Oligopoly
In one line. An oligopoly has a few large interdependent firms behind high barriers to entry. The kinked demand curve explains price rigidity, firms lean on non price competition, and they face a constant tension between colluding to raise prices and competing in a price war. H2 only.
Exam relevance: a core H2 microeconomics theme, firms and market structures recur across essay and case study almost every year, on ETG analysis. Taught the way an economics tutor who wrote the answer keys teaches it.
01What an oligopoly is
An oligopoly is the structure most real markets resemble: a handful of large firms, each big enough that what one does affects the others.
H2 only. This whole topic, costs, economies of scale and market structures, is H2 content. H1 students do not study it, so if you are taking H1 Economics you can skip this page.
An oligopoly is a market structure dominated by a few large firms, protected by high barriers to entry, whose decisions are mutually interdependent.
Because there are only a few firms, each must consider how rivals will react before changing its price or strategy. That interdependence is the defining feature of the structure and the source of almost everything else on this page.
02Few firms and interdependence
With only a few large firms, each one's market share is big enough that its actions visibly affect rivals, and rivals will respond.
High barriers to entry, large economies of scale, heavy setup costs, brand loyalty and control of supply chains, keep the number of firms small and protect their position. A useful sign of an oligopoly is a high concentration ratio, where a small number of firms hold a large combined share of the market. Mutual interdependence means no firm can plan in isolation; each anticipates the reaction of the others.
03The kinked demand curve and price rigidity
Interdependence produces a distinctive demand curve with a kink at the prevailing price, which explains why oligopoly prices tend to be sticky.
Each firm assumes rivals will match a price cut but not follow a price rise. So if it raises price it loses many customers (elastic demand above), and if it cuts price it gains few because rivals cut too (inelastic demand below). With little to gain either way, the firm leaves its price unchanged, which is price rigidity.
04Non price competition
Because changing price is risky, oligopolists compete mostly on factors other than price.
Non price competition includes branding and advertising, product differentiation, quality, loyalty schemes, service and bundling. It builds a more durable customer base without inviting the retaliatory price cuts that a price war would bring, which is why it is so common in oligopolistic markets such as fast food, supermarkets and airlines.
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05Collusion versus competition
Interdependence pulls oligopolists two ways: they can cooperate to act like a monopoly, or they can compete and risk a price war.
- Collusion. Firms may agree, formally as a cartel or tacitly through price leadership, to fix prices or output and raise joint profit toward the monopoly level. Collusion is unstable, because each firm has an incentive to cheat, and it is typically illegal under competition law.
- Competition. Alternatively firms may compete, occasionally through price wars or predatory pricing, which can be mutually destructive and lower revenue for all.
06Game theory intuition
The choice between colluding and competing has the structure of a strategic game, which is a useful way to see the tension.
Each firm would be better off if all colluded and held prices high, but each also has a private incentive to undercut and win extra sales. Because every firm reasons the same way, the temptation to cheat makes collusion fragile and competitive outcomes hard to avoid. This is the basic game theory intuition; the formal payoff analysis is reserved for class.
07Common misconceptions
Explain price rigidity through the kinked demand curve and interdependence, not just "firms set MC equals MR". A common error is to describe an oligopoly as if it were a monopoly and ignore the interaction between rivals, which is the whole point of the structure.
08Test yourself
- Use the kinked demand curve to explain why oligopoly prices tend to be rigid.
- Explain why an oligopolist often prefers non price competition to a price cut.
- Why is collusion in an oligopoly inherently unstable?
Key terms on this page
OligopolyInterdependenceKinked demand curvePrice rigidityCollusionNon price competition
09Questions students ask
An oligopoly is a market structure dominated by a few large firms protected by high barriers to entry, where each firm's decisions depend on how rivals are expected to react, a feature called mutual interdependence. This interdependence explains the kinked demand curve, price rigidity, the heavy use of non price competition, and the tension between colluding and competing. This is H2 content.
It explains price rigidity in oligopoly. Each firm believes rivals will match a price cut but not a price rise, so its demand curve is more elastic above the prevailing price and more inelastic below it, giving a kink at that price. Raising price loses many customers while cutting price starts a damaging price war, so firms tend to keep the price stable.
Because price competition in an oligopoly can trigger a mutually destructive price war, a race to the bottom that lowers everyone's revenue. Non price competition, branding, advertising, product differentiation, loyalty schemes and quality, is a more sustainable way to win customers without inviting retaliatory price cuts.