What happens in an oligopoly if one firm reduces its price?

In an oligopoly, the market is dominated by a small number of firms, which means that the actions of one firm can significantly impact the behavior of others. When one firm reduces its price, it creates an incentive for competitors to respond in order to maintain their market share. If competitors choose to match the price decrease, it could escalate into a price war, which would erode profits for all firms involved.

This response arises from the interdependent nature of firms in an oligopoly. Each firm closely monitors the actions of its competitors, particularly regarding pricing strategies. If one firm lowers prices, rivals may see the need to follow suit to remain competitive, thus leading to price reductions across the market. Such a strategy helps firms prevent losing customers to the firm that has lowered prices, which is why the likelihood of competitors matching a price decrease is high.

In contrast, if firms were to ignore the price reduction, they risk losing market share to the price-cutting firm. Meanwhile, a widespread follow-through on price cuts (widespread price decreases) can create a scenario of minimum profitability for all firms, not just the one that initiated the price reduction. Therefore, the most accurate depiction of the situation in an oligopoly following a price reduction by one firm