An oligopoly is a market structure in which a small number of firms dominate the market. The word oligopoly is derived from the Greek word for “few”.
It involves competition among a few major firms, meaning that decisions made by each firm in terms of prices, production, advertisement, and innovation will influence the decisions of the other firms. There are also barriers to entry in oligopoly.
Unlike a monopoly, an oligopoly has more than one major seller. However, unlike a market with many competing firms, each oligopolist must consider how its competitors will respond before changing prices, production or marketing strategies.
Most Important Characteristics of Oligopoly Market Structure
The market structure contains a few sellers providing standardised or differentiated product commodities, and entry to an oligopoly market is free, but it is actually highly difficult due to several hurdles, such as technology, money, and so on. Because oligopolistic firms are few in number, they may band together to create a cartel in which they have an implicit agreement to control prices.
Any firm can have some influence on price, especially if it is a differentiated product. Price can be determined by a dominant firm that becomes the market leader; however, the firm can use advertising activities to compete with other firms and indulge in non-price competition to attract consumers. Basically, the oligopoly market can become a monopoly through mergers and acquisitions
There are several different types of oligopolies. One common type is a duopoly, in which only two firms are in the market. A more general oligopoly has three or more firms.
Oligopolies can be found in many industries, from aerospace to automotive and pharmaceuticals. Generally, any industry with high entry barriers and capital requirements is likely to be an oligopoly.
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Types of Oligopoly
Pure Oligopoly
A pure oligopoly involves firms producing products that are very similar or essentially homogeneous. Examples often include industries involving commodities or standardized products.
Differentiated Oligopoly
A differentiated oligopoly involves firms selling products that differ in features, branding, design or perceived quality. Automobiles and consumer technology provide useful examples.
Duopoly
A duopoly is a special type of oligopoly in which two firms dominate the market. OpenStax defines duopoly as an oligopoly with only two firms.
How Do Firms Behave in an Oligopoly?
Oligopolistic firms are strategically interdependent. A firm cannot always predict the effect of a price or output decision without considering how competitors may react.
Suppose Firm A reduces its price.
Firm B may:
- match the price reduction;
- keep its price unchanged;
- reduce its price even further;
- respond through advertising rather than price.
Firm A therefore has to consider possible competitor reactions before making its decision.
This is why economists often use game theory to study oligopolistic behaviour. OpenStax identifies game theory and the prisoner’s dilemma as important tools for analysing strategic decisions in oligopolies.
Major Oligopoly Models
| Model | Main idea |
|---|---|
| Cournot model | Firms compete mainly by choosing quantities |
| Bertrand model | Firms compete mainly through prices |
| Kinked demand model | Explains possible price rigidity |
| Price leadership | One major firm sets or leads the market price |
| Cartel model | Firms coordinate output or pricing to increase joint profits |
What Are the Strategies in Oligopoly Markets?
There are a number of different ways that firms in an oligopoly can compete. One common strategy is known as price leadership.” In this strategy, one firm sets the price for the entire market. The other firms then follow suit, because they know that if they don’t, they will lose market share.
Another common strategy is known as product differentiation. In this strategy, companies try to make their products stand out from their competitors to get more customers. For example, a firm might offer a more premium product or one with more features.
Oligopolies can be dangerous for consumers because they can lead to higher prices and less innovation. However, they can also be beneficial because they can provide economies of scale that would not be possible with smaller firms.
Conclusion
Oligopoly is an economic market structure in which a few sellers make up the dominant force within the market through their large share of sales within the market. It is characterized by strategic interdependence, in which each company will have to be on the lookout as to how other firms might react to any changes in pricing, output, and marketing of products. Barriers to entry are usually high within such markets, protecting the existing firms from competition from newcomers. The oligopoly market structure can lead to innovation, economies of scale, and intense competition but at the same time raise issues of market power and collusion.
