Oligopoly

Definition

An oligopoly is a market structure characterized by a small number of firms that dominate an industry, leading to limited competition. These firms have significant market power, allowing them to influence prices and other market factors. Because of the interdependence among the firms in an oligopoly, decisions made by one firm can directly affect others, often leading to strategic behavior like collusion or price-fixing.

5 Must Know Facts For Your Next Test

1. In an oligopoly, the few firms that dominate the market can lead to higher prices and reduced output compared to more competitive markets.
2. Firms in an oligopoly must consider the potential reactions of their competitors when making pricing or production decisions, creating a strategic environment.
3. Examples of industries that often exhibit oligopoly include telecommunications, airlines, and automotive manufacturing.
4. The presence of barriers to entry in an oligopoly can prevent new competitors from entering the market, further solidifying the dominance of existing firms.
5. Oligopolistic firms may engage in non-price competition strategies, such as advertising and product differentiation, to gain market share.

Review Questions

• How does the interdependence of firms in an oligopoly affect their decision-making processes?
  • In an oligopoly, firms are highly interdependent, meaning that the actions of one firm significantly impact the others. When a firm decides to change its prices or launch new products, other firms must consider how these moves will affect their own sales and strategies. This creates a complex decision-making environment where firms may choose to cooperate or compete aggressively based on anticipated responses from rivals.
• Discuss the role of barriers to entry in maintaining an oligopolistic market structure and its implications for consumers.
  • Barriers to entry play a crucial role in sustaining an oligopolistic market structure by preventing new firms from entering the industry. These barriers can include high startup costs, strong brand loyalty, and regulatory requirements. As a result, established firms can maintain higher prices and reduce output without the threat of new competitors entering the market, which can lead to less choice and higher costs for consumers.
• Evaluate how oligopolies might influence regulatory policies and what impact this could have on market competition and consumer welfare.
  • Oligopolies often have significant influence over regulatory policies due to their economic power and lobbying efforts. This influence can lead to regulations that favor established firms over potential competitors, further entrenching their market position. As a result, such dynamics can stifle competition and innovation while harming consumer welfare by keeping prices artificially high and limiting choices available in the marketplace.

Related terms

Monopoly:

A market structure where a single firm controls the entire market for a good or service, allowing it to set prices without competition.

Perfect Competition:

A market structure characterized by a large number of firms competing against each other with identical products, resulting in no single firm having market power.

Cartel: An agreement among competing firms to coordinate their pricing and production decisions, often seen in oligopolistic markets to maximize joint profits.