OxfordAQA International AS and A-level Economics: Oligopoly (9640) – Revision Notes

Quick recall for section 3.3.3.4 (Oligopoly) of the OxfordAQA International AS and A-level Economics (9640) specification, version 1.2. This belongs to the Unit 3 (International A2) content. For the reasoning and fuller examples, go to the study guide. Then try the practice questions, the course hub, the printable checklist and the free diagnostics. All figures are invented.

Key definitions

Term	Meaning
Oligopoly	A market where a few big sellers supply most output, with barriers to entry and interdependence
Concentration ratio	Combined market share of the largest firms, for example the four-firm ratio
Interdependence	Each firm’s outcome depends on rivals’ reactions
Uncertainty	Firms cannot know how rivals will respond
Collusive oligopoly	Firms coordinate to limit competition
Competitive oligopoly	Firms rival each other on price and other variables
Overt collusion	Open or formal agreement; a cartel is a group of firms with one
Tacit collusion	Coordination without a formal agreement
Price leadership	One firm changes price and rivals follow
Predatory pricing	Pricing below cost to drive out rivals or deter entry
Limit pricing	Price set low enough to make entry unprofitable, but above cost
Price war	Repeated rounds of price cutting
Non-price competition	Rivalry through branding, advertising, quality, service and similar
Innocent barrier	Arises from the market itself, such as economies of scale
Strategic barrier	Created or used by incumbents, such as limit pricing

Market differences and what shapes behaviour

Oligopolies differ by how many firms there are, how differentiated products are and how easy entry is. Conduct and performance depend on barriers to entry, concentration, differentiation, objectives and technology.

Method: concentration ratio.

1. Sum the sales of the top firms named in the question.
2. Divide that sum by the whole market’s sales.
3. Convert to a percentage.

Reminder: shares of 30%, 20%, 12% and 8% give a three-firm ratio of 62% and a four-firm ratio of 70%.

Kinked demand curve

• If price rises and rivals hold theirs, customers switch, so demand above the kink is elastic.
• On a price cut rivals copy, so demand below the kink is inelastic.
• Marginal revenue has a vertical gap under the kink; MC can move within it without changing price.

Method: kinked demand.

1. Check both demand equations give the same price at the kink quantity.
2. Find MR for each: for P = a − bQ, MR = a − 2bQ.
3. Evaluate both MR values at the kink quantity to get the gap.
4. If MC is inside the gap, price and output stay put.
5. If MC is above the gap, solve MR (upper segment) = MC.

Reminder: for PED use (1 / slope) × (P / Q). A segment P = 24 − 0.04Q at P = 16, Q = 200 gives PED (1 / 0.04) × (16 / 200) = 2.0.

Limits of the model (evaluation). It is silent on why the kink price was chosen. It covers only some features of some oligopolies. A cost rise common to all firms is likely to be matched by rivals. Prices do change in practice, often through leadership.

Collusion

Collusion lets firms behave like a single monopolist and maximise joint profit. The cartel produces where industry MR = MC and shares output.

Method: cartel calculation.

1. Write MR (double the slope of a linear demand curve).
2. Set MR = MC to find the cartel output.
3. Put output into demand to find price.
4. Profit = (P − MC) × Q, then divide by the number of firms.
5. For cheating, recalculate the market price with the extra output and compare each firm’s profit.

Helps collusion	Hinders collusion
Few firms	Many firms
Similar products and costs	Different costs or products
Stable demand	Unstable demand
Hard entry	Easy entry
Cheating easy to detect	Cheating hard to detect

Must-know distinctions. Overt versus tacit collusion. Limit pricing (price above cost, entry unprofitable) versus predatory pricing (price below cost, to remove a rival). Price leadership (rivals follow a leader) versus price war (rivals undercut each other).

Pricing behaviour and non-price competition

• Price war: consumers gain in the short run; profits fall; weaker firms may leave; rivals may later raise price.
• Predatory pricing only pays if the loss now is less than the later gain, so test payback: sacrifice divided by yearly extra profit.
• Non-price competition makes demand less elastic, builds loyalty and avoids price wars. Types include branding and advertising, quality, service and design.
• Advertising break-even: extra units needed = campaign cost divided by margin per unit.

R&D and barriers

R&D lets firms compete without price cuts but is uncertain. R&D intensity = R&D spending / revenue × 100. Expected value = probability of success × payoff. Innocent barriers: economies of scale, capital cost. Strategic barriers: limit and predatory pricing, heavy advertising, excess capacity, exclusive contracts.

Objectives, advantages and disadvantages

Objective	Output rule	Effect
Profit maximisation	MR = MC	Highest profit; lower output, higher price
Revenue maximisation	MR = 0	More output, lower price, lower profit
Satisficing or survival	Acceptable profit	Prices may be below the profit-maximising level

Advantages: economies of scale, funds for R&D, variety, price stability. Disadvantages: higher prices under collusion, allocative inefficiency, wasteful advertising, barriers that protect profit, less cost pressure.

Evaluation checklist: barriers to entry, collusion or competition, short run or long run, level of R&D, regulation, and the type of market.

Small worked reminders

Cartel against competition (invented). Demand P = 96 − 2Q, MC = £24, three firms. Competitive output: 96 − 2Q = 24, Q = 36, P = £24, zero profit. Cartel: 96 − 4Q = 24, Q = 18, P = £60, joint profit (60 − 24) × 18 = 648, which is 216 per firm. If one firm raises output from 6 to 9, Q = 21 and P = £54. That firm earns 30 × 9 = 270 (up 54) and each rival earns 30 × 6 = 180 (down 36). Joint profit is 630, below 648.

Kinked demand (invented). Kink at £30 and 200 units. Above: P = 40 − 0.05Q. Below: P = 90 − 0.3Q. MR at the kink is 20 above and −30 below, so any MC in that gap leaves the price unchanged. A rise to £33 cuts sales to 140 and revenue from 6,000 to 4,620 (down 23%). A cut to £27 raises sales to 210 but revenue falls to 5,670 (down 5.5%).

Predation payback (invented). Normal profit 0.9 million a year. A one-year war loses 0.72 million, so the sacrifice is 0.9 + 0.72 = 1.62 million. Afterwards profit is 1.68 million, a gain of 0.78 million a year. Payback is 1.62 / 0.78 = about 2.1 years.

Objectives (invented). P = 80 − 2Q, MC = £20. Profit maximisation: Q = 15, P = £50, profit 450. Revenue maximisation: Q = 20, P = £40, revenue 800, profit 400.

Chains of reasoning to rehearse

• Few firms lead to interdependence. Interdependence leads to uncertainty about rivals’ reactions. Uncertainty makes price cuts risky, so firms prefer non-price competition or collusion.
• Collusion raises price and profit towards the monopoly level. The gain from cheating is large, so agreements break down unless cheating is easy to spot and punish.
• High profit attracts entrants unless barriers exist. Incumbents can add strategic barriers, which protect profit and may reduce consumer welfare.

Quick self-test

1. A market has firm shares of 28%, 22%, 15% and 9%. Find the concentration ratio for the top three firms and for the top four.
2. A firm’s demand is P = 18 − 0.02Q above a kink at £12 and P = 30 − 0.06Q below it. Find MR above and below at the kink, and the PED above.
3. Demand is P = 72 − Q and MC is £18. Find the cartel output, price and joint profit.
4. Explain why a price war may leave all firms worse off.
5. A campaign costs £0.9 million and each extra unit adds £2.50 to profit. How many extra units are needed to break even?
6. An entrant would have average cost £8.20. An incumbent sets price £8.00. Would entry be profitable? Name the behaviour.
7. A firm earning £150 million revenue spends £12 million on R&D. Calculate R&D intensity.
8. Classify exclusive contracts with retailers as a strategic or innocent barrier.
9. Demand is P = 50 − Q and MC is £10. Compare profit-maximising and revenue-maximising output, price and profit.
10. State the difference between tacit and overt collusion.

Answers

1. 28 + 22 + 15 = 65%; 65 + 9 = 74%.
2. MR above = 18 − 0.04 × 300 = 6; MR below = 30 − 0.12 × 300 = −6; PED above = (1 / 0.02) × (12 / 300) = 2.0.
3. MR = 72 − 2Q = 18, so Q = 27; P = 72 − 27 = £45; profit = (45 − 18) × 27 = £729 (in units matching Q).
4. Rivals match cuts, so market share barely changes while margins fall. All lose profit, and weaker firms may exit.
5. 0.9 million / 2.50 = 360,000 units.
6. No: £8.00 is below the entrant’s cost of £8.20. This is limit pricing.
7. 12 / 150 × 100 = 8%.
8. Strategic, because the incumbent chooses it to shut out rivals.
9. Profit maximising: 50 − 2Q = 10, Q = 20, P = £30, profit = 20 × 20 = 400. Revenue maximising: MR = 0, Q = 25, P = £25, profit = 15 × 25 = 375. The revenue maximiser sells more at a lower price.
10. Overt is an open or formal agreement; tacit is coordination without one, such as following a leader’s price.

Where marks are usually lost

• Describing the kinked curve without the assumed rival reactions.
• Using the demand slope as the MR slope when finding cartel output.
• Giving cartel profit per firm without dividing by the number of firms.
• Calling every low price predatory when it may be limit pricing or a price war.
• Treating a high concentration ratio as proof of collusion.
• Listing advantages and disadvantages without a judgement tied to the market given.
• Calling any barrier innocent or strategic without saying who creates it.
• Leaving out units, such as Q in thousands or profit in £ thousand.

Official syllabus

OxfordAQA International AS and A-level Economics (9640), specification version 1.2, first teaching September 2020, first AS exams May/June 2021, first A-level exams May/June 2022; published by OxfordAQA.