B) Competition in an oligopoly; interdependence and price stability

The idea

An oligopoly is characterised by a few dominant firms whose decisions are mutually interdependent. This interdependence means that one firm's actions regarding price, output, or marketing will directly affect its rivals, prompting them to react. Because of this, firms often avoid price competition, leading to price stability or sticky prices. If a firm lowers its price, rivals will likely match the cut to retain market share, resulting in a price war where all firms lose revenue. If a firm raises its price, rivals may keep theirs stable to capture the lost customers. Consequently, oligopolists prefer non-price competition, such as advertising, branding, and loyalty schemes, to gain market share without triggering destructive price wars.

What earns the marks

• Explain interdependence as the characteristic where the actions of one firm directly impact its rivals' decisions and market share.
• Describe how interdependence leads to price stability, as firms anticipate rivals' reactions to any price changes.
• Identify that a price cut is likely to be matched by rivals, leading to lower profits for all firms involved.
• Identify that a price increase is unlikely to be matched, causing the firm that raised prices to lose market share.
• Explain the reliance on non-price competition, such as branding and advertising, in oligopolistic markets to avoid price wars.

Common mistakes and how to put them right

• Stating that oligopolies never change their prices.

  Put it right: Prices can change, but they tend to be stable relative to costs, and firms avoid using price as a primary competitive weapon.

• Confusing interdependence with collusion.

  Put it right: Interdependence is a structural feature where firms react to each other; collusion is an explicit or tacit agreement to restrict competition.

• Assuming price wars are the most common feature of oligopolies.

  Put it right: While price wars can occur, firms generally avoid them in favour of price stability and non-price competition.

Exam tips

• Use the concept of interdependence to explain why firms in an oligopoly might engage in heavy advertising rather than discounting.
• When discussing price stability, explicitly mention the asymmetric reaction of rivals to price increases versus price decreases.
• Apply the concept of interdependence to real-world examples, such as supermarkets or mobile network operators, to strengthen your analysis.