Oligopoly

Definition

An oligopoly is a market structure characterized by a small number of firms that have significant market power, allowing them to influence prices and control supply. These firms often compete on factors other than price, such as advertising and product differentiation, leading to interdependent pricing strategies. The presence of barriers to entry and the possibility of collusion among firms define this competitive landscape, shaping how resources are allocated within an economy.

5 Must Know Facts For Your Next Test

1. In an oligopoly, firms are interdependent, meaning the actions of one firm directly affect the decisions of others, leading to strategic behavior.
2. Oligopolistic markets often experience price rigidity, where prices remain stable over time despite changes in demand or costs due to fear of losing customers or provoking price wars.
3. Barriers to entry, such as high startup costs and strong brand loyalty, prevent new competitors from easily entering the market, thus maintaining the oligopoly.
4. Firms in an oligopoly may engage in non-price competition, including advertising and product innovation, to gain market share without directly altering prices.
5. The potential for collusion in oligopolies can lead to higher prices for consumers and reduced overall market efficiency, as firms may work together rather than compete.

Review Questions

• How do the characteristics of oligopoly impact the behavior of firms within this market structure?
  • In an oligopoly, the small number of firms means that each firm's decisions directly affect the others. This interdependence leads to strategic behavior, where firms must consider how their actions will be perceived by competitors. For example, if one firm lowers its prices, others may follow suit to maintain their market share. This dynamic often results in price stability and encourages non-price competition strategies like advertising and product differentiation.
• Discuss the implications of collusion among firms in an oligopolistic market for consumers and overall market efficiency.
  • Collusion among firms in an oligopoly can have significant implications for consumers and market efficiency. When firms agree to set prices or limit production collectively, they can effectively act like a monopoly, leading to higher prices and reduced choices for consumers. This behavior undermines competition and can result in allocative inefficiency since resources are not being used optimally. Additionally, collusion can stifle innovation as firms may prioritize maintaining their agreements over investing in new products or improvements.
• Evaluate how barriers to entry influence the stability and longevity of oligopolistic markets compared to other market structures.
  • Barriers to entry play a crucial role in maintaining the stability and longevity of oligopolistic markets by preventing new competitors from entering the market easily. High startup costs, established brand loyalty, and regulatory hurdles create an environment where existing firms can dominate without facing significant threats from newcomers. Compared to perfect competition or monopolistic competition where barriers are low, this creates a more stable environment for incumbent firms. However, it also means that consumers may face less choice and higher prices over time due to reduced competitive pressure.

Related terms

Monopoly: A market structure where a single firm dominates the market, controlling the entire supply of a good or service, leading to higher prices and reduced consumer choice.

Cartel: An agreement among competing firms in an oligopoly to coordinate their production and pricing strategies to maximize profits at the expense of competition.

Market Power: The ability of a firm or group of firms to influence the price of goods or services in a market, often a key feature in oligopolistic competition.