Oligopoly

What It Means

The word oligopoly means “few sellers.” In an oligopoly a small number of companies control the majority of the output, or the market, for a good or service. The few companies (which are usually large in size) produce goods that are slightly or somewhat different from each other.

An oligopoly is similar to a monopoly, in which one company alone exerts control over a market. An oligopolistic industry is more concentrated than a competitive industry (that is, a small number of firms operate within the oligopolistic market), but it is less concentrated than a monopoly, in which only one firm dominates the market. A duopoly is an oligopoly in which only two firms control a market.

In an oligopoly there are so few firms that the actions of any one of them will very likely affect the price of the good and therefore have an impact on other firms in the oligopoly. For example, the majority of automobiles in the United States are manufactured by three automakers: Ford, General Motors, and Chrysler. If Ford were to lower its prices, more consumers would buy Fords, and the other two firms would experience a drop in sales. To counteract this, the other firms would most likely cut their prices as well, which would in turn impact Ford. These automakers, like firms in all oligopolies, are able to set their own pricing policies exclusive of market forces (the interaction of supply and demand that affects a market economy).

When Did It Begin?

During the Industrial Revolution the production of goods and services and the competition between companies increased, as did the formation of both monopolies and oligopolies. In the 1900s several large companies dominating the U.S. automobile and steel industries were the first oligopolies. These oligopolies attracted the close scrutiny of the U.S. government, and, over time, the U.S. government made some forms of oligopoly illegal under laws known as antitrust laws. The objective of these laws is to encourage greater competition between firms by restricting trade practices that are considered to be unfair. For instance, antitrust laws enforce pricing that is determined by market forces rather than by price setting among a small and controlling group of corporations.

Large corporations have come to dominate the business world in the twentieth century and the early years of the twenty-first century. Many corporations are the result of the merging, or joining, of several smaller companies. Fewer, larger corporations exert much of their power by controlling the supply of a particular good, much as the large automakers and petroleum companies do.

More Detailed Information

There are two basic types of oligopoly. A perfect (or homogeneous) oligopoly is one in which all firms in the industry produce an identical good or service. For example, the oil, milk, coal, copper wire, and cement industries all produce goods that are identical or nearly identical within their respective industries. The breakfast cereal industry is an example of a so-called imperfect oligopoly, or one in which each firm’s product has different characteristics but is essentially similar to the others. Imperfect oligopolies are sometimes called heterogeneous or differentiated oligopolies.

An oligopoly may be international, as in the case of automobile manufacturing, in which six automakers from the United States and Japan (General Motors, Ford, Chrysler, Honda, Toyota, and Nissan) control a large majority of U.S. automobile sales. The breakfast cereal oligopoly is a national, U.S. oligopoly. Some daily newspapers in small U.S. cities operate in an oligopoly.

Because there are so few firms in an oligopoly and they operate in highly interactive and interdependent ways, each firm will know the percentage of the total market, called the market share, for the good or service it produces. The decisions of one firm influence and are influenced by the decisions of other firms, so that any alteration in price or percentage of market share on the part of one firm will affect the other firms. Once prices are established by firms in an oligopoly, they tend to remain fixed, since each firm is aware of the consequences for other firms when it makes price and production decisions.

One of the most distinctive traits of oligopolies is the restrictions they place on the entry of firms not established in the oligopoly group, as well as restrictions on the exit of firms already in the group. An outside firm attempting to gain entry into an oligopoly must have money to pay for the high costs of starting up and conducting the research activities necessary to becoming competitive. It also must have resources to advertise and time to build the loyalty of customers. Often the significant financial and technical resources needed to gain entry into an established group of interdependent firms prohibit any other firms from joining.

The collective effort to prevent new firms from joining is a key strategy of oligopolistic competition. Within an oligopoly, firms also devise ways to outmaneuver one another in order to gain a larger portion of market share. For example, while it may be that no single firm in an oligopoly is willing to upset the price equilibrium among all the firms by raising or lowering its prices, a firm might try to distinguish itself from the others by signaling to customers that the quality of its product is superior. One way for a firm to demonstrate confidence in the quality of its product is to offer customers an extended warranty (a type of guarantee). Within an oligopoly, a firm might also vie for a dominant position by concealing from other firms its efforts to innovate in hopes of taking the market by surprise with a new or improved product. Although illegal, some firms in oligopolies have bargained with one another, agreeing to keep prices high or to stay out of each other’s most profitable geographical areas. The field of game theory in economics centers around efforts to understand how individual firms engage in strategic competition within an oligopolistic, or interdependent, situation.

Recent Trends

In the last part of the twentieth century and the early years of the twenty-first century the number and power of oligopolies have increased because of corporate globalization, or the growth of transnational companies (companies that operate and invest in many countries around the world). Transnational corporations dominate the global economy, and many of them are parts of oligopolies.

In addition to globalization, increased competition has caused the growth of larger and more powerful corporate concentrations in such industries as food, drug, and agriculture. For example, the world’s top 10 seed companies currently control roughly one-third of the seed industry. In the United States oligopolistic industries also include the music-recording industry and the aerospace industry, in which Boeing and Airbus form a duopoly to control the market for large passenger aircraft manufacturing. Within the heavily regulated wireless communications industry, many U.S. states will license only two or three providers of cellular phone services, and these companies form local oligopolies.

When firms in an oligopoly grow intensely competitive with one another, different outcomes will occur. The firms in the group may agree to come together and agree as a group, or collude, to raise prices and restrict production. If the firms involved come to a formal agreement in this way, they are called a cartel.