Question

Give reasons for Price Stability under Oligopoly.

Answer 1

Reasons for Price Stability (Price Rigidity) under Oligopoly are as follows:

1. Experience of Futility of Price Wars: Individual sellers in an oligopolistic industry might have learned through experience that engaging in price wars is unproductive and detrimental, so they prefer maintaining price stability.
2. Contentment with Current Prices and Profits: Firms may be satisfied with the existing prices, output levels, and profits and thus avoid taking risks associated with changing prices, which could lead to insecurity and uncertainty.
3. Prevention of Entry of New Firms: Firms may prefer sticking to the current price levels to discourage new firms from entering the industry, thus maintaining their market power.
4. Sales Promotion Efforts at Current Price Levels: Firms may focus on intensifying their sales promotion efforts (non-price competition) rather than altering prices, to retain customers.
5. Investment in Advertising: After spending substantial amounts on advertising for their products, firms may be reluctant to raise prices and risk losing the benefits gained from advertising efforts.
6. Collusion or Agreement: If stable prices have been set through agreement or collusion among oligopolists, no seller likes to disturb the price for fear of triggering a price war and an unstable competitive environment.
7. Kinked Demand Curve Explanation: The kinked demand curve model explains price rigidity in oligopolistic markets. Firms believe that if they lower prices, rivals will follow, and if they raise prices, rivals will not follow, leading to asymmetric demand elasticities and a kink in the demand curve which results in stable prices despite changes in costs or demand.