What is an Oligopoly?
An oligopoly is a type of market structure in which a small number of firms control the market. In these markets, producers can indirectly or directly restrict output or prices to achieve higher returns. A key characteristic of an oligopoly is that no single firm can prevent the others from significantly influencing the market. Unlike a monopoly, where one firm dominates, an oligopoly involves multiple firms sharing control.
Key Takeaways
- An oligopoly is a market structure characterized by a small number of firms operating to restrict output or fix prices for higher returns.
- Factors like economics, technology, and law play a role in the formation of oligopolies.
- The major challenge faced by oligopolies is a prisoner’s dilemma, encouraging members to cheat.
- Government policies can discourage or encourage oligopolistic behavior, often with companies lobbying for favorable conditions.
Understanding Oligopolies
Market structures come in various forms and sizes. These structures describe the distinctions between industries formed by different companies selling their products and services. While most aim for perfect competition (a theoretical construct that doesn’t actually exist), oligopolies consist of few companies that control the market.
Firms in an oligopoly set prices—either collectively in a cartel or under the leadership of one firm—rather than taking prices from the market. Consequently, profit margins are higher than in a more competitive market.
The barriers to entry in an oligopoly can include economies of scale, regulatory obstacles, access to supply and distribution channels, capital requirements, and brand loyalty.
Historical oligopolies include steel manufacturers, oil companies, railroads, tire manufacturing, grocery store chains, and wireless carriers. The legal and economic concern is that oligopolies can block new entrants, slow innovation, and increase prices, thereby harming consumers.
Special Considerations
Governments may respond to oligopolies with laws against price-fixing and collusion. However, cartels can still price-fix if they operate beyond government reach or with governmental consent. Oligopolies in mixed economies often seek favorable government policies to operate under regulation or direct supervision.
The primary issue for firms in an oligopoly is the incentive to cheat. If all agree to restrict supply and maintain high prices, then each firm can outcompete by breaking the agreement and capturing a larger market share. Such competition can be price-based or just through expanding individual output.
Companies benefit from collective price-setting or direction from dominant firms, circumventing free-market forces.
Oligopoly Characteristics
Oligopolies tend to be stable because participating firms see the value in collaboration over competition. They may find creative ways to avoid apparent price-fixing, such as following a price leader or subtle arrangement.
High entry costs, legal privileges, and platforms’ network effects help oligopolies to exist. Nonetheless, global technological and trade transformations have changed some conditions. For example, the steel industry has been influenced by offshore production and mini-mills, while Microsoft’s dominance in office software faced challenges from Google Docs.
Oligopolies and Game Theory
Game theorists have modeled such market behaviors into scenarios that resemble the prisoner’s dilemma. This includes achieving a Nash equilibrium where no firm wants to break agreements due to balanced costs and benefits.
Maintaining an oligopoly requires shaping the payoffs for repeated coordination games, supported by contract enforcement, trust, and laissez-faire policies.
Advantages and Disadvantages of an Oligopoly
Advantages
- Limited competition
- Higher profits for companies
- Greater consumer demand
Disadvantages
- High barriers to entry for new participants
- Lack of innovation
- Limited choices for consumers
Example of an Oligopoly
A prominent example is the Organization of the Petroleum Exporting Countries (OPEC). Founded in 1960 with five members, it expanded to 13 by 1975. OPEC’s oligopolistic power comes from its members’ significant market share, making collective decisions to influence supply and prices.
Negative Effects of an Oligopoly
Oligopolies often involve price control through collusion, leading to uncompetitive prices harming consumers. Barriers to entry and stifled innovation are common, with industries like oil, railways, wireless carriers, and big tech exhibiting these traits.
Example of a Current Oligopoly
A high concentration ratio often indicates an oligopoly, such as the U.S. mass media sector dominated by NBC Universal, Walt Disney, Time Warner, Viacom CBS, and News Corporation. Similarly, Google Android and Apple iOS control the smartphone operating systems market.
Is the U.S. Airline Industry an Oligopoly?
The airline industry is considered an oligopoly, with four companies controlling two-thirds of domestic flights: Delta Airlines, United Airlines Holdings, Southwest Airlines, and American Airlines. This concentration results in reduced competition and increased fees, a situation exacerbated after the Airline Deregulation Act of 1978.
The Bottom Line
While there’s no perfect competition, oligopolies are a distinctive market structure characterized by a few firms setting prices.
Related Terms: monopoly, cartel, market structure, barriers to entry.
References
- Organization of Petroleum Exporting Countries. “Brief History”.
- The White House. “Fact Sheet for Executive Order on Promoting Competition in the American Economy”.
- Congress.gov. “S.2493 - Airline Deregulation Act”.
