Oligopoly: Meaning and Characteristics in a Market (2024)

What Is an Oligopoly?

An oligopoly is a type of market structure in which a small number of firms control the market. Where oligopolies exists, producers can indirectly or directly restrict output or prices to achieve higher returns. A key characteristic of an oligopoly is that no one firm can keep the others from having significant influence over the market. An oligopoly differs from a monopoly, in which one firm dominates a market.

Key Takeaways

  • An oligopoly is a market structure wherein a small number of producers work to restrict output or fix prices so they can achieve above-normal market returns.
  • Economic, legal, and technological factors can contribute to the formation and maintenance, or dissolution, of oligopolies.
  • The major difficulty that oligopolies face is the prisoner's dilemma that each member faces, which encourages each member to cheat.
  • Government policy can discourage or encourage oligopolistic behavior, and firms in mixed economies often seek government blessing for ways to limit competition.

Oligopoly: Meaning and Characteristics in a Market (1)

Understanding Oligopolies

Market structures come in different forms and sizes. The term is used to describe the distinctions between industries, which are made up of different companies that sell their products and services. Most market structures aim for perfect competition, which is a theoretical construct that doesn't actually exist.

These market structures are made up of a small number of companies within an industry that controls the market. Firms in an oligopoly set prices, whethercollectively—in a cartel—or under the leadership of one firm, rather than taking prices from the market.Profit margins are thus higher than they would be in a more competitive market.

Some of the barriers to entry (that prevent new players from entering the market) in an oligopoly include economies of scale, regulatory barriers, accessing supply and distribution channels, capital requirements, and brand loyalty.

Oligopolies in history include steel manufacturers, oil companies, railroads, tire manufacturing, grocery store chains, and wireless carriers. The economic and legal concern is that an oligopoly can block new entrants, slow innovation, and increase prices, all of which harmconsumers.

Special Considerations

Governments sometimes respond to oligopolies with laws against price-fixing and collusion. Yet, a cartel can price fix if they operate beyond the reach or with the blessing of governments. Oligopolies that exist in mixed economies often seek out and lobby for favorable government policy to operate under the regulation or even direct supervision of government agencies.

The main problem that firms in an oligopoly face is that each firm has an incentive to cheat. if all firms in the oligopoly agree to jointly restrict supply and keep prices high, then each firm stands to capture substantial business from the others by breaking the agreement and undercutting the others. Such competition can be waged through prices, or through simply the individual company expanding its own output brought to market.

Companies in an oligopoly benefit from price-fixing, setting prices collectively, or under the direction of one firm in the bunch, rather than relying on free-market forces to do so.

Oligopoly Characteristics

Oligopolies are considered stable. One of the main reasons why they are is because participating firms need to see the benefits of collaboration over the costs of economic competition, then agree to not compete and instead agree on the benefits of cooperation.

The firms sometimes find creative ways to avoid the appearance of price-fixing, such as using phases of the moon. Price-fixing is the act of setting prices, rather than letting them be determined by the free-market forces. Another approach is for firms to follow a recognized price leader so that when the leader raises prices, the others will follow.

The conditions that enable oligopolies to existincludehigh entry costs in capital expenditures, legal privilege (license to use wireless spectrum or land for railroads), and a platform that gains value with more customers, such as social media.

The global tech and trade transformation has changed some of these conditions. For instance, offshore production and the rise of mini-mills have affected the steel industry.In the office software application space, Microsoft (MSFT) was targeted by Google Docs, which Google funded using cash from its web search business.

Oligopolies and Game Theory

Game theorists have developed models for these scenarios, which form a sort of prisoner's dilemma. When costs and benefits are balanced so that no firm wants to break from the group, it is considered the Nash equilibriumstate for oligopolies. This can be achieved by contractual or market conditions, legal restrictions, or strategic relationships between members of the oligopoly that enable the punishment of cheaters.

Maintaining an oligopoly and coordinating action among buyers and sellers in general on the market involves shaping the payoffs to various prisoner's dilemmas and related coordination games that repeat over time.

As a result, many of the same institutional factors that facilitate the development of market economies by reducing prisoner's dilemma problems among market participants, such as secure enforcement of contracts, cultural conditions of high trust and reciprocity, and laissez-faire economic policy, might also potentially help encourage and sustain oligopolies.

Advantages and Disadvantages of an Oligopoly

Advantages

One of the main benefits of having an oligopoly is that competition is very limited. That's because there are very few players in the market. Since there are few competitors, an oligopoly allows those who participate to net a higher amount of profits.

Disadvantages

Oligopolies come with higher barriers to entry for new participants. This means that it can be difficult to enter the market because of the high costs associated with doing business, the regulatory environment, and the problems that arise when it comes to accessing supply and distribution channels.

Because of the lack of competition, there may be very little incentive to innovate product and service offerings. With no diversity in offerings, consumers remain loyal to what they know best.

Pros

  • Limited competition

  • Higher profits for companies

  • Greater consumer demand

Cons

  • High barriers to entry for new participants

  • Lack of innovation

  • Very little choice for consumers

Example of an Oligopoly

There are many examples of oligopolies in the market. But one of the major examples of a global oligopoly is the Organization of the Petroleum Exporting Countries (OPEC). The organization was founded in Baghdad in 1960 with five countries but expanded to 13 oil-producing countries in 1975.

One of the main reasons why OPEC is considered an oligopoly is because it has no overarching authority. Every member nation within the group also has a substantial portion of the group's market share. These countries also have a great deal of power together (not separately) when it comes to supply and demand issues and pricing. So when the group lowers its supply as demand drops, prices rise. The opposite is true when demand rises.

What Are Some Negative Effects of an Oligopoly?

An oligopoly is when a few companies exert significant control over a given market. Together, these companies may control prices by colluding with each other, ultimately providing uncompetitive prices in the market. Among other detrimental effects of an oligopoly include limiting new entrants in the market and decreased innovation. Oligopolies have been found in the oil industry, railroad companies, wireless carriers, and big tech.

What Is an Example of a Current Oligopoly?

One measure that shows if an oligopoly is present is the concentration ratio, which calculates the size of companies in comparison to their industry. Instances where a high concentration ratio is present include mass media. In the U.S., for example, the sector is dominated by just five companies: NBC Universal; Walt Disney; Time Warner; Viacom CBS; and News Corporation—even as streaming services like Netflix and Amazon Prime begin to encroach on this market. Meanwhile, within big tech, two companies control smartphone operating systems: Google Android and Apple iOS.

Is the U.S. Airline Industry an Oligopoly?

With just four companies controlling nearly two-thirds of all domestic flights in the U.S. as of 2021, it has been purported that the airline industry is an oligopoly. These four companies are Delta Airlines, United Airlines Holdings, Southwest Airlines, and American Airlines. According to a report compiled by the White House, "reduced competition contributes to increasing fees like baggage and cancellation fees. These fees are often raised in lockstep, demonstrating a lack of meaningful competitive pressure, and are often hidden from consumers at the point of purchase." Interestingly, in 1978, The Airline Deregulation Act was imposed, which stripped away the Civil Aeronautics Board the ability to regulate the industry. Prior to this time, the airline industry operated much like a public utility, while fare prices had declined 20 years before the deregulation was introduced.

The Bottom Line

There is no such thing as perfect competition in the market. But there are different market structures, including oligopolies. These types of markets are characterized by a small number of participating firms, which may work together to set prices.

Oligopoly: Meaning and Characteristics in a Market (2024)

FAQs

Oligopoly: Meaning and Characteristics in a Market? ›

An oligopoly refers to a market structure that consists of a small number of firms, who together have substantial influence over a certain industry or market. While the group holds a great deal of market power, no one company within the group has enough sway to undermine the others or steal market share.

What is oligopoly defined meaning and characteristics in a market? ›

An Oligopoly Market is a system of Markets where there are more than one Vendor (or firm) for trading of a particular good but there are very few Vendors. This is imperfect competition as the decision of one Vendor affects the decision of others in the Market, although the competition is very limited.

What is oligopoly defined meaning and characteristics in a market investopedia? ›

An oligopoly is when a few companies exert significant control over a given market. Together, these companies may control prices by colluding with each other, ultimately providing uncompetitive prices in the market.

What are oligopoly markets Characterised by? ›

Oligopoly = A market structure characterized by barriers to entry and a few firms.

Which of the following is a characteristic of a market that is an oligopoly? ›

Option c) is correct: Strategic Interdependence.

In an oligopolistic market, the goods are closely related, but few firms are there, so each firm is interdependent to maximize profit. They decide price and output together to capture the market.

What characterizes oligopolistic markets? ›

An oligopoly is a market characterized by a small number of firms that have almost all the control of a market. Generally, there are 2 to 10 firms that dominate the market. Additionally, the firms that are present in this market structure are interdependent.

What is oligopoly with an example? ›

Oligopoly is a form of imperfect competition and is usually described as the competition among a few. Hence, Oligopoly exists when there are two to ten sellers in a market selling hom*ogeneous or differentiated products. A good example of an Oligopoly is the cold drinks industry.

What is a characteristic found only in oligopolies? ›

One characteristic found only in oligopolies and not in any other types of markets is the interdependence that oligopolies share with one another. Since oligopolies are made up of a few large firms that produce the same or similar type of product or service, they're typically aware of the actions of their competitors.

Which of the following is the basic characteristic of oligopoly? ›

Few sellers, many buyers is a basic characteristic of 'Oligopoly'. Oligopoly is a situation where there are only a few sellers who sell different or identical products and dominate the market since they have control over the price of the product.

What is a characteristic of oligopoly quizlet? ›

One key characteristic that is distinctive of an oligopoly market is that. The decisions of one seller often influences the price of products, the output, and the profits of rival firms. An oligopoly is a market structure in which. There are few firms selling either a hom*ogenous or differentiated product.

Which best describes an oligopoly? ›

An oligopoly refers to a market structure that consists of a small number of firms, who together have substantial influence over a certain industry or market. While the group holds a great deal of market power, no one company within the group has enough sway to undermine the others or steal market share.

What are the pros and cons of an oligopoly? ›

The advantages of an oligopoly include increased efficiency and innovation, while the disadvantages include limited competition and potential for collusion.

Which is a characteristic of oligopolies and monopolies? ›

A monopoly and an oligopoly are market structures that exist when there is imperfect competition. A monopoly is when a single company produces goods with no close substitute, while an oligopoly is when a small number of relatively large companies produce similar but slightly different goods.

What is oligopoly market and its characteristics? ›

An oligopoly exists when the market is dominated by a small number of firms. Key characteristics include high barrier to entry, small number of firms, similar product offerings, and pricing that is dictated by the firms involved.

What is one key characteristic that is distinctive of an oligopoly market? ›

The distinctive nature of an oligopolistic structure is that there is strategic interaction between companies; such interaction is absent in a monopoly and in perfect competition, in which companies, taking price as a given, behave atomistically.

Which industry is most likely to be an oligopoly? ›

Oligopolies in history include steel manufacturers, oil companies, railroads, tire manufacturing, grocery store chains, and wireless carriers.

What describes an oligopoly? ›

An oligopoly refers to a market structure that consists of a small number of firms, who together have substantial influence over a certain industry or market. While the group holds a great deal of market power, no one company within the group has enough sway to undermine the others or steal market share.

What are the main characteristics of oligopoly quizlet? ›

Q-Chat
  • few large firms.
  • hom*ogeneous or differentiated.
  • control over price but mutual interdependence.
  • entry barriers.

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