Oligopoly

Definition

An oligopoly is a market structure characterized by a small number of firms that dominate the market, leading to limited competition and interdependence among the firms. In this setting, the actions of one firm can significantly impact the others, making strategic decision-making crucial. Oligopolistic markets often arise in industries where high barriers to entry prevent new competitors from entering, and this can lead to unique pricing strategies, potential collusion, and variations in supply and demand dynamics.

5 Must Know Facts For Your Next Test

1. Oligopolies often exhibit price rigidity, meaning that prices tend to be stable over time because firms are reluctant to change prices for fear of losing market share to rivals.
2. Market power in oligopolistic industries can lead to non-price competition, where firms compete through advertising, product differentiation, and customer service instead of price cuts.
3. Examples of oligopolistic markets include the automotive industry, telecommunications, and airline services, where a few companies hold significant market shares.
4. Firms in an oligopoly may engage in tacit collusion, where they indirectly coordinate actions without formal agreements to maintain their profitability.
5. Regulators often scrutinize oligopolistic markets to prevent anti-competitive practices and ensure that consumers benefit from fair pricing and choice.

Review Questions

• How does the interdependence of firms in an oligopoly affect their pricing strategies?
  • In an oligopoly, firms are highly interdependent, meaning that the pricing decisions made by one firm can significantly affect the others. This leads to a scenario where firms often avoid drastic price changes since they risk starting a price war or losing market share. As a result, they may opt for stable pricing or engage in non-price competition methods like advertising or improving product quality.
• Discuss the implications of high barriers to entry in an oligopolistic market and how it affects supply and demand.
  • High barriers to entry in an oligopolistic market limit the number of competitors able to enter the industry. This concentration can lead to less overall supply and can allow existing firms to maintain higher prices than in more competitive markets. The limited number of suppliers may also result in less responsive supply changes to shifts in demand, making the market less flexible and potentially leading to shortages or surpluses.
• Evaluate the potential consequences of collusion among firms within an oligopoly on consumer welfare and market efficiency.
  • Collusion among firms within an oligopoly can lead to higher prices and reduced output, ultimately harming consumer welfare as buyers face fewer choices and pay more for goods. This behavior undermines market efficiency because resources are not allocated optimally; instead, firms focus on maximizing joint profits at the expense of competitive practices. Moreover, collusion can discourage innovation and improvements in products or services as firms become complacent in their protected positions.

Related terms

Duopoly: A specific type of oligopoly where only two firms dominate the market, often resulting in direct competition between them.

Barriers to Entry: Obstacles that make it difficult for new competitors to enter a market, such as high startup costs, regulatory requirements, or strong brand loyalty.

Collusion: An agreement among firms in an oligopoly to set prices or output levels, which can reduce competition and lead to higher profits for the involved parties.