1.5.5a Characteristics and definition of oligopoly (A-level only)

Oligopoly Is a Few Interdependent Firms Behind High Barriers to Entry

1. Oligopoly is a market dominated by a few large firms with high barriers to entry.
2. Its key feature is interdependence: each firm anticipates rivals' reactions.
3. Oligopolies vary widely in the number of firms, the degree of product differentiation and ease of entry.
4. It can be defined by structure (high concentration) or by conduct (strategic behaviour).

The Concentration Ratio Sums the Market Shares of the Largest Firms

1. The n-firm concentration ratio adds up the market shares of the largest n firms.
2. A high ratio signals a concentrated, oligopolistic market.
3. It is read from market-share data, usually as a four-firm or five-firm ratio.

Interdependence Forces Each Firm to Anticipate Rivals' Reactions

1. With few rivals, one firm's move affects the others directly.
2. Each must guess how rivals will respond before acting.
3. This uncertainty drives strategic behaviour and tends to produce price stability.

Define Oligopoly by Concentration and Conduct, Not Firm Numbers Alone

1.5.5b Collusion and the kinked demand curve (A-level only)

Firms May Collude Overtly or Tacitly, but the Incentive to Cheat Makes It Unstable

1. In a collusive oligopoly firms coordinate their decisions; in a non-collusive oligopoly they act independently and compete.
2. Collusion is an agreement to limit competition, and can be overt (a formal cartel) or tacit (an informal understanding).
3. Cooperation, such as joint research or shared standards, can be legal and beneficial, whereas collusion to fix prices or output is anti-competitive and usually illegal.
4. A cartel fixes price or restricts output, so firms act like a monopoly.

A Payoff Matrix Reveals Each Firm's Dominant Strategy

1. A two-firm matrix shows each firm's profit for each pair of choices.
2. A dominant strategy is the best choice whatever the rival does.
3. When both cut price, they end up worse off than if both had held.

Each Firm's Incentive to Undercut Makes Cartels Unstable

1. Each firm can gain by secretly undercutting the agreed price.
2. If one cheats, the others follow, and the cartel collapses.
3. Cartels hold best with few firms, easy monitoring and stable demand.

Find Each Firm's Dominant Strategy in the Matrix

The Kinked Demand Curve Explains Price Rigidity in Non-Collusive Oligopoly

1. The kinked demand curve explains stable prices in non-collusive oligopoly.
2. A firm assumes rivals match a price cut but not a price rise.
3. So demand is elastic above the current price and inelastic below it.

Neither Raising nor Cutting Price Looks Attractive, so the Price Sticks

1. Raise the price and rivals hold theirs, so the firm loses many sales.
2. Cut the price and rivals match it, so the firm gains few sales.
3. Either move looks unattractive, so the price tends to stick.

With Price Rigid, Firms Compete on Branding, Quality and Service

1. With price rigid, firms turn to non-price competition.
2. Branding, quality and service become the main weapons.
3. This helps explain the stable prices often seen in oligopoly.

Draw Demand Elastic Above and Inelastic Below, with a Broken MR Curve

1.5.5c Non-price competition and pricing strategies (A-level only)

Non-Price Competition Wins Customers by Adding Value Rather than Cutting Price

1. Non-price competition means attracting and keeping customers by changing something other than price.
2. Instead of cutting price to win sales, a firm improves its product, builds its brand, or adds value through the service around the sale.
3. It is the normal way firms behave in oligopoly and monopolistic competition, where goods are differentiated and a price cut often just triggers a price war.

Firms Add Value Through Advertising, Branding, Loyalty Schemes, Quality and Service

1. Each of the following methods works by making the product more attractive at its current price rather than by making it cheaper.
2. Advertising and marketing
   1. Advertising builds awareness and shapes preferences, as with the John Lewis Christmas advert or Coca-Cola's global campaigns.
3. Branding
   1. A strong brand makes buyers loyal and less sensitive to price, which is why Apple can charge a premium.
4. Loyalty schemes
   1. Rewards for repeat custom lock buyers in, such as the Tesco Clubcard and Nectar points.
5. Packaging and design
   1. Distinctive packaging helps a product stand out on the shelf and signals quality.
6. Quality improvements
   1. Better materials, reliability or features raise the product's appeal without a price change.
7. After-sales service
   1. Warranties, support and easy returns reassure buyers, as with Kia's seven-year warranty in the UK car market.
8. Product innovation
   1. New or improved products keep a firm ahead of rivals, as with smartphone makers releasing new models each year.

Firms Also Coordinate Prices Through Leadership, Agreements and Cartels

1. Price methods include price wars, predatory pricing (to drive out existing rivals) and limit pricing (to deter potential entrants).
2. Under price leadership, one firm sets the price and rivals follow.
3. Informal price agreements and cartels can coordinate prices, giving some gains of collusion, though cartels are illegal in the UK.

Rigid Prices Push Firms to Compete Non-Price and Make Demand Less Elastic

1. In oligopoly, prices are often rigid because a price cut is quickly matched by rivals, leaving everyone worse off.
2. A price rise loses customers to firms that hold their price, which is the logic behind the kinked demand curve.
3. With price a dangerous weapon, firms turn to non-price methods to gain an edge.

Non-Price Competition Brings Benefits and Costs That Must Be Weighed

1. Non-price competition creates both gains and costs, and strong answers weigh them rather than listing methods.
2. Benefits: consumers gain more choice, better quality and useful information; innovation can drive long-run improvements, supporting dynamic efficiency; and firms build stable revenue without a damaging price war.
3. Costs: heavy advertising is an expense that can be passed on in higher prices; persuasive advertising may create wants rather than inform, wasting resources; and established brands entrench incumbents and make entry harder.

Build the Chain of Reasoning from Method to Profit

1.5.5d Interdependence and evaluation of oligopoly (A-level only)

Oligopoly Can Help or Harm Consumers Depending on How Firms Behave

1. Because oligopolists are interdependent, each anticipates rivals' reactions, and this uncertainty shapes whether they collude or compete.
2. Oligopoly can harm consumers where firms collude and restrict output.
3. But it can benefit them through economies of scale and innovation.
4. The outcome depends on whether firms collude or compete.

There Is a Case for and Against Oligopoly

1. Against: collusion, higher prices and allocative inefficiency.
2. For: economies of scale and stable prices.
3. For: supernormal profit that can fund research and dynamic efficiency.

The Verdict Turns on Collusion, Competition and Contestability

1. Where firms collude, oligopoly looks much like monopoly and harms consumers.
2. Where they compete, or the market is contestable (easy for new firms to enter and challenge the incumbents), outcomes improve.
3. The dynamic gains from scale and innovation can offset static losses.
4. On balance, oligopoly is neither uniformly good nor bad, and the verdict turns on conduct and contestability.

Judge Oligopoly by Collusion and Contestability