Oligopoly: Price & Non-Price Competition (AQA A Level Economics)

Competition in Oligopoly Markets

• Firms in an oligopolistic market are highly competitive and can use price or non-price strategies to increase market share

• There is a high degree of interdependence between competitors in an oligopoly market

  • Competitors closely watch each others actions

  • They are very responsive to new innovations

  • They use game theory to determine the best course of action

• Non-price competition tends to be the most common way in which they compete

  • The focus of competition is on product differentiation to develop brand loyalty

    • E.g. Firms achieve this high levels of spending on advertising, branding, packaging, loyalty cards, etc 

• Price competition is less common, as firms want to avoid a price war

  • As goods and services are very close substitutes in an oligopolistic market, a price change initiated by one firm will cause other firms to react to price change

  • Individual firms will take into account the likely reactions of their competitors

    • This mutual interdependence leads to price stability or rigidity within the market 

  • The kinked demand curve demonstrates the concept of price rigidity

The Kinked Demand Curve Model

• The kinked demand curve provides one explanation of why prices are stable in oligopolistic competition

• Rival firms react to price changes initiated by a competitor

Diagram: Kinked Demand Curve

Prices are rigid at P_1. Competitors will not raise their price above this price.  If the firm sets its price lower, all competitors will follow suit, and there will be little change to market share 

Diagram analysis

• A firm produces a quantity of Q₁ and sells at price P₁

• This is a very similar price point found in the industry

Elastic section (A-B)

• If a firm increases its price from P₁ to P₂, it is unlikely that rival firms will follow the price increase

  • The firm will lose consumers to rival firms if they charge a higher price 

• This means that a small increase in price leads to a greater than proportionate decrease in quantity demanded, resulting in an overall fall in market share and total revenue

  • This section of the demand curve (A-B) is elastic

Inelastic section (B-C)

• If a firm decreases its price from P₁ to P₃, it is likely that rival firms will respond by also decreasing price

  • All firms in the market will offer the new lower price

  • Market share remains the same. However, total revenue and profit decline for all

• This means that a decrease in price leads to a less than proportionate increase in quantity demanded, resulting in an overall fall in total revenue

  • This section of the demand curve (B-C) is inelastic

• The change in elasticities, brings about a kink in the demand curve at a price level of P₁

  • This creates price rigidity, as firms tend not to change price due to the anticipated behaviour of competitors (mutual interdependence)

• To avoid a price war, firms focus on non-price competition strategies to increase sales

  • This is why there is a high level of expenditure on research and advertising in oligopolistic industries

Reasons for Non-Price Competition

• Firms in oligopolistic markets commonly engage in non-price competition

• In other market structures, price competition is usually competitive

• Several reasons push firms towards a focus of non-price competition

Reasons why Oligopolistic Firms Engage in Non-price Competition

The Advantages & Disadvantages of Oligopoly

Evaluating an Oligopoly Market Structure