Market Power Part 4: Oligopoly, Collusion, and the Game Theory Mind Games

Imagine four burger chains selling in a small city. One lowers prices. The rest panic. Then one boosts advertising. Another launches a new "limited edition" pineapple chilli mayo burger. Things escalate quickly.

Welcome to the wonderfully chaotic world of oligopoly - a market ruled not by hundreds of tiny firms, but by a few big players constantly watching, reacting, and sometimes… colluding.

What Is an Oligopoly?

An oligopoly is a market structure where a small number of large firms dominate. Each has market power, and the power dynamics are intense.

It’s like an economic group project - except everyone has a marketing department and their own legal team.

Two Faces of Oligopoly

1. Collusive Oligopoly

Firms work together - formally or informally - to limit competition.

• Why? It boosts profits. If all firms raise prices together or restrict output, they create artificial scarcity.

• This can form a cartel, like the OPEC coordinating oil output.

• Problem? It’s illegal in many countries. And hard to prove, especially in cases of tacit collusion (silent agreement, no paper trail).

2. Non-Collusive Oligopoly

Firms compete, but they’re watching each other like hawks. No agreement - just strategy.

• The danger? Price wars. One firm cuts prices, others retaliate. Everyone bleeds profit.

• The temptation? Cheat on collusion. If Firm A secretly undercuts prices, they steal customers - at least until the others catch on.

Game Theory: Where Economics Meets Chess

You can't talk about oligopoly without mentioning Game Theory - specifically the Prisoner’s Dilemma.

Developed in the 1950s by John Nash, Game Theory shows that:

• Rational behaviour can lead to irrational outcomes.

• Firms trying to outsmart each other may all end up worse off.

• Collusion can maximise profits… but only if no one cheats.

The Nash Equilibrium

This is the point where no firm changes strategy - because doing so wouldn't help, given the other's choice.

Example:
Two firms can choose to collude or compete. If both collude, they both win. But if one cheats, they win big and the other loses. But if both cheat - everyone loses. Classic dilemma.

Price Competition: The Downward Spiral

Oligopolies sometimes fight on price - but it’s risky.

Why?

• Everyone’s watching. A price cut triggers retaliation.

• It’s easy to match a price cut. Harder to win a price war.

Common Price Tactics:

• Introductory pricing (low to gain share)

• Undercutting rivals

• Discounts for bulk purchases

• “Everyday low prices” tactics

But often, this turns into a race to the bottom - so firms look elsewhere…

Non-Price Competition: The Real Battlefield

This is where oligopolies shine - in product features, branding, and marketing genius.

Examples include:

• Coca-Cola vs Pepsi: Years of ads, celebrity endorsements, and Christmas trucks

• Apple vs Samsung: Features, design, exclusivity, and a lot of innovation

• McDonald’s vs Burger King: Menu tweaks, loyalty apps, and limited editions (remember the BTS Meal?)

Top Non-Price Moves:

• Branding and image-building

• Product development (limited editions, upgrades)

• Slick packaging

• Customer service

• Advertising everywhere (from YouTube to bus stops)

Interdependence: It’s All About Reactions

In oligopoly, every move is calculated - because one firm’s decision affects everyone else. It’s economic chess, not checkers.

• If one brand launches a “Buy One Get One Free” deal, others might do the same.

• If one firm introduces a new product feature, rivals will match it or beat it.

This interdependence is why price changes are sticky and have the ability to remain - it’s risky to be the first mover.

Market Failure and Oligopoly

Oligopolies often lead to:

• Allocative inefficiency – Prices exceed marginal cost (P > MC)

• Restricted output – Firms produce less to drive up price

• Reduced consumer choice – Especially in collusive settings

• Anti-competitive behaviour – Illegal cartels, price-fixing, or predatory pricing

That’s why governments regulate oligopolies - monitoring for competition abuse and promoting transparency.

Recap: The Oligopoly Survival Guide

• A few firms hold major power

• They may collude or compete - but both have risks

• Game theory explains strategic decision-making

• Price wars are dangerous, so firms rely on non-price competition

• The market is interdependent, reactive, and always evolving

Coming Up: Market Power Part 5 – The final entry

We’ll wrap up the series by covering Monopolistic Competition, Market Concentration, and Evaluating Big Market Power.

Stay well and see you in Part 5 - the final round of Market Power!