least some of his rival’s decisions depend on his own behaviour, and it must take this fact into account in his own decision-making.
6. Oligopolistic Uncertainty:
Another serious difficulty under oligopoly arises directly out of a firm’s need to take account of its competitor’s reaction patterns. When a firm’s manager thinks about making a decision, he takes into account the likely response of his competitors to it, but he has to recognize that his competitor too. The firms, thus, attempt to outguess one another. Thus, uncertainty always prevails regarding price and output.
7. Price Rigidity Non-Price Competition:
Oligopoly markets are characterized by rigid prices. Once a price comes to prevail, it continues for years as such in spite of changes in costs and demand. Firms tend to stick to the established price and limit their competitive effort to non-price competition i.e., changes in the design and advertising of the product.
Even, Hall and Hitch and Paul M. Sweezy, have put forward the ‘kinked demand curve hypothesis’ to explain it. But it has not been viewed as an altogether satisfactory attempt. Similarly, Professor Chamberlin’s insights into non-price competition have proved valuable but not always applicable.
8. Existence of Non-Profit Motives:
The marginalist economic theory provides good results on the basis of the fundamental assumption that every firm strives to get maximum profits by equating its marginal costs with marginal revenue. This is turn requires that it is possible to calculate marginal cost and marginal revenue and that businessmen actually do so. Under oligopoly situations, there are many other motives than profit- maximization such as security and sales maximization, risk minimization etc. It has not been possible so far to combine these non-profit aims with profit maximization and to find out the way the firm makes its price- output decision.
9. Conflicting Attitudes of Firms:
Firms do not always have a co-operative attitude towards each other rather the attitudes are conflicting under oligopoly. At one time, the rival firms may realize the disadvantages of competition and may have a desire to unite so as to maximize their joint profits. Thus two conflicting attitudes are at work under oligopoly-one of co- operation and united action and the other of conflict. This creates an atmosphere of indeterminacy under oligopoly.
From the above explanation, it is clear, that since there is no single solution to the price and output problem in oligopoly, the price is said to be indeterminate. To quote Furguson and Maurice, who say, “There is no theory of oligopoly in the sense ‘that there is a theory of perfect competition or of monopoly’. There is no unique general solution but merely many different behavioural models, each of which reaches a different solution.”