AQA Specification focus:
‘The reasons for non-price competition, the operation of cartels, price leadership, price agreements, price wars and barriers to entry.’
Introduction
In oligopolistic markets, firms engage in strategic behaviour to protect profits, respond to rivals, and maintain market power through non-price competition, collusion, or price leadership.
Non-Price Rivalry
In oligopoly, firms often avoid competing on price due to the risk of destructive price wars. Instead, they rely on non-price competition, which focuses on increasing market share without reducing prices.
Non-price competition: Competition between firms based on product features other than price, such as quality, branding, or customer service.
Key forms of non-price rivalry include:
Advertising and branding – Heavy investment to build consumer loyalty.
Product differentiation – Creating unique product features or services.
Customer service and quality – Enhancing after-sales service or guarantees.
Innovation and R&D – Developing new products to gain a competitive edge.
These strategies allow firms to compete while maintaining stable prices, protecting profit margins in markets with barriers to entry.
Cartels
A cartel occurs when rival firms collude, usually secretly, to control prices, restrict output, or divide markets. This behaviour is generally illegal but can be highly profitable.
Cartel: A formal or informal agreement between firms in the same industry to restrict competition and maximise collective profits.
Reasons for cartel formation:
To avoid price wars and uncertainty.
To maximise joint profits by acting as a monopoly.
To secure predictable market shares for each member.
Problems faced by cartels:
Incentive to cheat: Members may undercut secretly to gain market share.
Legal restrictions: Many governments ban cartels to protect consumers.
Detection difficulties: Maintaining secrecy is difficult in practice.
Cartels can reduce competition, leading to higher prices, restricted output, and allocative inefficiency (where price exceeds marginal cost).
A cartel operates by collectively restricting industry output and setting a common price to maximise joint profits.
Headquarters of the Organization of the Petroleum Exporting Countries (OPEC) in Vienna, often cited as a real-world example of coordinated output decisions in commodity markets. Source
Price Leadership
Another form of strategic behaviour in oligopolistic markets is price leadership, where one firm, often the largest or most efficient, sets a price that other firms follow.
Price leadership: A pricing strategy where one dominant firm sets the market price, and other firms in the industry adopt the same pricing policy.
Types of price leadership:
Dominant firm leadership – The largest firm sets prices, others follow.
Barometric leadership – A firm recognised as a reliable indicator of market conditions sets the price.
Aggressive leadership – A powerful firm deliberately lowers prices to force weaker rivals to comply or exit the market.
This approach reduces uncertainty, stabilises prices, and avoids destructive competition. However, it can limit consumer choice and encourage tacit collusion (unspoken agreements to follow a leader’s strategy).
In dominant-firm price leadership, a large firm sets price based on the residual demand after the competitive fringe’s supply, and smaller firms follow.
Diagram of a dominant firm choosing output where MR(residual)=MC, with price determined by residual demand. The fringe supplies the remainder, showing how a leader sets price while others follow. Source
Price Agreements and Price Wars
While formal cartels are illegal in most countries, firms may attempt to stabilise markets through price agreements. These can include aligning minimum prices, discount policies, or output levels. Even informal agreements reduce competition and may attract regulatory penalties.
In contrast, when cooperation breaks down, price wars can occur.
Price war: A situation where firms repeatedly lower prices to undercut rivals, often leading to unsustainably low profits.
Price wars are damaging because:
Firms’ profits collapse.
Smaller firms may be forced out of the market.
Consumers benefit in the short run through lower prices, but long-run competition may diminish.
Barriers to Entry
Strategic behaviour in oligopoly is reinforced by barriers to entry, which protect incumbent firms and discourage new competitors.
Barriers to entry: Obstacles that make it difficult for new firms to enter a market and compete effectively.
Typical barriers include:
High start-up costs and sunk costs.
Brand loyalty created through advertising.
Control of essential resources or distribution networks.
Legal protections such as patents.
These barriers allow firms to maintain non-price rivalry or collusive practices without immediate threat from new entrants, ensuring continued market power.
Interdependence and Strategy
Underlying all these behaviours is the concept of interdependence. In oligopoly, each firm’s actions affect the outcomes of others. Decisions on pricing, output, or investment are made with expectations of rival reactions. This explains why non-price rivalry, cartels, and price leadership are central to oligopoly strategy: firms must balance competition with cooperation to maintain profitability.
FAQ
Tacit collusion occurs when firms implicitly coordinate behaviour, such as following a price leader, without direct communication or formal agreements.
Formal cartels, by contrast, involve explicit agreements on price or output. Tacit collusion is harder to detect legally but still restricts competition, whereas formal cartels are often illegal and subject to heavy penalties.
Cartels face strong incentives for members to cheat by secretly undercutting prices to increase their own market share.
Other difficulties include:
Legal intervention and fines from competition authorities.
Falling demand reducing the benefits of collusion.
New entrants disrupting the agreement.
Sustaining long-term cooperation is therefore rare outside highly regulated or resource-based markets.
Advertising helps firms build brand loyalty, differentiate products, and make demand more inelastic.
It can also act as a barrier to entry, since new firms may struggle to match the advertising budgets of established rivals. In oligopolistic markets, high advertising expenditure may escalate into an “arms race”, where firms compete to outspend each other without reducing prices.
Smaller firms gain stability by following a dominant firm’s pricing decisions. This reduces uncertainty and the risk of destructive price wars.
It also lowers decision-making costs, since weaker firms rely on the leader’s assessment of market demand and costs. However, they may lose pricing independence and become dependent on the leader’s strategy.
Strong barriers to entry protect incumbents from new competition, making heavy investment in non-price strategies more worthwhile.
Examples include:
Brand loyalty developed through advertising, which deters new rivals.
High sunk costs in R&D, discouraging entrants who cannot match innovation.
Control of distribution channels, preventing newcomers from reaching consumers.
These reinforce long-term profitability without resorting to risky price cuts.
Practice Questions
Explain what is meant by the term price leadership in oligopolistic markets. (3 marks)
1 mark for stating that price leadership occurs when one firm sets the price and others follow.
1 mark for identifying the type of firm that usually leads (e.g. dominant, barometric, or aggressive).
1 mark for explaining why firms follow (to avoid price wars or because the leader is most efficient/reliable).
Using examples, analyse why firms in oligopolistic markets may prefer non-price competition to price competition. (6 marks)
1 mark for defining non-price competition (methods of competition other than lowering prices, such as advertising, product differentiation, or customer service).
1 mark for explaining that price competition may lead to destructive price wars and reduced profits.
1–2 marks for showing how non-price competition can build brand loyalty, increase demand, or create barriers to entry.
1–2 marks for analysis of why this is beneficial in oligopoly (e.g. stable prices, higher profits, maintaining market share).
Maximum 2 marks can be awarded for relevant real-world examples (e.g. supermarkets differentiating through loyalty schemes, or mobile phone firms competing on features).
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