Oligopoly

DEFINITION of 'Oligopoly'

Oligopoly is a market structure in which a small number of firms has the large majority of market share. An oligopoly is similar to a monopoly, except that rather than one firm, two or more firms dominate the market. There is no precise upper limit to the number of firms in an oligopoly, but the number must be low enough that the actions of one firm significantly impact and influence the others.

BREAKING DOWN 'Oligopoly'

An example of an oligopoly is the wireless service industry in Canada, in which three companies – Rogers Communications Inc (RCI), BCE Inc (BCE) subsidiary Bell and Telus Corp (TU) – control approximately 90% of the market. Canadians are conscious of this oligopolistic market structure and often lump the three together as "Robelus," as though they were indistinguishable. In fact, they are often indistinguishable in price: in early 2014 all three companies raised the price for smartphone plans to $80 in most markets, more or less in tandem.

This example shows that participants in oligopolies are often able to set prices, rather than take them. For this reason oligopolies are considered to be able increase profit margins above what a truly free market would allow.

Most jurisdictions have laws against price fixing and collusion. An oligopoly in which participants explicitly engage in price fixing is a cartelOPEC is one example. Tacit collusion, on the other hand, is perhaps more common though more difficult to detect. A stable oligopoly will often have a price leader; when the leader raises prices, the others will follow.

The alternative is for one or more firms to take advantage of the price rise by cutting prices and siphoning business away from the company with the highest price. If that happens, firms may align in a number of different ways: the majority may keep prices low in an attempt to squeeze the firm with the highest price out of the market; the majority may raise prices, isolating the "cheating" firm and putting it under financial strain; or they may each attempt to undercut the rest, setting off a price war that could damage them all. The late 19th-century railroad cartel in the U.S. was characterized by blatant collusion and price fixing, interspersed with vicious price wars.

Game theorists have developed models for these scenarios, which form a sort of prisoner's dilemma. In general, a situation of (tacit) collusion on prices is considered to be the Nash equilibrium state for oligopolies. Rather than using price, firms in oligopolies tend to prefer to use product differentiationbranding and marketing to compete, with the goal being to increase market share.

The reason new entrants seldom come in to disrupt the market is that oligopolistic industries tend to have high barriers to entry. Wireless carriers, for example, must either build and maintain towers, requiring massive capital expenditures, or lease the incumbents' infrastructure at vampiric rates. Carriers also tend to have strong, instantly recognizable brands. Even if these brands carry certain negative associations (ie, "cartel"), they provide a distinct advantage over unknown new entrants. Other industries that have commonly seen oligopolies also have high barriers to entry: oil and gas drillers, airlines, grocers and movie studios are a few examples.

A duopoly​ is an oligopoly composed of two participants. 

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