Course Content
Price System, Microeconomy: Consumer Theory
Price System, Microeconomy: Efficiency and market failure, Private costs and benefits, externalities and social costs and benefits
Price System, Microeconomy: Growth and survival of firms; Differing objectives and policies of firms
Macroeconomy: Economic growth and sustainability, Employment, Money and banking
CAIE Alevel Economics (A2)

  • The kinked demand curve is a noncooperative equilibrium model used to explain oligopoly behavior.
  • It is based on the assumption that firms in an oligopoly market are interdependent, meaning that they are aware of the impact of their actions on each other's profits.
  • The kinked demand curve model predicts that in the short run, firms will face a relatively elastic demand curve above the kink point and a relatively inelastic demand curve below the kink point.
  • The kink in the demand curve occurs when a firm assumes that its competitors will match any price decrease it makes but will not follow any price increase.
  • This leads to a gap or kink in the demand curve, where the demand is more elastic above the kink and less elastic below it.
  • In this model, firms are assumed to maximize their profits and choose their prices based on their assumptions about the behavior of their competitors.
  • If a firm raises its price above the kink point, it will lead to a significant loss in market share, resulting in a sharp decline in revenue.
  • If it lowers its price below the kink point, it will result in a relatively small increase in market share, which will not offset the revenue lost due to the price cut.
  • Therefore, firms are likely to maintain the existing price level, resulting in a state of stable equilibrium.
  • The model is based on the assumption of noncooperative behavior, where firms do not cooperate to maximize industry profits.
  • This model has been criticized for its oversimplification and unrealistic assumptions.

  • Cooperative equilibrium refers to a situation in which firms in an industry cooperate with each other to maximize their collective profits.
  • One form of cooperation is collusion, which occurs when firms in an industry agree to fix prices, output levels, or other terms of competition in order to increase their profits.
  • Collusion typically involves a group of firms acting together as a cartel.
  • Cartels can agree to limit output, allocate market share, or fix prices at a higher level than would exist in a competitive market. By limiting competition, cartels can earn higher profits than they would in a competitive market.
  • The success of collusion depends on a number of factors,
    • Number of firms in the industry - difficult to coordinate
    • Level of competition from closely related industries
    • stability of the market for its products
    • barriers to entry
    • range of products (similarity) made by cartel members
    • similarity of cost structure between firms
    • monitoring cost to identify cheating
    • benefits of cheating vs. benefits of long term cooperation
    • legal obstacles, illegal in most countries
  • In many cases, collusion may be illegal under antitrust laws, which prohibit agreements that restrain competition.
  • In a cooperative equilibrium, firms can earn higher profits than they would in a non-cooperative equilibrium. However, the benefits of cooperation are often offset by the costs of organizing and enforcing the agreement. In addition, the benefits of cooperation may be unevenly distributed among the firms in the industry, leading to tensions and conflicts within the cartel.
  • Tacit collusion: firms refrain from competing on price, but without communication or formal agreement between them - price leadership
    • a dominant producer takes the lead in setting the price, other firms following
    • one firm tries out a price increase and then waits to see whether other firms follow; if they do, a new higher price has been reached without the need for discussions between the firms; if others not following, the firm drop back the price.


  • Economies of scale: Oligopolistic firms have the potential to achieve economies of scale, which leads to lower average costs of production.
  • Innovation: Oligopolistic firms have the financial resources to invest in research and development, leading to innovation and new product development.
  • Competition: Although there are only a few dominant firms in the industry, they still compete with each other, leading to higher product quality, lower prices, and improved consumer welfare.
  • Advertising: Oligopolistic firms invest heavily in advertising, leading to increased consumer awareness and brand loyalty.


  • Barriers to entry: High entry barriers prevent new firms from entering the market, limiting competition and innovation.
  • Price rigidity: In an oligopoly, firms tend to follow the pricing strategies of their competitors, leading to price rigidity and lack of price competition.
  • Collusion: Oligopolistic firms may engage in collusion, leading to anti-competitive behavior and higher prices for consumers.
  • Lack of consumer choice: With a limited number of firms dominating the industry, consumers have fewer choices in terms of product variety and price.

  • Collusion refers to a secret agreement between firms to cooperate with each other and act as a single monopolistic entity in order to maximize profits.
    • In oligopolistic markets, collusion can take place through price-fixing, production quotas, or market sharing agreements.
  • The Prisoner’s Dilemma is a concept in game theory that explains why it is difficult for firms to cooperate with each other, even when it is in their best interest to do so.
    • The dilemma arises when two players have to choose between cooperation and self-interest, and their decision depends on the decision of the other player.
    • If both players cooperate, they can achieve a better outcome than if they both choose self-interest.
    • However, if one player chooses self-interest and the other cooperates, the player who chooses self-interest will achieve a better outcome than the cooperating player.
  • In an oligopolistic market, the pay-off matrix for a two-player Prisoner’s Dilemma game can be as follows:

    • In this matrix, the first number in each cell represents the pay-off for Firm A, while the second number represents the pay-off for Firm B.
      • If both players cooperate, they will each receive a pay-off of 8.
      • However, if one player defects while the other cooperates, the defector will receive a higher pay-off of 10, while the cooperator will receive a pay-off of 1.
      • The dilemma is that, if both players act in their self-interest and defect, they will both receive a pay-off of 3, which is lower than the pay-off of 8 that they would receive if they both cooperated.
      • The dominant strategy for each player is to defect, even though they would both be better off if they cooperated.
  • In oligopolistic markets, the Prisoner’s Dilemma makes it difficult for firms to collude and cooperate with each other. Even if collusion would lead to higher profits for all firms involved, the temptation to cheat and defect can be too great, as each firm may fear that the other firms will cheat and take a larger share of the market.
  • Dominant strategy: a situation in game theory where a player's best strategy is independent of those chosen by others
  • Nash Equilibrium: a situation occurring within a game when each player's chosen strategy maximises her payoffs given the other player's choice, so no player has an incentive to alter current strategy unilaterally

Non-price competition refers to the marketing strategy where firms differentiate their products from those of their competitors to gain a competitive advantage.

  • One common way of product differentiation is through quality, design, and features of a product. Other ways include branding, packaging, advertising, and customer service.
  • Product differentiation helps firms to capture a greater market share by creating customer loyalty and brand recognition. This makes it difficult for competitors to enter the market and gain customers. For example, companies such as Apple, Nike, and Coca-Cola use product differentiation to maintain their market share.
  • However, there are also drawbacks to product differentiation.
    • It can increase production costs and reduce economies of scale, which can lead to higher prices for consumers.
    • Moreover, it can also result in a wasteful duplication of research and development efforts and advertising costs.

In summary, non-price competition through product differentiation can be beneficial to firms, but it can also lead to higher costs and less competition in the market.

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