[OPE-L:5488] price determination by oligopolies

From: Gerald_A_Levy (Gerald_A_Levy@email.msn.com)
Date: Wed May 02 2001 - 22:25:52 EDT

Re Steve K's [5482]:

I agree that the (neo-) neo-classical models of
perfect competition and pure monopoly should
be rejected (for a whole host of reasons). 

However, I continue to think that even after
those models are abandoned, concepts including
the price elasticity of demand and the income
elasticity of demand are useful in comprehending
pricing decisions in oligopolistic markets.

The degree to which the firm strategy of product
differentiation has been successful in creating
brand loyalty allows oligopolies to set prices
in a more arbitrary manner than would be the
case in less concentrated markets (here we do
not have to assume PC to compare oligopolistic
markets to more competitive markets in e.g. the
Smithian sense).  In other words, the success of
firm product differentiation strategy allows firms
to mark-up the market price over the value of
the commodity produced. 

Although there is thus somewhat arbitrary price
setting by oligopolies (and there are lots of
non neo-classical models that offer formulas
for oligopolistic price determination, e.g. by 
Eichner and Sylos-Labini), there are LIMITS
on the extent to which oligopolies can mark-up
prices over value.  One can observe that these
limits do in fact exist if one considers the price
and income elasticities of demand.

E.g. let's say that it costs Nike $3 to produce
a pair of sneakers and that they then sell those
sneakers in the marketplace for $170. It would
seem that there is then an inelastic demand 
curve for Nike sneakers. This is not really the 
case, though. E.g. if they offered those same
sneakers  for sale for $1,000 then I believe 
demand would decrease. It thus only appears
that there is a rigidly inelastic demand curve for 
these sneakers and that for consumers the
"sky is the limit" in terms of price. This is an
illusion, though. Relatedly, if  the income of
working-class consumers goes down far enough
and the commodity was produced for sale to
the working-class, then the income elasticity
of demand would suggest rightly that there can
be expected to be a decrease in demand for that

Of course, the above by no means exhausts
this subject. E.g. the extent to which firms can 
increase price over value is also related to 
whether there are substitute goods that can be
purchased by consumers. For some goods,
often including utilities and energy, there are 
few if any substitutes (although huge price 
increases by oligopolies in these branches can 
stimulate research on alternative goods that can 
then become available in the future). For others, 
there are substitutes. E.g. Planter's Peanuts is 
a well-established brand. This doesn't mean,
though, that they can charge _any_ price for
their nuts because consumers can purchase
substitutes (e.g. "no-name" generic peanuts).

So, I think that some of the concepts associated
with elasticity are useful in comprehending the 
limits to which oligopolies can mark-up the prices
of commodities. And, it should be remembered
that oligopolies have different degrees of 
monopoly power depending on the market,
the nature of the commodity produced (e.g. is
it a 'necessity'?), and the availability of 
substitutes.  These concepts can be used, along
with the concepts associated with product
differentiation and oligopoly pricing, to help
establish a *range* of prices in which oligopolies
are able to price their output.

In solidarity, Jerry

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