Price rigidity refers to the phenomenon where prices in a market remain relatively stable or inflexible, even in the face of changes in supply and demand conditions. This concept is particularly relevant in the context of oligopoly markets, where a few dominant firms have the power to influence and control prices.
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Price rigidity in oligopoly markets is often attributed to the fear of retaliation from competitors, as firms are reluctant to initiate price changes that could trigger a price war.
Firms in an oligopoly may engage in tacit collusion, where they coordinate their pricing decisions without explicit communication, leading to price rigidity.
The kinked demand curve theory suggests that firms in an oligopoly face a demand curve with a kink at the current market price, which creates a disincentive for them to change prices.
Government regulations, such as price controls or minimum wage laws, can also contribute to price rigidity in certain markets.
Price rigidity can have implications for the efficiency of resource allocation and the distribution of economic surplus in an oligopoly market.
Review Questions
Explain how the fear of retaliation from competitors can lead to price rigidity in an oligopoly market.
In an oligopoly, firms are aware that any price changes they initiate may be met with a swift response from their competitors. Firms are reluctant to lower prices, fearing that their competitors will match the price cut, leading to a price war that would erode their profits. Similarly, firms are hesitant to raise prices, as they fear that their competitors may not follow suit, causing them to lose market share. This mutual understanding and fear of retaliation creates an environment of price rigidity, where firms are unwilling to deviate from the current market price.
Describe the role of the kinked demand curve theory in explaining price rigidity in oligopoly markets.
The kinked demand curve theory suggests that in an oligopoly, firms face a demand curve with a kink at the current market price. This kink arises from the assumption that if a firm raises its price, its competitors will not follow suit, leading to a significant loss in market share. Conversely, if a firm lowers its price, its competitors will match the price cut, leading to a smaller increase in market share. This asymmetric response to price changes creates a disincentive for firms to deviate from the current price, resulting in price rigidity in the market.
Analyze how collusion among firms in an oligopoly can contribute to price rigidity, and discuss the potential implications for market efficiency and economic welfare.
In an oligopoly, firms may engage in collusion, either explicitly or tacitly, to coordinate their pricing and output decisions. By colluding, firms can maintain a higher market price and avoid price competition, leading to price rigidity. This collusive behavior can have significant implications for market efficiency and economic welfare. Price rigidity resulting from collusion can lead to a misallocation of resources, as the market price may not accurately reflect the true scarcity of goods and services. Additionally, the lack of price competition can result in higher prices for consumers, reducing their economic surplus and leading to a less efficient distribution of economic benefits. Policymakers may intervene to address collusive practices and promote greater competition, which can help alleviate the issues associated with price rigidity in oligopoly markets.
An oligopoly is a market structure characterized by a small number of firms that dominate the market and have the ability to influence prices and output levels.
The kinked demand curve theory suggests that in an oligopoly, firms face a demand curve with a kink at the current market price, leading to price rigidity.