What is an Oligopoly
Oligopoly is a market structure with a small number of firms, none of which can keep the others from having significant influence. The concentration ratio measures the market share of the largest firms. A monopoly is one firm, duopoly is two firms and oligopoly is two or more firms. 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.
BREAKING DOWN Oligopoly
Oligopolies in history include steel manufacturers, oil companies, rail roads, 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, which harms 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.
Why Are Oligopolies Stable?
An interesting question is why such a group is stable. The firms need to see the benefits of collaboration over costs of economic war, then agree to not compete and instead allocate the benefits of collaboration. They must avoid cheating, which would lead to economic war. Such wars can be waged through prices, or through attacks on territories or customer lists.
Governments have responded to oligopolies with laws against price fixing and collusion. Yet, if a cartel can price fix if they operate beyond the reach of governments – OPEC is one example. Firms have found creative ways to avoid the appearance of price fixing, such as using phases of the moon. Another approach is to for firms to follow a recognized price leader; when the leader raises prices, the others will follow.
Because price wars are easy to start and destructive to the participants, oligopolies tend to prefer the use of nonprice methods such as product differentiation, branding and marketing to increase market share.
Conditions that Enable Oligopolies
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 (social media). The global tech and trade transformation has changed some of these conditions: offshore production and the rise of "mini-mills" have affected the steel industry, for example. In the office software application space, Microsoft was targeted by Google Docs, which Google funded using cash from its web search business. Oil and gas well drilling costs were cut through technology in the mid-2010s. OPEC retaliated against North American producers with production cuts to reduce supply.
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 equilibrium state for oligopolies.