Most markets you actually buy from are oligopolies: supermarkets, banks, mobile networks, petrol stations. The special feature is not that the firms are big. It is that each one has to think about what the others will do before it moves. That is called interdependence, and it changes everything.
📘 What you need to know
An oligopoly is a market dominated by a few large firms, with a high concentration ratio and high barriers to entry.
Firms are interdependent: one firm’s best move depends on what its rivals do.
The concentration ratio adds up the market shares of the biggest few firms.
Collusion means firms cooperate to fix prices or limit output, so the group behaves like a monopoly.
Collusion can be overt (an actual agreement, usually illegal — a cartel) or tacit (no agreement, but everyone follows the price leader).
Game theory and the payoff matrix show why firms often end up in a worse outcome than if they had cooperated.
Because price wars hurt everyone, oligopolists prefer non-price competition.
What makes a market an oligopoly
A few large firms. There may be dozens of small firms too, but a handful hold most of the sales.
High barriers to entry and exit. Start-up costs are enormous, and much of the spending is sunk — you cannot get it back if you leave.
Interdependence. If one supermarket cuts prices, the others notice within a day and respond.
Product differentiation. Even where the good is basically identical, like petrol, branding makes customers loyal.
Abnormal profit can last in the long run, because the barriers keep new firms out.
Measuring it: the concentration ratio
The concentration ratio tells you what share of the market the largest firms hold between them. A five-firm ratio around 60% or above is normally treated as an oligopoly.
Concentration ratio
CRn = combined sales of the largest n firms ÷ total market sales × 100
The grey bar matters as much as the teal ones. All the remaining firms together are smaller than Firm A alone, so none of them can discipline the big five on price.
Collusion: acting like one big firm
If a few firms compete hard on price, they all end up with lower profits and roughly the same market shares as before. So there is a strong temptation to stop competing and agree on a price instead. When they do, the group behaves like a monopoly — higher price, lower output, bigger profit.
Overt collusion
An actual agreement to fix prices, set output quotas, or block new entrants. The strongest form is a cartel. It is illegal in most countries.
Price fixing
Output quotas that limit supply
Agreeing what to pay suppliers
Tacit collusion
No meeting, no agreement, no evidence. Firms simply watch the largest firm and copy its price. This is price leadership.
Very hard for regulators to prove
Similar effects on consumers
Usually a little less profitable than a cartel
Effects on consumers are the same either way: higher prices, less output, weaker incentives to improve quality or innovate. That is why collusion is treated as market failure.
Game theory: why firms end up worse off
Game theory is a way of writing down decisions when the result depends on somebody else’s choice too. Any game has three parts: the players, the strategies open to them, and the payoffs for each combination.
Read a payoff matrix one cell at a time. In each cell, one number is Firm A’s profit and the other is Firm B’s.
Work through it as Firm A. If B cuts, cutting gives A 20 rather than 8. If B keeps prices high, cutting gives A 40 rather than 30. Cutting wins either way, so A cuts — and B reasons identically.
🤔 Why cartels are unstable
Look at the green cell again. Both firms are earning 30, but each one can jump to 40 by quietly breaking the agreement and undercutting. Every member of a cartel has that same private incentive to cheat, and every member knows the others have it too. That is why cartels keep collapsing even without a regulator getting involved.
Price and non-price competition
🧩 Three types of price competition
Price wars — rivals repeatedly undercut each other to win market share. Shares barely move, but everyone’s profit falls.
Predatory pricing — deliberately pricing below cost to drive a new entrant out, then raising prices again. Usually illegal.
Limit pricing — keeping the price low enough that entering the market does not look worth it to outsiders.
Because price competition is so damaging, oligopolists usually compete in other ways: branding and advertising, loyalty cards, packaging, after-sales service, free delivery, warranties and sponsorship. The aim is the same — win customers without triggering a price war.
A neat way to remember it: in an oligopoly, cutting your price is copied within a week, but building a brand takes years for a rival to copy. That is why the advertising budget is bigger than the discount budget.
Worked examples
WORKED EXAMPLE 1
Annual sales ($m) are: Firm A 340, Firm B 260, Firm C 175, Firm D 130, Firm E 95, all other firms 200. Calculate the five-firm concentration ratio. [2]
Step 1: Add the top five firms’ sales340 + 260 + 175 + 130 + 95 = $1,000mStep 2: Find total market sales1,000 + 200 = $1,200mStep 3: Turn it into a percentage1,000 ÷ 1,200 × 100 = 83.33…CR5 = 83.3% (1 d.p.)Do not forget to include “all others” in the total. It is the classic slip.
WORKED EXAMPLE 2
Using the payoff matrix above, explain the outcome you would expect and why it is not the best outcome for the two firms. [4]
Step 1: Look at it as Firm A
If B cuts, A earns 20 by cutting vs 8 by not → cut.
If B keeps prices high, A earns 40 by cutting vs 30 by not → cut.
Step 2: Name it
Cutting is A’s dominant strategy, and B faces the identical choice.
Step 3: The outcomeBoth cut price and each earns $20mStep 4: Why it is not the best
If both kept prices high they would each earn $30m. Acting in self-interest leaves both worse off.
Always test both of your rival’s choices before naming a dominant strategy.
💡 Exam tip
Use the word interdependence early. It is the defining feature and examiners look for it.
In a payoff matrix, state clearly which number belongs to which firm before you reason.
Test a dominant strategy properly: check what happens under each of the rival’s options.
Distinguish overt and tacit collusion by name. It is a quick, easy definition mark.
For evaluation, remember cartels are unstable: there is always an incentive to cheat.
Non-price competition explains why oligopoly prices are often sticky even when costs move.
⚠ Common mix-up
Thinking oligopoly means exactly two or three firms. It means a few firms dominate, however many small ones exist.
Confusing collusion with a merger. Colluding firms stay separate; they just stop competing.
Reading the payoff matrix diagonally. Each cell has one payoff per firm — identify whose is whose first.
Saying a five-firm ratio covers five firms but writing four numbers. Count them.
Assuming collusion is always illegal. Tacit collusion breaks no law, which is exactly why it is hard to stop.
Treating price wars as good news. They help consumers briefly but can drive out rivals and leave less competition later.
Up next: Monopolistic Competition — many small firms, easy entry, and a demand curve that slopes down just a little because every firm’s product is slightly different.
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