Oligopoly

Definition

An oligopoly is a market structure characterized by a small number of firms that dominate the market, leading to limited competition and significant influence over prices. This structure often leads to strategic interactions among firms, where the actions of one firm can greatly affect the others. Oligopolies often result in higher prices and reduced output compared to more competitive markets, as firms may collude or engage in non-price competition to maintain their market power.

5 Must Know Facts For Your Next Test

1. Oligopolies can be found in various industries, including automotive, telecommunications, and pharmaceuticals, where only a few large firms hold significant market share.
2. Firms in an oligopoly may engage in price leadership, where one firm sets a price that other firms follow, reducing the likelihood of price wars.
3. Non-price competition, such as advertising and product differentiation, is common in oligopolistic markets as firms try to attract customers without changing prices.
4. Game theory is often used to analyze the strategic interactions among firms in an oligopoly, highlighting how their decisions impact one another.
5. The potential for collusion can lead to higher prices and less consumer choice, prompting regulatory scrutiny from governments to prevent anti-competitive practices.

Review Questions

• How do the characteristics of an oligopoly influence firms' pricing strategies?
  • In an oligopoly, the limited number of firms means that each has significant market power and must consider the potential reactions of competitors when setting prices. This interdependence leads to strategic pricing decisions, where one firm's price change can trigger reactions from others. For instance, if one firm lowers its prices to attract customers, others may follow suit to avoid losing market share, which can lead to price wars or collusive behavior.
• Evaluate the impact of non-price competition on consumer choice within an oligopoly.
  • Non-price competition allows firms in an oligopoly to differentiate their products through advertising, branding, and unique features. This strategy helps firms maintain customer loyalty without engaging in destructive price competition. However, while it can enhance consumer choice by offering varied products, it can also limit choices if dominant firms create barriers for smaller competitors trying to enter the market. Therefore, consumers may face limited options overall despite the diversity presented by established firms.
• Analyze the implications of collusion among firms in an oligopoly on market efficiency and consumer welfare.
  • Collusion among firms in an oligopoly typically leads to higher prices and reduced output compared to a competitive market. By coordinating their actions, colluding firms can maximize joint profits at the expense of consumers, resulting in decreased market efficiency. This behavior can stifle innovation and limit consumer choices since firms may not feel pressure to improve products or reduce prices. Ultimately, collusion undermines consumer welfare and can prompt regulatory interventions aimed at preserving competitive markets.

Related terms

Collusion: An agreement among firms in an oligopoly to set prices or limit production to increase their joint profits.

Market Power:

The ability of a firm or group of firms to influence the price of a good or service in the market.

Kinked Demand Curve: A model that describes how the demand curve for an oligopolistic firm is shaped, reflecting the reaction of firms to price changes by their competitors.