An oligopoly is when a market is shared by only a small number of firms, resulting in a state of limited competition. An oligopoly is similar to a monopoly, but in a monopoly, only a single company or group owns all or nearly all of the market for a given type of product or service.
There is no upper limit to the number of firms in an oligopoly. However, the number must be low enough that the actions of one firm significantly influence the others. Even though companies within oligopolies are competitors, they tend to cooperate with each other—either directly or indirectly—in order to benefit as a whole. This often leads to higher prices for consumers.
- An oligopoly is when a market is shared by only a small number of firms, resulting in a state of limited competition.
- Since the 1980s, it has become more common for industries to be dominated by two or three firms as merger agreements between major players have resulted in industry consolidation.
- Currently, some of the most notable oligopolies in the U.S. are in film and television production, recorded music, wireless carriers, and airlines.
- For consumers and citizens, the consolidation of private power generally means they will incur higher costs, and historically, consumer efforts have been effective over time at stopping some of the abuses of power that result from industry consolidation.
- Government policy can discourage or encourage oligopolistic behavior, and firms in mixed economies often seek government blessing for ways to limit competition.
Historical Examples of Oligopolies
Oligopolies in history include steel manufacturers, oil companies, railroads, tire manufacturing, grocery store chains, and wireless carriers. The conditions that enable oligopolies to exist include high 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 railroad boom in the 19th century was ripe with such conditions.
In the United States during the mid- to late-1800s, a boom of railroad construction took place, including establishing the transcontinental railroad that stretched from the East Coast to California. Railroads, being both capital and labor-intensive, presented high barriers to entry and legal status as a sort of public utility. Four of the five transcontinental railroads were built with assistance from the federal government through land grants, receiving millions of acres of public lands from Congress.
This allowed for an oligopoly, especially as smaller competitors were acquired. For instance, in 1901, nine locomotive manufacturing companies combined in a merger to form the American Locomotive Company (ALCO).
Industry Consolidation Is on the Rise
Throughout history, there have been oligopolies in many different industries, including steel manufacturing, oil, railroads, tire manufacturing, grocery store chains, and wireless carriers. Currently, some of the most notable oligopolies in the U.S. are in film and television production, recorded music, wireless carriers, and airlines.
Since the 1980s, it has become more common for industries to be dominated by two or three firms. Merger agreements between major players have resulted in industry consolidation.
The concentration ratio measures the market share of the largest firms in an industry and is used to detect an oligopoly. 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 influence the others.
The economic and legal concern is that an oligopoly can block new entrants, slow innovation, and increase prices, all of which harm consumers. Firms in an oligopoly set prices, whether collectively—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.
Media Conglomerates Dominate Film and Television
Film and television production in the U.S. is dominated by the film and television production units of five media conglomerates: The Walt Disney Company, WarnerMedia, NBCUniversal, Sony, and Viacom. In 2018 alone, the box office proceeds of Disney exceeded $7 billion.
Previously, 21st Century Fox was included in this list of the largest film production companies, but in March 2019, all the media assets of 21st Century Fox were acquired by Disney for $71.3 billion. This acquisition made The Walt Disney Company the largest media company in the world.
Wireless Carriers Represent Highly-Concentrated Industry
The combined market share of the four major wireless carrier companies in the U.S.—Sprint-Nextel, T-Mobile, Verizon, and AT&T—is over 98%. In this highly concentrated industry, certain practices that are unfriendly to the consumer have become the norm, including termination fees and sneaky overage charges.
The majority of consumers are locked in contracts with one of these four companies, and there is very little recourse for this oligopoly behavior.
The Big 3 Music Labels
Although there are niche record companies that cater to specific audiences and music styles, the music industry is dominated by three major recording labels: Sony BMG, Universal Music Group, and Warner Music Group. EMI was included in this group until Universal Music Group purchased EMI in 2012.
When Universal Music Group initially expressed interest in purchasing EMI for $1.9 billion in 2012, industry watchdog groups encouraged the government to stop the deal, claiming that the consolidation would result in the newly created music superpower disrupting pricing and raising costs for consumers. Although a congressional hearing was held and the issue was examined by both American and European regulators, the takeover was eventually approved.
Domestic Airlines Oligopoly
The airline industry in the U.S. is also arguably an oligopoly, with four major domestic airlines— American Airlines, Delta Air Lines, Southwest Airlines, and United Airlines—flying about 80% of all domestic passengers in 2017.
Prior to 1978, domestic air travel in the U.S. was managed like a public good by the Civil Aeronautics Board (CAB). They established schedules, fares, and approved new routes. With the introduction of the Airline Deregulation Act in 1978—intended to increase competition in the airline industry—the price of fares dropped, in addition to the number of flights offered.
However, after extensive consolidation in the industry and the failure of many smaller airlines, prices of airline flights started to sharply rise and have continued to rise despite the sharp decline in the cost of fuel. In addition, starting in 2008, airlines have begun charging fees for services that were earlier included in the airfare.
Market Structures Exist on a Spectrum
In reality, market structures should be thought of as on a spectrum from pure monopoly to perfect competition. While these industries all exhibit oligopoly behavior, structural shifts could easily upend the existing powers in the coming decades.
For consumers and citizens, the consolidation of private power generally means they will incur higher costs, and historically, consumer efforts have been effective over time at stopping some of the abuses of power that result from industry consolidation.
Frequently Asked Questions
Is the automobile industry an oligopoly?
Automobile manufacturing is an example of an oligopoly, with the leading auto manufacturers in the United States being Ford (F), GM, and Stellantis (the new iteration of Chrysler through mergers). Worldwide there remain perhaps just a dozen key automakers including Toyota, Honda, Volkswagen Group, and Renault-Nissan-Mitsubishi.
What is a homogenous oligopoly?
A homogenous, or undifferentiated oligopoly involves a small group of firms that all produce the same product, often in a standardized fashion. Oil companies, for example, all produce crude oil that is then standardized through the refining process.
What is a differentiated oligopoly?
Unlike a homogenous oligopoly, a differential one involves firms that produce close, but not perfect substitutes. For example, car companies all produce vehicles, but a luxury car is not a perfect substitute for a rugged pickup truck.
How does the prisoner's dilemma relate to oligopoly?
The prisoner's dilemma is a scenario in decision analysis and game theory in which two actors, acting in their own self-interests do not produce the optimal outcome. For firms in an oligopoly, the problem is that each individual firm has an incentive to undercut the others—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 undercutting the others. The result is a sub-optimal outcome for all firms involved.
What is a Cournot oligopoly?
The Cournot oligopoly model is a popular model to depict conditions of imperfect competition. lt describes an industry structure in which rival firms offering identical products compete on the amount of output they produce, independently and at the same time. The idea that one firm reacts to what it believes a rival will produce forms part of the perfect competition theory.
The Bottom Line
Oligopolies exist naturally or can be supported by government forces as a means to better manage an industry. Customers can experience higher prices and inferior products because of oligopolies, but not to the extent they would through a monopoly, as oligopolies still experience competition. The majority of the industries in the U.S. have oligopolies, creating significant barriers to entry for those wishing to enter the marketplace.