Oligopoly Practice Questions

8 representative multiple-choice questions on oligopoly for AP Microeconomics, drawn from our 15-question bank for this module. Work through each one, then open “Show answer” for the correct choice and an explanation. For scored, timed practice across the full bank, take a full practice test.

1. 1. What is the defining characteristic that distinguishes oligopoly from other market structures?

   • A. Firms produce only identical products
   • B. Firms are mutually interdependent in their decision-making
   • C. There are no barriers to entry
   • D. Firms are price takers
   Show answer

   Correct answer: B. Firms are mutually interdependent in their decision-making

   Mutual interdependence is the hallmark of oligopoly: each firm's pricing and output decisions directly shape what rivals do and vice versa. (A) is wrong because oligopolies can sell identical or differentiated products. (C) is backwards; high barriers to entry are what keep the number of firms small. (D) describes perfect competition, not oligopoly, because these firms have real pricing power.

2. 2. In a prisoner's dilemma between two firms deciding whether to set high or low prices, what outcome represents the Nash equilibrium?

   • A. Both firms set high prices
   • B. Both firms set low prices
   • C. One firm sets a high price and the other sets a low price
   • D. Firms alternate between high and low prices each period
   Show answer

   Correct answer: B. Both firms set low prices

   Both choosing low prices is the Nash equilibrium because neither firm can improve its payoff by unilaterally switching to high prices, since doing so would just mean losing customers to the rival who stays low. (A) is the cooperative outcome both firms would prefer, but it's unstable since each firm is tempted to undercut. (C) isn't stable because the high-price firm would immediately want to switch. (D) describes repeated-game dynamics, not a one-shot prisoner's dilemma.

3. 3. According to the kinked demand curve model, why do oligopoly prices tend to be sticky?

   • A. Government price controls prevent firms from changing prices
   • B. Firms face a gap in the marginal revenue curve that absorbs cost changes
   • C. Firms have perfectly elastic demand at the current price
   • D. Colluding firms agree to never change prices
   Show answer

   Correct answer: B. Firms face a gap in the marginal revenue curve that absorbs cost changes

   The kink in the demand curve produces a vertical discontinuity in the MR curve. When MC shifts within that gap, the profit-maximizing quantity and price don't budge. (A) is irrelevant because the model has nothing to do with government regulation. (C) is inaccurate; demand is more elastic above the kink and less elastic below it, not perfectly elastic throughout. (D) mixes up two different models; the kinked demand curve explains stickiness without requiring any collusion.

4. 4. Which of the following conditions makes collusion between firms EASIER to sustain?

   • A. A large number of firms in the market
   • B. Highly differentiated products
   • C. Frequent, repeated interactions between firms
   • D. Rapidly fluctuating demand conditions
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   Correct answer: C. Frequent, repeated interactions between firms

   Repeated interactions let firms credibly threaten punishment, something like 'undercut me today and I'll undercut you for the next six months', which keeps everyone in line. (A) makes collusion harder because coordinating and monitoring behavior becomes exponentially more difficult with more players. (B) complicates agreements because differentiated products make it tougher to agree on a single price or detect when someone is secretly discounting. (D) makes it hard to tell whether a rival's price cut is cheating or just a response to shifting demand, which erodes trust.

5. 5. Referring to the same payoff matrix from Question 5, what is the cooperative (jointly optimal) outcome, and why is it unlikely to persist?

   • A. (3, 3), because both firms prefer low prices
   • B. (8, 8), because each firm is tempted to defect to Low Price and earn 10
   • C. (10, 1), because Firm A always dominates Firm B
   • D. (8, 8), because government regulation enforces it
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   Correct answer: B. (8, 8), because each firm is tempted to defect to Low Price and earn 10

   (8, 8) is the cooperative optimum: both firms earn 8 by choosing High Price. It's unstable because either firm can defect to Low Price and jump from 8 to 10 while the cooperating firm crashes to 1. That temptation is exactly why real-world cartels collapse. (A) identifies the Nash equilibrium, not the cooperative outcome. Firms are trapped there rather than choosing it voluntarily. (C) is just one cell in the matrix, not an equilibrium or cooperative result. (D) names the right outcome but the wrong mechanism entirely.

6. 6. A Nash equilibrium in a two-player game is best defined as an outcome where:

   • A. Both players achieve the highest possible combined payoff
   • B. Neither player can improve their own payoff by unilaterally changing strategy
   • C. One player has a dominant strategy and the other does not
   • D. The game has been repeated enough times for cooperation to emerge
   Show answer

   Correct answer: B. Neither player can improve their own payoff by unilaterally changing strategy

   Nash equilibrium means each player's strategy is the best response to the other player's strategy, so no one gains from changing their own choice while the other holds constant. It's about individual stability, not collective optimality. (A) describes the cooperative or socially optimal outcome, which is often different from Nash. (C) isn't necessary or sufficient because Nash equilibria can exist with or without dominant strategies. (D) describes a feature of repeated games that might help sustain cooperation, but Nash equilibrium applies to one-shot games just fine.

7. 7. OPEC successfully raises oil prices by restricting production quotas among members. Over time, cartel discipline weakens primarily because:

   • A. Consumer demand for oil becomes perfectly elastic
   • B. Each member has an individual incentive to exceed its quota and sell more at the high price
   • C. Non-OPEC countries reduce their oil production in solidarity
   • D. Governments in OPEC nations enforce strict compliance with quotas
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   Correct answer: B. Each member has an individual incentive to exceed its quota and sell more at the high price

   Once the cartel pushes the price up, each member realizes it can boost its own revenue by quietly pumping beyond its quota. If only one member cheats, the price barely moves and that member profits handsomely. But when multiple members cheat at once, supply floods the market and the cartel price collapses. Prisoner's dilemma in real life. (A) is wrong because oil demand is famously inelastic, which is exactly why restricting supply works so well. (C) is the opposite of what happens; non-OPEC producers like U.S. shale companies ramp up output to capitalize on higher prices, further undermining the cartel. (D) describes effective enforcement, which is the exception in OPEC's history, not the norm.

8. 8. A four-firm concentration ratio of 92% in an industry indicates that:

   • A. The industry is perfectly competitive because many firms share the market
   • B. The four largest firms control 92% of total market sales, suggesting an oligopoly
   • C. Each of the four firms earns exactly 23% of industry profit
   • D. The industry has no barriers to entry
   Show answer

   Correct answer: B. The four largest firms control 92% of total market sales, suggesting an oligopoly

   The four-firm concentration ratio adds up the market shares of the four biggest firms. At 92%, the market is highly concentrated, solidly in oligopoly territory. (A) draws the exact wrong conclusion; 92% concentration is about as far from competitive as it gets. (C) assumes equal shares, but the ratio is a sum. One firm might hold 60% while the other three split 32%. (D) contradicts the high concentration; industries without entry barriers tend toward many firms and low concentration.