Economics – The allocation of resources - The role of markets in allocating resources | e-Consult

In an oligopoly, the actions of one seller are highly significant because there are only a few firms competing. Each firm must consider how its competitors will react to its decisions.

Price Change by One Seller: If one seller lowers its price, it will likely attract customers away from its competitors. This will put pressure on the other sellers to respond. They might lower their own prices to remain competitive, leading to a price war. If all sellers lower their prices, the overall market price will fall, and the quantity traded will increase.

Price Increase by One Seller: If one seller raises its price, it risks losing customers to its competitors. If the other sellers do not raise their prices, the seller with the higher price will likely see a decrease in demand and a reduction in quantity sold. However, if the other sellers raise their prices as well, the price increase might be sustained, and the seller with the higher price could maintain its profitability.

Price Wars: A price war occurs when sellers repeatedly lower their prices in response to each other's price cuts. This can be damaging to all firms in the market, as it reduces profitability and can lead to losses. Price wars are often a result of firms trying to gain market share or to prevent competitors from gaining market share.

Strategic Considerations: Oligopolistic firms often engage in strategic behavior, anticipating their competitors' actions. They might choose to maintain prices even if a competitor lowers its price, hoping that the competitor will not sustain the price cut. They might also collude (illegally) to fix prices and restrict output, but this is generally illegal and carries significant penalties.