Why do a few large firms behave so differently from many small ones?
The characteristics of oligopoly, concentration ratios, interdependence and the kinked demand curve, collusion and cartels, and price and non-price competition.
An answer to AQA A-Level Economics 4.1.5, covering the characteristics of oligopoly, concentration ratios, interdependence and the kinked demand curve, collusion and cartels, and price and non-price competition.
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What this dot point is asking
AQA wants you to describe the characteristics of oligopoly, measure concentration, explain interdependence using the kinked demand curve, distinguish collusive from competitive behaviour, and explain price and non-price competition. Game theory is the recommended way to show interdependence.
Characteristics and concentration
Key features are a high concentration ratio, high barriers to entry, interdependence between firms, and differentiated products. UK examples include supermarkets, banking and mobile networks.
Interdependence and the kinked demand curve
The kink creates a vertical discontinuity (gap) in the marginal revenue curve. Provided the marginal cost curve passes through this gap, the profit-maximising price and output stay the same even if costs change, reinforcing price rigidity. Game theory adds depth: in the prisoner's dilemma, the dominant strategy can lead both firms to a worse outcome than cooperation, which models both price wars and the temptation to break a cartel.
Collusion and cartels
Collusion may be overt (formal), such as an explicit cartel, or tacit (informal), such as price leadership where firms follow a dominant firm's price. It raises prices and profits at consumers' expense and is illegal under UK and EU competition law, enforced by the Competition and Markets Authority. Cartels are unstable because each member has an incentive to cheat by secretly undercutting the agreed price, the prisoner's dilemma in action, so they tend to break down.
Price and non-price competition
Where firms compete, they may use price competition (price wars, predatory pricing, limit pricing to deter entry) or, more commonly, non-price competition: advertising and branding, product quality and innovation, loyalty schemes, and customer service. Non-price competition is favoured because it avoids the mutual losses of a price war and builds durable brand loyalty.
Exam-style practice questions
Practice questions written in the style of AQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
AQA 20199 marksUsing the kinked demand curve, analyse why prices in an oligopolistic market tend to be stable.Show worked answer →
A 9 mark analysis question rewards a developed chain and an accurate diagram.
- Set-up
- Draw demand with a kink at the current price. Above the price demand is elastic (rivals do not match a price rise, so the firm loses many sales); below it demand is inelastic (rivals match a price cut, so the firm gains few sales).
- MR discontinuity
- The kink creates a vertical gap in the MR curve. As long as MC passes through this gap, the profit-maximising price and output do not change even if MC shifts.
- Conclusion
- Firms have little incentive to change price in either direction, so prices are sticky. Markers reward the elastic-above, inelastic-below logic and the MR gap.
AQA 20219 marksAssess the view that collusion between firms in an oligopoly always harms consumers.Show worked answer →
A 9 mark assessment question needs balance and a judgement.
- Harm
- Overt or tacit collusion (cartels, price leadership) raises prices and restricts output, transferring welfare from consumers to producers and creating allocative inefficiency, which is why it is illegal under UK competition law.
- Possible benefit
- Joint action can fund research and set common standards, and stable prices may aid planning; supernormal profit can finance innovation that benefits consumers over time.
- Instability
- Cartels often break down because each member can gain by secretly undercutting (a prisoner's dilemma), so harm may be limited.
- Judgement
- Collusion usually harms consumers, but the extent depends on enforcement and whether any efficiency gains are passed on. Markers reward a supported stance.
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Sources & how we know this
- AQA A-level Economics (7136) specification — AQA (2015)