OCR A Level Economics: Oligopoly, interdependence and concentration ratios (H460)

This guide teaches the oligopoly part of the OCR A Level Economics (H460) specification, Version 3.0 (June 2026). It sits in the Competition and market power area of study, under Market structures, in Component 01, Microeconomics.

It covers every oligopoly statement in the table below. Use it with the revision notes and the practice questions. Related: the OCR microeconomics guide, the course hub, the checklist and the free diagnostics sit alongside it.

Every firm, market and number here is made up for teaching. None is a real statistic.

What the specification asks for

Specification statement (summarised)	Section
Explain the characteristics of oligopoly	1
Explain what is meant by non-price competition	2
Explain the significance of interdependence, using, for example, game theory and the kinked demand curve	3
Explain the significance of types of collusion	4
Explain the significance of product differentiation in oligopoly	5
Evaluate, with the aid of a diagram, the advantages and disadvantages of oligopoly	6
Explain and calculate concentration ratios	7
Using diagrams, compare and contrast perfect competition, monopolistic competition, oligopoly and monopoly	8
Evaluate, using examples, the extent to which theory of the firm explains behaviour and performance	9

1. Characteristics of oligopoly

In an oligopoly, a handful of big sellers share the market, and each is large enough to move the others’ decisions. The usual characteristics are:

• high concentration: a few firms hold most of the sales
• high barriers to entry and exit
• interdependence: each firm must predict rivals’ reactions
• product differentiation, often strong, supporting non-price competition
• the possibility of collusion, formal or tacit
• price stability, with rivalry mainly in non-price ways

2. Non-price competition

Non-price competition is rivalry based on anything other than a lower price: branding and advertising, quality and design, after-sales service, delivery speed, loyalty schemes, product range and innovation.

Oligopolists favour it because a price cut is copied at once, while a loyal customer base is harder to copy.

Worked example (invented firm). A firm sells 200,000 units at £10. Variable cost is £6 a unit and other fixed costs are £600,000. An advertising campaign costs £280,000.

• Profit before: 200,000 × (10 − 6) − 600,000 = £200,000.
• Contribution per extra unit = 10 − 6 = £4.
• Extra sales needed to cover the campaign = 280,000 ÷ 4 = 70,000 units.
• Check: 270,000 × 4 − 600,000 − 280,000 = £200,000.

If the campaign adds just 30,000 units, profit falls to 230,000 × 4 − 880,000 = £40,000. If a rival matches the spend, neither gains share and both carry the cost.

3. Interdependence

Interdependence means a firm’s best choice depends on its rivals’ choices. Two models show it.

3a. Game theory

Game theory analyses strategic choices. A pay-off matrix lists each firm’s profit for each pair of choices. Two firms choose a High or Low price (annual profit, £m, invented; firm A first, firm B second):

	B: High	B: Low
A: High	A 15, B 15	A 4, B 21
A: Low	A 21, B 4	A 9, B 9

• If B prices High, A earns 15 with High but 21 with Low. If B prices Low, A earns 4 with High but 9 with Low. Low is better whatever B does: a dominant strategy.
• The game is symmetrical, so B also prices Low.
• The outcome is Low/Low, with 9 each (18 in total). Both would prefer High/High, 15 each (30 in total).

A Nash equilibrium is an outcome where neither firm can gain by changing its own choice, given the other’s. Here it is Low/Low. This pattern is the prisoner’s dilemma: self-interest drives both firms to an outcome that leaves each worse off than cooperation would.

This explains price wars and the temptation to collude. It also shows why collusion is unstable: from High/High, either firm gains (15 to 21) by cutting price secretly. A game need not have a dominant strategy, and in a repeated game cooperation can last because cheating invites punishment.

3b. The kinked demand curve

The model starts from an assumed price, with rivals reacting asymmetrically:

• A price rise is not copied by rivals, so the firm loses customers: demand above the current price is elastic.
• A price cut is matched at once, so few customers are won: demand below the current price is inelastic.

Illustrative demand for a firm at a price of £8 and 1,000 units a week:

• Above the kink: P = 12 − 0.004Q. At Q = 1,000, P = £8.
• Below the kink: P = 18 − 0.01Q. At Q = 1,000, P = £8.
• Price elasticity at the kink: above, 8 ÷ (0.004 × 1,000) = 2.0 (elastic); below, 8 ÷ (0.01 × 1,000) = 0.8 (inelastic).

The segments have different slopes, so marginal revenue (MR) has a gap at Q = 1,000:

• Upper MR = 12 − 0.008Q = £4 at Q = 1,000.
• Lower MR = 18 − 0.02Q = −£2 at Q = 1,000.

Price
 |\
 | \ upper D (elastic)
 8 + - - K          K = kink at (1,000 units, £8)
 |    \ \
 |     \  \ lower D (inelastic)
 |  MR   \   \
 +---------+-------- Quantity
         1,000
 MR is broken: it drops vertically from 4 to -2 at 1,000.

If marginal cost (MC) passes through the gap, profit is maximised at 1,000 units and £8. With MC = 1 + 0.001Q, MC is £2 there. A cost rise to 2.5 + 0.001Q makes MC £3.5, still in the gap, so price stays at £8. Only when MC leaves the gap does price move: with MC = 4.5 + 0.001Q, the firm sets MR = MC on the upper segment, 12 − 0.008Q = 4.5 + 0.001Q, so Q = 833 and P = £8.67.

The model explains price rigidity. For evaluation: the model says nothing about how the starting price arose, rivals may react differently, and prices do change, sometimes in price wars.

4. Types of collusion

Collusion is cooperation between firms to limit competition.

• Formal (overt) collusion: an explicit agreement, such as a cartel fixing price or output quotas.
• Informal (tacit) collusion: no agreement, but firms follow a common practice, such as price leadership (a dominant firm sets the price and rivals follow) or avoiding price cuts.

Worked example (invented cartel). Four firms face market demand P = 96 − Q (Q in thousands) with constant MC of £24.

• Acting as one monopolist, MR = 96 − 2Q = 24, so Q = 36 and P = £60.
• Total profit = (60 − 24) × 36 = 1,296; each firm, producing 9, earns 324.
• Now one firm secretly produces 13. Total output is 40, so P = £56.
• The cheat earns (56 − 24) × 13 = 416. Each other firm earns (56 − 24) × 9 = 288.

The cheat gains 92 and each loyal firm loses 36, so every member is tempted to cheat. Cartels hold best with few firms, similar products, easy detection of cheating and blocked entry. Tacit collusion is harder to prove.

Consumers lose through higher prices and less output; firms gain only while the agreement lasts.

5. Product differentiation in oligopoly

Differentiation makes a product different in the buyer’s mind, through features, design, brand image or service.

• It makes demand less price elastic, giving some pricing power.
• It builds loyalty and so a barrier to entry.
• It moves competition away from price, supporting price stability.
• It gives consumers choice, but branding spend can raise costs.

Where products are near-identical, price competition and tacit price leadership are more likely.

6. Advantages and disadvantages of oligopoly

Diagram in words. Draw the kinked firm in section 3b with AC. Price is set above MC at the kink. If the firm earns supernormal profit, AR is above AC at that output. Price exceeds MC, so the market is not allocatively efficient. Output is probably below the lowest point of AC, so there may be no productive efficiency.

Advantages	Disadvantages
Large scale can bring economies of scale and lower unit costs	Price above marginal cost: allocative inefficiency
Supernormal profit can fund research and innovation (dynamic efficiency)	Collusion and cartels can raise prices and cut output
Non-price competition can raise quality and choice	Barriers to entry protect profit; advertising adds cost; possible X-inefficiency

To evaluate, judge which side is larger. Key factors: the degree of rivalry, the threat of entry, whether firms really invest their profits, regulation, and the time period (dynamic gains build over the long run).

7. Concentration ratios

An n-firm concentration ratio (CRn) adds the market shares of the n biggest firms, usually measured by sales, though output or employment can be used.

CRn = (sales of the top n firms added together ÷ whole-market sales) × 100

Worked example (invented market, sales in £m). Alder 88, Brook 74, Corvin 61, Dunmore 47, Elmgate 30, Fenn 22 and many small sellers 78. Total = 400.

• Alder’s share = 88 ÷ 400 = 22%.
• CR3 = (88 + 74 + 61) ÷ 400 = 223 ÷ 400 = 55.75%.
• CR4 = 270 ÷ 400 = 67.5%.

Suppose Corvin and Dunmore merge into one firm with sales 108. The new ranking is 108, 88, 74. CR3 = 270 ÷ 400 = 67.5%, up by 11.75 percentage points.

A high ratio suggests market power, but it ignores how sales are split among the leaders, hides foreign competition, depends on how the market is defined and says nothing about contestability.

8. Comparing the four market structures

	Perfect competition	Monopolistic competition	Oligopoly	Monopoly
Firms	Very many	Many	Few	One
Product	Identical	Differentiated	Often differentiated	Unique
Entry barriers	None	Low	High	Very high
Long-run profit	Normal	Normal	Supernormal possible	Supernormal possible
Allocative efficiency	Yes, P = MC	No, P > MC	Usually no	No

Market-level numbers (invented). Demand P = 96 − Q, MC = £24 with no fixed cost.

• Perfect competition: P = MC, so Q = 72, P = £24. Consumer surplus = ½ × 72 × 72 = 2,592.
• Monopoly (or a successful cartel): Q = 36, P = £60. Consumer surplus = ½ × 36 × 36 = 648. Supernormal profit = 1,296.
• Deadweight loss = ½ × (60 − 24) × (72 − 36) = 648.

Firm-level numbers (invented). TC = 100 + 10q + 0.1q², so AC = 100/q + 10 + 0.1q. In long-run monopolistic competition, the firm’s demand AR = 20 − 0.15q just touches AC.

• At q = 20: AC = 5 + 10 + 2 = £17; AR = 20 − 3 = £17. Profit is normal.
• MR = 20 − 0.3q = 14 and MC = 10 + 0.2q = 14, so MR = MC holds.
• AC is lowest at q = √(100 ÷ 0.1) = 31.6, where AC = £16.32. A perfectly competitive firm would sit there.
• The monopolistically competitive firm has excess capacity of about 11.6 units, and P − MC = 17 − 14 = £3.

Oligopoly falls between: collusion approaches the monopoly result; fierce rivalry approaches the competitive one.

9. Does theory of the firm explain real behaviour?

The standard theory assumes profit-maximising firms that know their costs and demand, and sort market structures into four neat types.

Strengths: it gives benchmarks (P = MC) and predicts that monopoly raises price and that profit attracts entry.

Weaknesses:

• Firms often pursue other objectives such as growth, sales revenue, satisficing or social goals.
• Managers and owners may have different aims (the principal-agent problem).
• Real firms rarely know exact MC and MR.
• Many markets sit between the four boxes, and defining the market is hard.
• The threat of entry can discipline a firm that looks like a monopoly.

Use examples. A small bakery in a town centre may fit monopolistic competition. Two supermarkets in a remote region may behave as a duopoly with price leadership. A firm run by managers who chase growth shows the limits of the profit assumption. Conclude that the theory is a useful benchmark, strongest where firms are profit-driven and markets stable, weakest where objectives and conditions are complex.

Common errors

• Saying oligopolists never change price: the kink explains stickiness only while MC stays in the gap.
• Swapping the elasticities: elastic above the kink, inelastic below.
• Naming a Nash equilibrium without checking each firm’s best reply.
• Giving a concentration ratio without n, or as a number of firms.

Official syllabus

Source: OCR A Level in Economics (H460), specification Version 3.0 (June 2026), for first assessment in 2021, published by OCR. Content from the Competition and market power area of study, topic Market structures and their implications for the way resources are allocated and the interdependence of firms.