Oligopoly and Game Theory (A Level Economics)

Oligopoly (A Level Economics) is the market structure you actually live in. A few big firms sell you your groceries, your phone contract, your energy and your petrol. Each one watches the others before it moves. That watching is called interdependence, and it is the whole topic. This page gives you the characteristics, the concentration ratio calculation, the kinked demand curve diagram, collusion and cartels, the prisoner’s dilemma payoff matrix, a worked example in pounds and three exam-style questions with the answers derived.

Spec map: where oligopoly sits on your board

Section numbers are from the AQA specification (the PDF numbers this section 4.1.5.5, the web version 3.1.5.5), the Edexcel specification (Issue 2), the OCR specification (v3.0, June 2026) and the Cambridge syllabus for 2026 to 2028, all checked in September 2026. One difference matters: AQA and OCR name the kinked demand curve, Edexcel does not; Edexcel and Cambridge name the prisoner’s dilemma, AQA does not. Learn both anyway. The other market structures are on the perfect competition and monopoly page.

What you must be able to do

• List the characteristics of oligopoly and explain why interdependence is the one that matters.
• Calculate an n-firm concentration ratio from market shares or sales figures, and say what it shows.
• Draw the kinked demand curve and use it to explain why prices in oligopoly stay put.
• Distinguish collusive from non-collusive oligopoly, overt from tacit collusion, and a cartel from price leadership.
• Read a 2 × 2 payoff matrix, find each firm’s dominant strategy and explain why a cartel is unstable.
• Evaluate whether oligopoly is good or bad for consumers, with non-price competition and dynamic efficiency on the other side.

What makes a market an oligopoly

Four things, and every board lists them. A few large firms dominate the market. Barriers to entry are high, so they stay dominant. Products are usually differentiated by brand, not identical. And firms are interdependent: what one does depends on what it expects the others to do. That last one is the definition examiners want. A supermarket does not just ask “what price maximises my profit?”. It asks “what will the others do if I cut?”.

Concentration ratios: measuring how few is “few”

An n-firm concentration ratio adds up the market shares of the largest n firms. The takeaway pizza market in one city, sales in £m a year:

Market share is the firm’s sales divided by the market total of £50m. The three-firm ratio is 70% and the five-firm ratio is 88%: a tight oligopoly. A common textbook rule of thumb is that a five-firm ratio above 50% makes a market an oligopoly. The ratio has limits, and the evaluation marks are in them. It ignores how the shares are split among the top firms (three equal firms behave differently from one giant and two minnows). It says nothing about the threat of entry. And it depends on how you define the market: “grocery” looks less concentrated than “supermarkets”.

The kinked demand curve: why oligopoly prices stick

Start at the current price. If the firm raises its price, rivals leave theirs alone and customers walk. Demand above the kink is elastic. If the firm cuts its price, rivals cut too to protect their share, so the firm wins few customers. Demand below the kink is inelastic. Two different demand curves meet at the current price, and that is the kink.

The clever part is marginal revenue. A kink in demand puts a vertical gap in MR, here from £20 down to £10 at the kink output. The firm produces where MC = MR. Any marginal cost curve that passes through the gap gives the same answer: 20 thousand customers at £40. So costs can rise from MC₁ to MC₂ and the price does not move. That is the model’s explanation of price rigidity.

The model’s weakness is also examinable: it explains why the price stays where it is, but not how it got there. And it assumes rivals always follow a cut and never a rise, which is not always true.

Collusion or competition: the two ways an oligopoly can go

The exam word is “incentive”. Collusion raises joint profit, so firms have an incentive to collude. Each firm can raise its own profit further by cheating on the deal, so it has an incentive to break it. Game theory shows both incentives in one table.

Game theory: why two prisoners and two firms face the same dilemma

Two firms, A and B, each choose a high price or a low price without knowing the other’s choice. Profit in £m a year is written as (A’s profit, B’s profit).

Read it as firm A. If B goes high, A gets £10m by going high and £15m by going low. Low is better. If B goes low, A gets £4m by going high and £6m by going low. Low is better again. Whatever B does, A’s best move is a low price: that is a dominant strategy. The table is symmetric, so B reasons the same way. Both go low and earn £6m each. That outcome is the Nash equilibrium: neither firm can do better by changing its own choice alone.

Now look at the top-left cell. Both firms would earn £10m, £4m more each, if they both went high. That is the dilemma. Collusion pays, but the moment one firm trusts the other, the other has £5m to gain by cheating. A cartel needs a way to punish cheats, which is why cartels are unstable and why the ones that last are the ones with few members and easy monitoring.

Worked example — two broadband providers in one town

Two firms supply broadband in a town. Each charges £40 a month and has 20 thousand customers. Above the current price, customers switch easily if only one firm raises its price: demand is P = 60 − Q (Q in thousand customers). Below it, the rival matches any cut, so the firm gains few customers: demand is P = 70 − 1.5Q. Marginal cost is 6 + 0.3Q per customer, in pounds. Revenue and cost are in £ thousand a month.

1. Revenue now: £40 × 20 thousand = £800 thousand a month.
2. Raise the price to £45. The rival holds at £40, so customers fall along the upper curve to 60 − 45 = 15 thousand. Revenue is £45 × 15 = £675 thousand, down £125 thousand.
3. Serving 5 thousand fewer customers saves cost, but only £56.25 thousand (the area under MC between 15 and 20). Profit falls by £68.75 thousand.
4. Check the elasticity: customers fell 25% for a 12.5% price rise. PED = −2, elastic, as the upper section of the curve says.
5. Now cut the price to £35 instead. The rival matches, so customers rise only along the lower curve, to (70 − 35) ÷ 1.5 = 23.3 thousand. Revenue is £35 × 23.3 = £816.7 thousand, up £16.7 thousand.
6. The extra customers cost £41.7 thousand to serve (the area under MC between 20 and 23.3). Profit falls by £25 thousand.
7. Elasticity check: customers rose 16.7% for a 12.5% cut. PED = −1.33, less elastic than above the kink. A cut brings in customers, just not enough of them.
8. Both moves lose money, so the firm stays at £40. That is the kink at work. On the diagram, MR is £20 just above the kink output and £10 just below it. MC is £12 at that output, inside the gap. If costs rose so that MC were £18, still inside the gap, the price would still be £40.

Exam-style questions

Q1: Using the takeaway pizza table above, calculate the four-firm concentration ratio and explain what it tells you about the market. (4 marks)
A: Market shares of the four largest firms: 30% + 25% + 15% + 10% (1). CR4 = 80% (1). Four firms make four-fifths of all sales, so the market is highly concentrated, an oligopoly (1). Evaluation: the ratio does not show how the 80% is split, whether entry is easy, or how narrowly the market has been defined (1).

Q2: Using the payoff matrix above, identify each firm’s dominant strategy, the likely outcome, and explain why the two firms might still try to collude. (6 marks)
A: For A: low beats high whether B goes high (£15m against £10m) or low (£6m against £4m), so low price is A’s dominant strategy (1). The matrix is symmetric, so low price is B’s dominant strategy too (1). The outcome is low/low, £6m each, a Nash equilibrium: neither firm gains by changing alone (1). Both would earn £10m in the high/high cell, £4m more each, so there is a clear incentive to collude (1). The agreement is unstable because each firm gains £5m (£15m against £10m) by cheating on it while the other keeps the deal (1). Collusion therefore needs trust, monitoring or punishment, and it is illegal under UK competition law, which is why it is often tacit (1).

Q3: Evaluate the view that firms in an oligopoly are more likely to collude than to compete. (25 marks)
A: Argue it both ways, two points a side, and finish with a clear verdict.

• For collusion: interdependence makes competition risky. A price cut is matched (the kinked demand curve), so price competition gains nothing and a price war loses for everyone. Joint profit is highest in the high/high cell of the payoff matrix, so the incentive to collude, at least tacitly through price leadership, is strong. High barriers keep the group small and stable.
• For competition: the prisoner’s dilemma shows each firm’s dominant strategy is to cut, so cartels tend to break down. Overt collusion is illegal and the Competition and Markets Authority investigates it. Firms compete hard on everything except price: brands, quality, loyalty schemes, advertising. In markets with a disruptive entrant, price competition returns.
• Evaluation: it depends on the number of firms (fewer makes collusion easier), on how similar the products and costs are, on whether cheating can be detected, on the strength of the competition authority, and on whether the market is contestable.
• Judgement: oligopolies usually avoid price competition, which looks like collusion, but they compete fiercely in other ways. “More likely to collude” is true of price, not of behaviour as a whole.

Examiner’s checklist: the mistakes that lose oligopoly marks

• Interdependence not defined. It is the characteristic that drives everything else. Say it in the first line.
• The kinked curve without the MR gap. The gap and the MC curve through it are the model. The bend on its own is one mark.
• Elastic and inelastic the wrong way round. Above the kink is elastic (rivals do not follow a rise). Below is inelastic (they follow a cut).
• Concentration ratio with the wrong firms. Always the largest n. Order the shares first.
• A dominant strategy found for one firm only. Do both, then name the equilibrium cell.
• “Oligopolies are bad for consumers” with nothing on the other side. Non-price competition, economies of scale and the profit that funds innovation are the evaluation.

Key takeaways

• Oligopoly: a few large firms, high barriers, differentiated products and, above all, interdependence.
• Concentration ratio: add the market shares of the largest n firms. 80% for four firms is a tight oligopoly.
• Kinked demand curve: elastic above the current price, inelastic below. The MR gap means costs can change and price does not.
• Collusion raises joint profit (cartels, price leadership, tacit rules). Cheating raises one firm’s profit. The prisoner’s dilemma holds both incentives in one table.
• Dominant strategy: the best move whatever the rival does. Nash equilibrium: the cell where neither firm gains by changing alone.
• Evaluate with non-price competition, contestability and the competition authority.

FAQ

Q: What is the kinked demand curve in A Level Economics?
A: A model of oligopoly pricing. Demand is elastic above the current price because rivals do not follow a rise, and inelastic below it because they do follow a cut. The kink puts a gap in marginal revenue, so a change in costs within the gap leaves the profit-maximising price unchanged. Figure 1 is the finished diagram.

Q: How do you calculate a concentration ratio?
A: Add up the market shares of the largest n firms. If the top four firms have 30%, 25%, 15% and 10%, the four-firm concentration ratio is 80%. If you are given sales instead of shares, divide each firm’s sales by the market total first.

Q: What is the prisoner’s dilemma in economics?
A: A two-firm game in which each firm’s dominant strategy is to compete (cut price), even though both would earn more if they colluded (kept price high). It explains why cartels form and why they break down: cooperation pays, but cheating on a deal pays more.

Q: Which game theory terms does the A Level need?
A: Payoff matrix, dominant strategy, Nash equilibrium and the prisoner’s dilemma. Edexcel and Cambridge name the prisoner’s dilemma in the specification; AQA and OCR reward the same reasoning under “interdependence and uncertainty”. No maths beyond reading the table is needed.

Q: Is collusion always illegal?
A: Cartels and price-fixing agreements between firms are illegal under UK competition law and the Competition and Markets Authority can fine firms for them. Tacit collusion, where firms simply follow a price leader without any agreement, is hard to prove and usually lawful. OPEC is a cartel of governments, not firms, which is why it is the standard example.

Q: Which questions come up on oligopoly?
A: “Explain, using a diagram, why prices tend to be stable in oligopoly” for 4 to 8 marks, a concentration-ratio or payoff-matrix calculation, and a 15 or 25-mark evaluation of collusion or of whether oligopoly harms consumers. Paper detail is on the AQA, Edexcel and OCR pages, and every market structure diagram is on the A Level economics diagrams page. The revision hub lists the rest of the micro topics.

Make interdependence earn its marks

If the kinked curve still comes out as a bend without a gap, or the payoff matrix takes ten minutes to read, one lesson fixes that. Tell me your board and when your micro paper is, and a first lesson can be booked within a day. More on price and format on the A Level economics tutor page.