Oligopoly and Duopoly

Oligopoly is a market form with only a few sellers, each large enough that its price or output decision visibly affects its rivals — the defining feature is mutual interdependence. Because a change by one firm invites a reaction from the others, oligopoly has no single, universally accepted theory of price the way perfect competition and monopoly do; instead economists use several models, each capturing a different assumption about how rivals react.

Duopoly is the simplest special case, with exactly two sellers. Augustin Cournot's classical duopoly model assumes each seller decides its own output level on the assumption that the rival's output will stay unchanged — each firm reacts to the other in successive rounds until both settle at an output neither wants to change unilaterally, called the Cournot equilibrium.

The kinked demand curve theory (associated with Paul Sweezy) explains a commonly observed feature of oligopoly — price rigidity — without needing a single-firm reaction function. It assumes that if a firm raises its price above the prevailing level, rivals will not follow, so the firm loses a large share of its customers (demand above the current price is relatively elastic). But if the firm cuts its price, rivals will match the cut to avoid losing customers, so the firm gains very little extra sales (demand below the current price is relatively inelastic). The demand curve therefore has a sharp "kink" at the prevailing price, and this creates a vertical gap in the firm's marginal-revenue curve. As long as marginal cost passes through this gap, the profit-maximising price and output do not change even when costs shift moderately — which is why oligopoly prices in the real world often stay unchanged for long p …