Price Rigidity Under Oligopoly:
An important characteristic of oligopoly is price rigidity. Whatever be the method of price-fixation, price under oligopoly tends to be rigid. What it means is that price under an oligopoly tends to be fixed or constant despite the changes in demand and cost conditions in the industry. Once established, oligopolistic prices remain constant for several months, nay even for years. For example, the price of an automobile remains unchanged for an entire model year. An oligopolistic price is, as said above, resistant to changes in demand and in costs. It does not move up and down with “every little quiver in demand or every little flutter in costs.” The question now is: Why is an oligopolistic price so rigid? The following may be the reasons for the rigidity of oligopolistic prices:
(1) There is a lot of uncertainty in the case of a non-collusive oligopoly. (Of course, when there is collusion, the element of uncertainty disappears). Due to this uncertainty, every firm is confronted with an indeterminate demand curve. This further results in an indeterminate level of price and output. An alternative (to this situation of uncertainty) on the part of an oligopoly firm is to discover a suitable price that should yield a satisfactory rate of profit. Once such a price is established, the firm will stick to it, whatever the consequences. The firm will continue with this price so long as it secures its reasonable profits. It will not like to experiment with other ‘prices’ because that will create further uncertainty as to the reactions of the rival firms. Such an attitude on the part of oligopoly firms tends to promote price rigidity in the market.
(2) A large oligopoly firm, for reasons of economy in sales-promotion expenditure, may not deem it proper to introduce any change in the existing price of the product. A change in price may prove expensive for the firm concerned; new lists and catalogs will have to be issued, dealers will have to be notified, and so on.
(3) The existing price itself might have been established after a prolonged period of negotiations, conflicts, maneuvers, etc., among the rival firms. No firm would, therefore, like to change it. Any change introduced by any firm will, once again set in motion the same old cycle of negotiations, conflicts, and maneuvers which none of the firms would relish. So the existing price is allowed to continue by all the firms.
(4) An oligopoly firm, when confronted with falling demand, intensifies its sales-promotion activities (advertisement, etc.) to maintain its sales instead of cutting down the price. This appears to be the normal behavior of all firms under an oligopoly.
(5) The price under a collusive oligopoly may be set at a sufficiently lower level to prevent the entry of new firms into the industry. So long as their objective is being achieved, they would not like to upset the existing price which has been set as a result of a formal agreement among the firms.
The most popular model of oligopoly is the model with the kinked demand curve because it offers a convincing explanation of price rigidity under an oligopoly.