IB Economics Oligopoly Collusion And Game Theory

Playing Games: Oligopoly, Cartels, and Why Firms Would Rather Not Compete

"What is the Nash equilibrium and how does it apply to oligopoly?"

The WhatsApp Group That Cost Four Banks £100 Million

Let's imagine that today is sometime before 2025. A small group of traders at four major banks - Citi, HSBC, Morgan Stanley, and the Royal Bank of Canada - are chatting in private one-to-one messaging threads. The conversations are not about football or about weekend plans. They are talking about UK government bonds. Specifically, about what they were going to charge for these bonds.

In early 2025, the UK's Competition and Markets Authority fined those four banks a total of over £100 million after finding that individual traders had shared competitively sensitive information relating to the buying and selling of UK government bonds on specific dates.

In other words: firms that should have been competing independently were quietly letting each other know what was going on. The result? Less competition, less transparency, and worse deals for the people on the other end of those trades.

This is a nice introduction to today's topic oligopoly - and the temptation to stop fighting and start cooperating often for unethical reasons.

What Is an Oligopoly?

Oligopoly is a market structure in which a small number of large firms dominate an industry, each holding significant market power. Because each firm's decisions directly affect its rivals, oligopolistic markets are characterised by interdependence - firms must consider competitors' likely reactions before making pricing or output decisions. Oligopolies may be collusive (firms cooperate to restrict competition) or non-collusive (firms compete independently while monitoring rivals closely).

IB Economics Real-life Examples: markets you interact with every day. UK supermarkets: Tesco, Sainsbury's, Asda, and Morrisons control the vast majority of grocery sales. Streaming: Netflix, Disney+, Amazon Prime, and Apple TV+ are fighting for your subscription. Smartphones: Apple and Samsung between them dominate premium handsets globally. Energy: a handful of companies supply nearly all UK households.

These are oligopolies. Not one dominant firm - but not hundreds of tiny competitors either. A small, powerful few, each watching the others very carefully.

In oligopolistic markets, firms can indirectly or directly restrict output or prices to achieve higher returns. They have the market power to do this. The question is whether they use it competitively - or collusively.

Two Types of Oligopoly

Economists split oligopolies into two distinct types, and understanding both is essential for your IB Economics exam:

Collusive oligopoly - where firms secretly (or not so secretly) agree to work together, fixing prices or limiting production to keep profits high.

Non-collusive oligopoly - where firms compete independently, watching each other's moves like chess players, but without any formal agreement.

Real-world oligopolies often move between these two types. Competition law tries to keep them firmly in the non-collusive side. And yet, as the bank traders' WhatsApp threads demonstrate, the temptation to collude never goes away.

Collusion: When Rivals Become Partners in Crime

Collusion occurs when two or more firms in an oligopolistic market make an agreement - explicit or tacit - to restrict competition. Firms may collude by fixing prices at an artificially high level, by collectively limiting output to force market prices up, or by dividing markets between them. The purpose of collusion is to act as a joint monopoly, maximising combined profits at the expense of consumers. Collusion is illegal in most countries because it is anti-competitive and leads to allocative inefficiency.

The idea is straightforward. If you and your two main competitors stop undercutting each other and instead agree on a minimum price, you all earn more. The consumer pays more. You split the spoils. It's essentially acting like a joint monopoly.

A cartel is a formal agreement between competing firms to coordinate their pricing, output, or market behaviour in order to restrict competition and maximise collective profit. Cartels operate like a joint monopoly - restricting supply to raise prices above the competitive level. They are illegal in most jurisdictions and subject to substantial fines. Cartels are inherently unstable because each member has a private incentive to cheat on the agreement by undercutting the agreed price to gain additional market share.

Cartels have two key objectives:

• Restrict supply to force market prices above what competition would deliver

• Create artificial barriers to entry to keep new rivals out and protect those higher prices

IB Economics Real-life Examples: Global cartel fines totalled $3.3 billion in 2025 - the highest annual total since 2021 - with enforcement by the European Commission and EU member states accounting for $2.6 billion of that figure. The biggest case? A $517.7 million fine levied on 15 major car manufacturers and the European Automobiles Manufacturers' Association for agreeing not to pay car dismantlers for processing end-of-life vehicles.

That's fifteen car companies, sitting in a room, agreeing not to compete on something. This is typical cartel behaviour - and a classic illustration of why regulators spend so much time and money trying to reverse this situation.

The Most Famous Cartel in the World: OPEC

If you want a textbook example of a collusive oligopoly in action - one that literally affects the price of everything from petrol to plane tickets - look no further than OPEC+, the Organisation of Petroleum Exporting Countries and its allies.

OPEC+ is a group of oil-producing nations - Saudi Arabia, Russia, Iraq, the UAE, and others - that collectively controls a huge proportion of the world's oil supply. Their entire purpose is to coordinate production levels to influence the global oil price. That is, by textbook definition, a cartel.

In September 2024, eight participating countries - including Saudi Arabia, Russia, Iraq, and the UAE - agreed to extend collective production cuts of 2.2 million barrels per day through the end of November 2024. Reduce supply, keep the price elevated, everyone in the group earns more per barrel. Simple economics.

But OPEC+ also perfectly illustrates the limits of collusion. Those production cuts did prop up oil prices - but they had a significant side-effect: OPEC gradually and steadily gave up market share to non-member producers, as elevated prices prompted the US, Brazil, Canada, and others to ramp up their own output.

In other words: hold the price too high, and you hand your market share to rivals who aren't in the cartel. The cartel can only control what its members do. It cannot control what everyone else does. Sound familiar? (It should - it's the same logic as the monopolist and demand.)

Why Is Collusion Illegal?

Collusive oligopolies and cartels are illegal in most countries - and for good reason.

Oligopoly is already an allocatively inefficient market structure because firms with market power can charge prices above their marginal cost of production: P = AR > MC.

Consumers pay more than they should. Output is lower than it would be in a competitive market.

Collusion makes this worse. When firms coordinate to restrict supply and fix prices, the damage to consumers is deliberate and systematic. If the market had more competitors, output would be higher and prices lower. Instead, cartel members pocket the difference.

IB Economics Real-life Example: In one particularly striking UK case, four pharmaceutical companies were fined for conspiring to limit the supply of anti-nausea drugs, causing a 700% price hike - forcing the NHS, as the main buyer, to pay significantly more for essential medication.

A 700% price increase. For drugs patients needed. That's what unchecked collusion looks like in practice.

Business ethics matter too. Identifying and breaking up cartels is notoriously difficult, because firms rarely issue press releases announcing their price-fixing agreement.

Tacit collusion - is an informal form of collusion in which firms coordinate their behaviour without any explicit agreement. Rather than meeting to fix prices, firms simply observe each other's pricing decisions and mirror them - each firm recognising that matching rivals' prices is mutually beneficial. Because there is no written agreement or direct communication, tacit collusion is extremely difficult for competition authorities to detect and prosecute, even though its effects on consumers and market efficiency are similar to formal price-fixing.

Can Collusion Actually Work?

Yes - but only under specific conditions. For a cartel to hold together, you typically need:

• Mutual trust among the colluding firms (everyone has to keep their side of the bargain)

• High barriers to entry to stop outsiders from undercutting the inflated prices and stealing market share

• A small number of dominant firms producing a relatively homogeneous product - it's much easier to agree on "one price for oil" than "one price for fast changing fashion"

When these conditions aren't met, cartels tend to collapse from the inside. Because even when colluding would benefit everyone, firms face a powerful incentive to cheat. Which brings us to game theory.

Game Theory: Extraordinary John Nash

In the 1950s, mathematician John Nash developed game theory:

A branch of economics that models strategic decision-making in situations where the outcome for each participant depends on the choices made by others. In the context of oligopoly, game theory - particularly the prisoner's dilemma model - illustrates why rational firms acting in their own self-interest may produce outcomes that are worse for all participants than if they had cooperated. It was formalised by mathematician John Nash in the 1950s and remains one of the most powerful tools for analysing competitive behaviour between firms.

You might know Nash from the film A Beautiful Mind, where Russell Crowe plays him. Or you might know the central concept from a more relatable source: every time you've wondered whether to stick to a group plan or quietly do your own thing for a better personal outcome. That tension - between collective benefit and individual self-interest - is at the heart of game theory.

In economics, game theory is often illustrated through the prisoner's dilemma. Here's the idea:

Two suspects are arrested. They can't communicate. Each is offered a deal: betray your partner and go free, while they get the heavy sentence. If both stay silent, both get a light sentence. If both betray each other, both get a medium sentence.

The individually rational choice - betray - leads to a worse outcome for both than if they'd cooperated (stayed silent). Acting in your own best interest makes both of you worse off.

This maps directly onto collusive oligopoly. Two firms can either:

• Cooperate: both stick to the agreed price, both earn good profits

• Cheat: one undercuts the agreed price to steal market share, earns more in the short run while the other loses badly

The temptation to cheat is always there. And if both firms cheat, prices collapse and everyone ends up worse off than if they'd cooperated.

The Payoff Matrix

Your IB Economics examiner will expect you to interpret a game theory payoff matrix - a simple grid showing the outcomes for two firms depending on their strategies. Here's a basic version:

For access to all IB Economics exam practice questions, model answers, IB Economics complete diagrams together with full explanations, and detailed assessment criteria, explore the Complete IB Economics Course

The Nash equilibrium:

Is a concept in game theory describing a stable outcome in which no participant can improve their position by unilaterally changing their strategy, given the strategies chosen by all other participants. In an oligopolistic payoff matrix, the Nash equilibrium is typically the outcome where both firms choose to compete (for example, both cut prices) rather than cooperate (both keep prices high) - even though cooperation would produce a better collective outcome. The Nash equilibrium is reached not because it is optimal, but because neither firm can do better by deviating from it alone.

This can be observed in the bottom-right cell: both firms cut prices. Both earn £5m.

But that's the worst joint outcome. If they'd both kept prices high, they'd each earn £10m. The problem? If Firm A keeps prices high and Firm B cheats, Firm B earns £15m and Firm A earns only £2m. So neither firm trusts the other to cooperate, and both end up cheating.

As Nash demonstrated: firms acting in their own best interest can make themselves and the market worse off. The rational individual choice produces a suboptimal collective outcome. It's a beautiful but at the same time slightly depressing result.

This is also exactly why cartels are inherently unstable. The incentive to cheat never disappears, even when cooperation would benefit everyone.

Non-Collusive Oligopoly: Competing Without Colluding

Of course, not all oligopolies collude. In non-collusive (competitive) oligopoly, firms compete independently - but they do so with one eye permanently fixed on their rivals. This mutual watchfulness is called interdependence, and it's the defining feature of competitive oligopoly.

Interdependence is the defining feature of oligopolistic markets. Because each large firm controls a significant share of the market, any strategic decision - a price change, a new product launch, an advertising campaign - will directly affect rivals and provoke a response. Oligopolistic firms therefore cannot make decisions in isolation; they must anticipate and factor in competitors' likely reactions. This mutual awareness makes oligopoly fundamentally different from both perfect competition and monopoly, where firms either have no market power or face no rivals at all.

Every major strategic decision a firm makes - what to charge, what to advertise, whether to launch a new product - is made from answering the question: "How will our rivals respond?"

Price Rigidity: Why Oligopolists Are Reluctant to Change Prices

Despite their enormous market power, oligopolistic firms are often very reluctant to change their prices. Why?

Because of price rigidity (also called price stickiness):

Price rigidity is the tendency for prices in oligopolistic markets to remain stable even when costs or demand conditions change. It arises from the logic of interdependence: if a firm cuts its price, rivals will match the cut, so no firm gains market share and all earn less revenue. If a firm raises its price, rivals will not follow, so the price-raising firm loses customers to cheaper competitors. The asymmetric consequences of price changes in both directions create a strong incentive for oligopolistic firms to leave prices unchanged and compete on non-price dimensions instead.

Think about it from a firm's perspective:

• Cut your price: rivals immediately match it. You've triggered a price war, nobody gains market share, and everyone earns less. Net result: you're worse off.

• Raise your price: rivals don't follow. You've just priced yourself out of the market while your competitors steal your customers. Net result: also worse off.

Neither move makes sense. So firms get stuck at roughly the same price, competing on everything else instead.

Price Wars: When the Logic Breaks Down

Sometimes, though, the discipline breaks. Price wars - where competing firms slash prices in an attempt to win market share - do happen, and they're great to watch if you have no interest on that specific market.

IB Economics Real-life Example: The UK supermarket sector is a masterclass in this. The dramatic rise of Lidl and Aldi in the 2010s and 2020s forced established players like Tesco and Sainsbury's into sustained price reductions across their own-label ranges, loyalty scheme discounts, and price-match guarantees. Those taking part didn't want to cut prices - it was forced on them by new competitive pressure from outside the traditional oligopoly.

The lesson? Price wars aren't in the best interests of the firms involved. They reduce the value of the offer for everyone in the market. The only winner is the consumer.

Non-Price Competition

Since cutting prices tends to trigger retaliation and price wars tend to hurt everyone, oligopolistic firms channel most of their competitive energy into non-price competition:

Refers to competitive strategies that firms use to attract customers without reducing price. In oligopolistic markets, where price cuts are easily matched by rivals and price wars harm all participants, firms typically compete through: advertising and branding (building emotional loyalty and brand recognition), product differentiation (making their offering feel distinct), product development and innovation (launching new features, editions, or products), packaging and design, and quality of service. Non-price competition is a defining feature of oligopoly precisely because it allows firms to compete vigorously without triggering mutually destructive price wars.

Non-price competition includes:

Advertising and branding - building emotional connections that make customers less price-sensitive. Why does Nike charge £120 for trainers that cost a fraction of that to make? Because of the swoosh, the "Just Do It", the association with elite athletes. That's non-price competition creating brand loyalty so powerful it shifts the demand curve.

Packaging and product differentiation - making your product feel distinct even when it's functionally similar. Think about the rivalry between Pepsi and Coca-Cola. Chemically, they're remarkably similar drinks. But brand, packaging, marketing, and identity have kept both companies profitable for over a century without relying primarily on price.

Product development and innovation - special editions, new features, innovative launches. Apple doesn't compete primarily on price; it competes on product. The iPhone 16 launch wasn't a price cut - it was a new camera system, a new chip, new colours. That's non-price competition.

Quality of service - giving customers a better experience to justify staying loyal even when a cheaper option exists. Amazon Prime's free next-day delivery isn't about the price of the subscription - it's about the convenience that keeps you from shopping elsewhere.

Oligopoly and Market Failure

Let's tie this together with a critical evaluation point - the kind your IB Economics examiners love.

Oligopoly is allocatively inefficient because firms with significant market power charge prices above their marginal cost of production (P = AR > MC). This means consumers pay more than the true cost of producing the last unit, and output is lower than the socially optimal level. If the market were more competitive, supply would be greater and prices lower. Both collusive and non-collusive oligopolies contribute to this inefficiency, making oligopoly a significant source of market failure.

Asymmetric information and market power in oligopolistic markets contribute to this market failure. Consumers often don't know they're paying inflated prices precisely because collusion is secret, or because brand loyalty has blurred their ability to compare.

The suboptimal output and anti-competitive behaviour of oligopolistic firms directly causes allocative inefficiency - and that's why competition authorities like the CMA, the EU's competition watchdog, and the US Department of Justice spend billions of euros and dollars each year trying to keep these markets as competitive as possible.

IB Economics Exam Tips

On the payoff matrix: when drawing or interpreting a game theory matrix, always identify the Nash equilibrium - the outcome where neither player can improve their position by changing strategy unilaterally. Explain why this tends to be suboptimal compared to the cooperative outcome, and why firms are tempted to cheat anyway.

On collusion vs non-collusion: IB Economics examiners love an essay question asking you to "discuss the factors that determine whether oligopolistic firms will collude or compete." Use: number of firms, homogeneity of product, barriers to entry, ease of monitoring, legal environment, and the temptation to cheat. Show both sides.

On non-price competition: don't just list examples - explain the economic fundamentals. Non-price competition builds brand loyalty, shifts the demand curve rightward, and makes demand more price inelastic. That's why firms do it.

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Frequently Asked Questions

What is an oligopoly in economics? An oligopoly is a market structure dominated by a small number of large firms, each with significant market power. The key feature of oligopoly is interdependence - every firm's decisions about price, output, and strategy directly affect its rivals, who will respond in turn. Oligopolies may be collusive (firms cooperate) or non-collusive (firms compete independently while watching each other closely).

What is the Nash equilibrium in game theory? The Nash equilibrium is the outcome in a strategic game where no participant can improve their result by changing their strategy alone, given what all other participants are doing. In oligopoly, the Nash equilibrium is typically reached when all firms choose to compete rather than cooperate - for example, both firms cut prices - even though cooperation would have produced better profits for everyone. It is stable not because it is the best outcome, but because no single firm has an incentive to deviate unilaterally.

Why is collusion illegal? Collusion is illegal because it is anti-competitive. When firms agree to fix prices or limit output, they act as a joint monopoly - raising prices above competitive levels at the expense of consumers. This causes allocative inefficiency: output is lower and prices higher than they would be in a competitive market. Competition authorities such as the UK's CMA and the EU's European Commission actively investigate and fine firms found to be colluding, with penalties reaching billions of pounds or euros.

What is the difference between collusive and non-collusive oligopoly? In a collusive oligopoly, firms make explicit or tacit agreements to coordinate their behaviour - fixing prices, dividing markets, or limiting output collectively. In a non-collusive oligopoly, firms compete independently, each making strategic decisions while anticipating rivals' reactions. Non-collusive oligopolies are characterised by interdependence, price rigidity, and a strong emphasis on non-price competition such as advertising, branding, and product innovation.

Why do oligopolistic firms prefer non-price competition? In oligopolistic markets, cutting prices is a risky strategy because rivals will typically match any price reduction, meaning no firm gains market share while all earn less revenue. Raising prices is equally risky because rivals will not follow, causing the price-raising firm to lose customers. This price rigidity pushes firms toward non-price competition - advertising, branding, product development, and service quality - as safer and more sustainable ways to attract and retain customers.

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Coming Up: Market Power – The final entry

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

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IB Economics Hub Page

IB Economics Module 2 Microeconomics Hub Page

IB Economics Diagrams Page to access all diagrams related to IB Economics

IB Economics Market Power Hub Page

IB Economics Oligopoly Hub Page containing all Oligopoly content

Revenue, Costs and Profit Page - abnormal profit is the incentive for collusion; check the profit maximisation entry

Market Failure hub page - oligopoly allocative inefficiency is a major real-world source of market failure; investigate this connection

Government Intervention hub page - cartel enforcement by the CMA and EU connects directly to government intervention in markets

IB Economics Paper 1 Guide - oligopoly and game theory are heavily examined at HL; cover the Paper 1 guidance

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