Oligopoly is a market structure, which has some distinctive qualities that separate it from the others. Most notably they are that oligopoly has barriers of entry and is made of only a few companies, which supply the majority of the market and are interdependent. In other market structures price of the product and other decisions are often based on technical information such as marginal cost or demand (when you are a monopoly) but what makes oligopoly unique from all other market structures is that companies cannot base their decisions solely on technical information they must be aware of and react to their competitors.
Oligopoly is also a distinctive market structure because price is not usually used as a competitive tool. There are exceptions of oligopolies that engage in price wars, for example AMD and Intel, semiconductor producers, both use fierce price lowering tactics because when one of them decreases their price of a product the other has nothing else to do but follow in order not to loose a big market share. Intel and AMD price wars are beneficial to the consumers but not to the companies which each year miss their target revenues and get lower profits. Relatively stable prices under oligopoly, which are called sticky prices or rigid prices, is a strong feature of this market structure and this essay will try to explain why such prices exist.
This essay will analyze situations when companies do not coordinate their actions (Non-collusive behavior) and when they do, implicitly (tacit collusion) and explicitly (formal collusion).
I. Non-collusive behavior
Non-collusive behavior is when companies do not coordinate their actions but still react to their competitors. In 1939 Robert Hall and Charles Hitch in UK and Paul Sweezy in USA individually presented a kinked demand curve, which demonstrates a reason why oligopolies do not what to change prices. The kinked demand curve (fig. 1) graph is hypothetical because companies will try to restrain from changing their prices. If a company raises its price, represented in the graph by the demand curve AA then their competitors presumably will not follow them and the first company looses customers. If a company decides to lower its price, represented by BB their competitors will have no choice but to also decrease their prices which would not be beneficial for every company in the market. The demand curve for a company is fused from AA and BB demand curves and has a kink at point P, though it is not exactly clear where the kink occurs exactly. Also in this graph marginal revenue curve MRa - MRb has a discontinuity at the quantity point of the kink. Marginal cost curve crosses marginal revenue curve somewhere at a discontinuity between points QR, though this does not mean that a kink occurs at a point when MR=MC.
Fig. 1 Kinked demand curve. R.L. Hall and C.J. Hitch, “Price Theory and Business Behavior,” Oxford Economic Papers, no. 2 (May 1939): 17
Kinked demand curve is one of the reasons why oligopolies keep their prices more stable though it is not a sole reason. One of the other explanations might be so called menu costs, the price of changing the cost of a product, e.g. reprinting menus at a restaurant, changing price labels at supermarkets, etc. One of the most famous examples of sticky prices was the Coca-Cola Company, which priced its bottle of Coca-Cola at five cents for more than 70 years, from 1886 to 1959. The rigid price was mostly because their vending machines could not accept any other coins, and the price to replace them would be too great (menu cost), also that the next available coin at the time was ten cents, so changing the price would be increasing it by 100%. Another factor for price stability is the number of companies in the market, the fewer there are the more stable the prices.
A good insight on how prices are set and varied...