Sweezy Oligopoly

1. Sweezy Oligopoly Here we introduce the notion of Oligopoly and look at one particular model.

2. Oligopoly In general, oligopoly is a market structure where there are a few firms in the industry. Examples might be the auto industry, soft drink industry or the computer operating system industry. A key feature of oligopoly is that firms understand their interdependence. The outcome for one firm depends upon what other firms in the industry do.

3. Sweezy model • A key assumption of the Sweezy model of oligopoly is that each firm believes that • Rivals will not match price increases, • Rivals will match price declines. • You and I know consumers buy less at higher prices. If a firm raises price the consumers want less. With the assumptions above, when a firm raises its price, not only do consumers want less, but the firm will lose some to other sellers because they have not matched the higher price.

4. Sweezy model Since other firms match price decreases, the only consumers you will get are those that want the good at the lower price, but you won’t steal from other firms because they match your lower price. The reasoning above leads to a demand curve for a firm that has a “kink” in it at the current price. Let’s see this on the next screen.

5. Kinked demand P The steep demand is when others follow the price change – we only use the bottom half. The flat demand is when others do not match the price change – we use the top half. The demand for the firm is the solid segments. Q

6. MR P We saw before when demand is downward sloping the MR is as well. Here we just take the relevant piece of MR from the relevant demand. The MR curve is also kinked and has a horizontal segment. Q

7. MC = MR P With MR having a vertical range, MC has a range where it can come through and give the same price and output level. MC range

8. Conclusion The Sweezy model is useful when we see an oligopoly industry that does not change much in terms of pricing and output decisions. MC can come through in a large range and not change P or Q. This model has limited relevance and we need to study other situations as well.

9. P D MR Q An idea we established before is that at a given quantity the price on the demand curve is higher than the MR. Another point to consider is that at a given dollar amount the quantity on the MR is one-half the quantity on the demand curve. For Example, in the graph I have a horizontal line at the height shown. If the quantity is 20 on the demand the quantity is 10 on the MR.