Oligopoly

Define the term ‘Oligopoly’

When a few large firms dominate the industry with each firm having significant market power

Explain three reasons why oligopolies have high barriers to entry and exit.

• It is difficult to enter due to the existing dominance of relatively few firms, meaning that it is difficult to brand loyalty given that it is competed away to these dominant firms who have already established its position in the industry.

• High start-off costs

• Difficult to exit due to the magnitude of sunk costs which are investment’s made that cannot be recovered, for example Advertising and R&D. This also, increases the risk of entering the industry given that firms wishing to enter are aware that they cannot recover these sunk costs and so this deters entry as a consequence

Explain the characteristic of product differentiation

• Highly differentiated

• May be similar to a degree, but is differentiated to the point where customers perceive it as different and so are extremely brand loyal. Therefore, oligopolistic firms face a relatively inelastic demand curve due to the perceived levels of imperfect substitutes

Write a chain of reasoning explaining interdependence (Incomplete as I haven’t finished to topic yet)

• Interdependence: One firms actions will directly affect it’s competitors action

  • Few sellers → Each firm is aware of the actions of others, assuming there is perfect information → Decision of a firm is influenced by the market decisions of its competitors → Firms must consider the likely decisions of its rivals to any change in output, price or non-price competition → (Game theory analysis) → Makes oligopolistic firms highly competitive despite a low number of firms in the industry → …

Explain the characteristic of a high concentration ratio

• Reveals the % of market share a firm has

• Oligopoly exists when top 5 firms in a market account for more than 60% of total market share

• UK supermarket concentration ratio is constantly around 67% (As of 2025)

• Higher the value, the less amount of firms in the industry

Explain the term ‘game theory’

A model used by firms to ensure optimal decisions are made in a strategic setting when there is very high levels of interdependence

Using an industry of your choice, illustrate the payoffs of two firms seeking to change prices.

• If British Airways and EasyJet both keep prices high, they each recieve a payoff of £2bn

• If EasyJet keeps it’s prices low, and British Airways keeps selling it’s aviation services at a high price, than EasyJet will be making a payoff of £3bn as it is more price competitive to aviation consumers and so will gain a greater proportion of market share

• If both EasyJet and British Airways lower the price of its aviation services, than both firms will recieve a lower payoff of £1.5bn. This is because, if both firms have low prices enables consumers to have a wider availability of substitutes and therefore quantity demanded will increase by a smaller percentage than a fall in price given that some customers are competed away, suggesting Inelastic demand,

Using an industry of your choice, use the model of game theory to illustrate a price-war.

Firms in a oligopolistic market may attempt to undercut each-over by deviating to lower prices as they have an incentive to receive higher payoffs and gain market share. If firms continue to lower prices, a price war will break out and supernormal profits will be crowded out in the long-run.

• When the price of AMD and Nividia CPU chips are both high, they receive an equal payoff of £2bn

• Nividia may deviate from this and undercut AMD as it has an incentive to gain a higher payoff of £3bn

• Given that AMD has this same incentive, it may also lower its price and so a price war may break out where both firms attempt to undercut eachover to gain the highest payoff

• As a consequence, both AMD and Nividia will receive a lower payoff as pricing its CPU chips so low means that supernormal profits may be crowded out, assuming demand is relatively price inelastic

Define the term ‘collusion’

When two or more firms agree to limit competition

Define the term ‘overt collusion’

A formal agreement between firms to limit competition or fix prices

OPEC STATS

• Cartel: A group of organisations providing the same products join together to limit output and raise prices

• Oil Producing Exporting Countries

• 42% of global oil production

• 73% of worlds proven oil reserves

• Able to influence the price of oil

• Acts as a pure monopoly

• Organisation’s of countries rather than individual firms and so is not subject to scrutiny by competition authorities

Explain the role of the CMA when investigating overt collusion.

The CMA has made collusion illegal in the UK, and if proven guilty of overtly colluding the firms will be prosecuted,

May include:

• Heavy fines

• 5 year imprisonment

• Director disqualification up to 15 years

• Confiscation of financial assets

Explain the term ‘Whistle-blowing’

When a firm confesses to the CMA for market misconduct. This allows the firm to be subject to the CMA’s leniency programme and receive lower prosecution relative to its colluding firm which may allow it to protect its supernormal profits to a certain degree.

Illustrate and explain the impacts of price fixing

Firms operating in overt collusion may have formal agreements to limit output and undertake in price fixing, which is when competitors agree on a fixed price for all their competing products usually set above the equilibrium price.

• Given that there are few dominant firms in a oligopolistic market, this gives them significant market power and so can engage in restrictive practices because consumers have limited substitutes and so face relatively inelastic demand

• Able to enact a fixed price at P1

• Output quota set at Qp which limits supply and results in subsequent price increases

• This leads to an increase in producer surplus by charging higher prices of P1 at level of output it does produce at Q1 although it may loose producer surplus it could have earned from supplying the additional units of Qe

• Able to make supernormal profits of (P1-C1) x Q1.

• Consumers who are willing to pay a higher price of P1 see a loss of consumer surplus of area P1AB, as well as pricing some consumers out of the market who were only only willing and able to pay the original price of Pe.

• There is now a condition of higher prices and restricted output relative to the allocatively efficient level of output where P=MC, meaning that consumers are unable to enjoy a variety of goods and services

• This leads to an area of deadweight loss of ABC as beneficial trades have been foregoned due to the degree of allocative inefficiency within the collusive oligopoly

How does the impacts of price fixing depend on the compliance of firms

Degree of compliance: In the long-run overt collusion is unsustainable and so some firms may have an incentive to ‘cheat’ and expand production beyond its quota. This is because of the incentive of making supernormal profits from producing in excess of the output quota at Q1. This may lead to an oversupply, which threatens the stability of overtly colluding firms as it may trigger a collapse in market prices and thus detoriates mutual trust amongst members, often resulting in a price war. Ceteris paribus, this fall in price may occur to the point where P=MC, limiting the extent in which consumer welfare is reduced as they are more willing and able to purchase a variety of goods and services that have previously been restricted from this collusion which may promote allocative efficiency to a certain degree.

How does the impacts of price fixing depend on the degree of regulation

Degree of regulation: In the UK, the CMA has made overt collusion Illegal, and if caught and proving guilty of this the overtly colluding firms may be prosecuted to a degree which may include a confiscation of it’s financial assets and substantially heavy fines. This may create a signal to competition authorities to increase regulation, and so these firms may be subject to price regulation such as an imposition of a maximum price set equal to where P=MC assuming that the government has perfect information and successfully quantifies the allocatively efficient level of output. This may limit the extent in which consumer welfare is reduced as they now face a market prices that they are willing and able to pay.

Define the term ‘Tactit collusion’

An unspoken agreement between firms

• May engage in price matching which is when firms monitor the price of the largest firm in the industry and adjusts its prices to match

• Given that there is no formal agreement, it is difficult for competition authorities to prove that collusion has occurred, limiting the effectiveness of regulation

  
  

Define the term ‘price war’

When firms attempt to undercut each-over by repeatedly lower prices, which may crowd out supernormal profit in the long run

Define the term ‘predatory pricing’

When firm’s aggressively lower prices, below its AVC when a new competitor joins an industry in order to drive them out

Define the term ‘limit pricing’

When incumbent firms set a price low enough to deter the entry of new competitors

Illustrate and explain predatory pricing on a diagram

• In order to drive out competition, an established firm may lower it’s price below it’s AVC at Qpred

• Although it is operating below its short-run shutdown point where AVC>MR, an established firm may decide that is able to absorb losses

• If successful, it is able to drive out competitors as they are perceived as more price competitive to consumers, increasing the amount of customers they receive which in turn increases their market share

• In the long run, it is able to reduce the degree of competition and so is able to establish it’s monopoly power to far greater extent

• In turn, it is able to raise prices to Pmax and restrict output, to the profit maximising level of output Qmax

• Therefore, the firm makes supernormal profit of area (P1-C1) x Q1.

Illustrate and explain limit pricing on a diagram

• Incumbent firms will set a lower price of P2 and sell at a level of output Q2, which is below the profit maximising equilibrium but above the competitive equilibrium where P=MC.

• It may be willing to forego some short-run supernormal profits of (P1-P2) x Q1 in order to deter the entry of new competitors

• The limit price of P2 will be below the estimated average cost and marginal cost of the rival firm, as it is not able to benefit from economies of scale to the same extent as incumbent firms in the oligopolistic market.

• Ceteris paribus, this may be below the short-run shutdown point where AVC>AR and so the rival firm may be making a sizeable loss

• Assuming it does not have the sufficient amount of recourses to sustain these losses, it may decide that the risk of entering the industry is too high if it is making insufficient revenue to cover it’s variable costs

• This reduces the no. of new entrants in the industry

• Incumbent firms are therefore, able to limit the degree of competition by setting up these high barriers to entry and so is able to establish it’s monopoly power to far greater extent

• In the long-run, it is able to raise prices to Pmax and restrict output, to the profit maximising level of output Qmax

• Therefore, the firm makes supernormal profit of area (P1-C1) x Q1.

Define the term ‘non-price competition’

Competition that is not based on price but rather on branding, product differentiation and marketing

Explain why some firms may engage in non-price competition

• To avoid a price war, which is where firms attempt to undercut each-over by repeatedly lower prices, which may crowd out supernormal profit in the long run.

Explain why prices are rigid in an oligopoly.

• Assuming the firm has the objective of profit maximisation it will operate where MC=MR

• An increase in selling price, will reduce market share as the firm is perceived as less price competitive which suggests that demand is relatively price elastic

• Conversely, a decrease in selling price will not increase market share to a great extent given that firms operate on interdependence in a oligopolistic market.

• If a firm lowers its price, competitor’s are likely to follow suit and cut price as well in order to protect their market share.

• This will lead to fewer additional customers, as there is a wide range of cheap substitutes now available for consumers which suggests inelastic demand

• Therefore, prices are rigid and due to this oligopolistic firms may engage in non-price competiton

State methods of non-price competition

• Advertising

• Loyalty cards

• Branding

• Quality/Innovation

Explain the consequences of improving product /Innovation

• Given that prices are rigid in a oligopolistic market, it may engage in method’s of non-price competition such as product innovation.

• This may be driven by the fact that firms in oligopolistic competition are able to make high levels of supernormal profits (P1-C1) x Q1.

• This is because there is high barriers to entry due to the existing dominance of relatively few firms, meaning that it is difficult to brand loyalty given that it is competed away to these dominant firms who have already established its position in the industry.

• In 2026, Apple made $112 billion in supernormal profit.

• Now that it has greater levels of retained earnings, it may be able to reinvest it’s long-run supernormal profit’s into R&D in order to speed up technological innovation

• In turn, this improves dynamic efficiency within the smartphone industry.

• This can be seen by Apple where, in Q4 of 2026 it introduced the IPhone Duo, which revolutionised the smartphone industry with its modern, sleek design and well integrated flip-phone interface.

• (Get sales revenue figures once released)

• Apple was therefore able to successfully differentiate itself from its competitors and hence experience improved revenue streams.

• This may positively impact consumers, as they are able to reap more satisfaction from technological innovation as they have access to a greater variety of products which may increase their marginal utility.

• This could lead to improvement’s in consumer welfare in the long-run

• Therefore, oligopolies may be able to promote allocatively efficient outcomes if it is driven by non-price competition which strengthens the case that oligopolies may not always have adverse impacts on society.