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Fundamentals of Business Economics and Management · Forms of Market

Oligopoly: Features, Kinked Demand Curve and Cartels

Updated 10 October 2026 · Fact-checked

Oligopoly is a market with a few large sellers whose decisions depend on each other. Products may be identical or differentiated, and entry is hard. To solve questions, spot the feature being tested, then match it to interdependence, price rigidity (kinked demand), or collusion (cartel and price leadership).

Understand Oligopoly

Oligopoly means competition among the few. A small number of big firms supply most of the market. Think of Indian markets for cars, telecom services, cement or air travel. Each firm is large enough that its actions affect the others.

The key feature is interdependence. When one firm changes its price, output or advertising, rivals notice and respond. So a firm cannot decide in isolation. It must guess how rivals will react. This is why there is no single standard price-output model for oligopoly.

Other features: few sellers, barriers to entry (large capital, brands, patents, economies of scale), heavy advertising and non-price competition, and group behaviour. The product can be homogeneous (steel, cement) or differentiated (cars, soaps). Because of the barriers, firms can earn abnormal profit even in the long run.

Types of oligopoly are classified in several ways. By product: pure (perfect) oligopoly has homogeneous products, and differentiated (imperfect) oligopoly has differentiated products. By behaviour: collusive oligopoly, where firms cooperate (cartel, price leadership), and non-collusive oligopoly, where firms compete independently. A cartel is a formal agreement among firms to fix price, output or market shares, acting like a joint monopoly. Price leadership is an informal arrangement where one firm sets the price and others follow.

The kinked demand curve explains why prices in oligopoly tend to stay stable. A firm assumes that if it raises its price, rivals will not follow, so it loses many customers and demand is elastic above the current price. If it cuts its price, rivals will match it, so it gains few customers and demand is inelastic below the current price. The demand curve therefore bends (kinks) at the current price. The marginal revenue curve has a vertical gap at the output of the kink. Within this gap, marginal cost can change without changing price or output.

Key formulas to remember

Kinked demand: above the kink
Price rise → rivals do not follow → demand elastic (e > 1)
The firm loses sales, so it avoids raising price.
Kinked demand: below the kink
Price cut → rivals follow → demand inelastic (e < 1)
The firm gains little, so it avoids cutting price.
Equilibrium on kinked demand
MC = MR, where MR has a vertical (discontinuous) gap at the kinked output
If MC shifts within the gap, price and output stay the same.
Cartel aim
Cartel output chosen where industry MC = industry MR
This is the joint profit-maximising (monopoly-like) outcome, then quotas are shared among members.
Classification
Pure vs differentiated (product); collusive vs non-collusive (behaviour)
Do not mix the two bases of classification.

How to solve Oligopoly questions

Use this method for any oligopoly question, whether it is a definition, a feature or a diagram-based concept.

  1. 1Read the question and find the key clue: number of sellers, reaction of rivals, price stability, or an agreement.
  2. 2If rivals' reactions are mentioned, think interdependence.
  3. 3If price stays stable despite cost changes, think kinked demand curve.
  4. 4If firms agree formally on price or output, think cartel; if informally with one leader, think price leadership.
  5. 5Decide whether the type asked is by product (pure or differentiated) or by behaviour (collusive or non-collusive).
  6. 6Eliminate options that describe other markets: many sellers and free entry point to perfect or monopolistic competition; one seller points to monopoly.
  7. 7Check the direction of elasticity for kinked demand questions: elastic above, inelastic below.
  8. 8Pick the option that matches every clue, not just one.

Quickest way: Clue-to-concept matching

When to use it: Use this for one-line MCQs when you have under a minute per question.

  1. Few sellers + reacting to rivals = oligopoly.
  2. Stable price + bent demand curve = kinked demand.
  3. Formal agreement = cartel; follow the leader = price leadership.
  4. Homogeneous product = pure oligopoly; differentiated product = imperfect oligopoly.
  5. Many sellers with some product differentiation = monopolistic competition, not oligopoly.

Common mistakes in Oligopoly

  • Saying that oligopoly firms act independently.

    Students carry over the idea from perfect competition.

    Fix: Remember that interdependence is the defining feature. Each firm must consider rivals' reactions.

  • Reversing elasticity on the kinked demand curve.

    Students memorise the shape but not the reasoning.

    Fix: Rivals ignore a price rise, so demand above the kink is elastic. Rivals match a price cut, so demand below is inelastic.

  • Confusing a cartel with price leadership.

    Both are forms of collusion.

    Fix: A cartel is a formal agreement. Price leadership is informal, with one firm setting the price and others following.

  • Saying that oligopoly has no advertising or only price competition.

    Students forget non-price competition.

    Fix: Oligopolists compete mainly through advertising, branding and service, because price cuts invite retaliation.

  • Treating oligopoly and monopolistic competition as the same.

    Both can have differentiated products.

    Fix: Oligopoly has few sellers, high entry barriers and interdependence. Monopolistic competition has many sellers, free entry and independent decisions.

  • Believing that the kinked demand curve explains how the price is set.

    The theory sounds like a price model.

    Fix: It explains price rigidity (why the price stays stable), not how the original price was determined.

Worked examples

Example 1

In the kinked demand curve model, a firm in an oligopoly market does not raise its price because:
(a) rivals will match the increase, so demand is inelastic
(b) rivals will not match the increase, so demand above the kink is elastic
(c) rivals will not match the increase, so demand is perfectly inelastic
(d) the government fixes the price

Show the solution
  1. The firm assumes that rivals ignore a price rise.
  2. Then customers move to rivals, and the firm loses many sales.
  3. A large fall in quantity for a small rise in price means demand is elastic above the kink.
  4. Option (a) wrongly says rivals match the rise. Option (c) is wrong because demand is not perfectly inelastic. Option (d) is irrelevant.

Answer: (b)

Example 2

Which of the following is an example of collusive oligopoly?
(a) Four firms in a market compete by advertising but set their prices independently
(b) Firms in a market agree formally to fix the price and share output quotas
(c) A single firm is the only seller of a product
(d) Thousands of small sellers sell similar products

Show the solution
  1. Collusive oligopoly means that firms cooperate instead of competing.
  2. Option (a) describes firms acting independently, which is non-collusive.
  3. Option (b) describes a formal agreement on price and output, which is a cartel and so collusive.
  4. Option (c) is monopoly and option (d) is perfect or monopolistic competition.

Answer: (b)

Exam tips

  • Questions often ask for the reason behind price rigidity. The answer is the kinked demand curve.
  • Learn the definitions of cartel and price leadership as a pair, so that you can tell them apart in options.
  • Be ready for 'which is not a feature of oligopoly' questions. Options such as free entry or a large number of sellers are the usual wrong features.
  • Compare oligopoly with monopolistic competition on number of sellers, entry and interdependence, since these comparisons are common.
  • If two options look similar, check for the words formal and informal, or pure and differentiated.

Practice questions from Forms of Market

Oligopoly: frequently asked questions

What are the main features of oligopoly?

The main features are few large sellers, interdependence among firms, barriers to entry, heavy advertising and non-price competition. The product may be homogeneous or differentiated. Firms may also collude or act independently.

Why is the demand curve kinked in oligopoly?

A firm believes rivals will not follow a price rise but will follow a price cut. So demand is elastic above the current price and inelastic below it. The curve bends at the current price, which keeps prices stable.

What is a cartel in oligopoly?

A cartel is a formal agreement among firms to fix price, output or market shares. It lets them behave like a single monopolist and earn higher joint profit. Members may be tempted to cheat on quotas, which can break the cartel.

What is the difference between oligopoly and monopolistic competition?

Oligopoly has a few sellers, strong entry barriers and clear interdependence. Monopolistic competition has many sellers, free entry and differentiated products, and each firm decides on its own. Both can involve advertising.