When most people think of market competition, they think of a perfectly competitive market. This is where there are a large number of buyers and sellers, all of which have perfect information. In this type of market, no single seller can influence the price of the good or service. However, in an oligopoly market structure, there are only a few sellers who dominate the market.
This can have different consequences because it can lead to higher prices and less innovation.
In this article, we will discuss the characteristics of an oligopoly and give some examples.
What is an oligopoly?
An oligopoly is a market structure in which only a few firms are producing a product. This typically happens in industries where there are high barriers to entry, such as the automotive or telecommunications industries.
If a few corporations work together to drive out other potential competitors, it is called a cartel. In this scenario, it would be difficult for new firms to enter the market. This may be considered illegal through the Sherman Antitrust Act in the United States depending on how unreasonable the restraint is towards any potential customers. However, if the oligopoly was formed without an agreement between the firms, it may not be illegal.
What is the origin of the word oligopoly?
The word “oligopoly” comes from the Greek words “oligo,” meaning “few,” and “polein,” meaning “to sell”. An oligopoly is a market structure in which there are only a few sellers (oligopolists).
What are the characteristics of an oligopoly?
The main characteristics of an oligopolistic competition are:
- There are only a few firms in the industry
- Each firm has a significant amount of market power
- There is mutual interdependence between firms - they must take into account how their actions will affect their competitors
- Barriers to entry are high
- There is non-price competition, such as advertising and product differentiation
Oligopoly market structure
The market structure of an oligopoly is one of the most important characteristics to consider when trying to understand the market.
This market structure can be easily identified if you enter the market and experience these three scenarios simultaneously:
- Limited Corporation Choices: There are only a few firms in the market
- Limited Diversity of Products: The products offered by the firms in the market are similar or identical.
- Limited Price Differences: The firms in the market are interdependent, meaning they are aware of and affect each other’s pricing and output decisions.
Oligopolies can also arise when there are economies of scale present. This means that it is cheaper for a few large firms to produce the product than it would be for many small firms.
For example, the aircraft manufacturing industry is an oligopoly because of the high barriers to entry, such as the need for large factories and expensive equipment. Another example of an oligopoly is the petroleum market.
The Organization of Petroleum Exporting Countries (OPEC) is an example of a cartel that has been able to influence the price of oil. The United States automobile industry is also a good example of an oligopoly.
There are only a few large firms that produce cars, such as General Motors, Ford, and Chrysler. These firms have been able to survive because they have been able to maintain high barriers to entry.
For example, it is very expensive to set up an automobile manufacturing plant. However, the automobile industry has not made it difficult for a competitor to enter the market through unethical means. Japanese carmakers, such as Toyota and Honda, have been able to successfully compete in the United States market by using different automobile models.
Tesla has also been able to enter the market and compete successfully. Thus, we see that oligopolies can take different forms and there are a variety of factors that can lead to the formation of an oligopoly.
In the next section, we will discuss the different types of market structures.
Oligopoly vs Monopoly vs Perfect competition
In an oligopoly, there are only a small number of firms that produce all or most of the output in the market. In contrast, a monopoly is a market structure in which only one firm produces all or most of the output. And finally, perfect competition is a market structure in which many small firms compete against each other.
The best market structure can be argued in a few ways. Some people believe that oligopolies are the best market structure because they allow for a small number of firms to produce all or most of the output in the market.
This can lead to better quality checks and less chance of faulty products. Others believe monopolies are best because they allow for one firm to produce all or most of the output. This can lead to less waste and more efficient use of resources.
Finally, some people believe that perfect competition is the best market structure because it allows for many small firms to compete against each other. This can lead to lower prices for consumers and higher quality products.
For free-market capitalists, perfect competition would be ideal because it would lead to the best possible outcomes for consumers. It can also allow consumers to effectively “vote with their dollars”.
This can cause companies that are not providing the best possible product to go out of business. It can also allow the wisdom of the market to favor companies that are more ethical and provide a better product or service.
From a more socialist perspective, oligopolies or monopolies may be seen as the best market structure because they allow for a small number of firms to control all or most of the output in the market. There is no one right answer to this question. It depends on your perspective.
Is an oligopoly perfectly competitive?
No, it is not. In perfect competition, there would be many firms producing identical products with no market power. In an oligopoly, there are only a few firms and each has some degree of market power.
What are the different types of oligopoly?
There are two main types of oligopoly: price-fixing and non-price fixing. In a price-fixing oligopoly, firms agree to charge the same price for their product. This is illegal in many countries as it reduces competition and can lead to higher prices for consumers.
In a non-price-fixing oligopoly, firms may charge different prices for their product, but they must take into account how this will affect their competitors.
What is the kinked demand curve model?
The kinked demand curve model is a model of an oligopolistic market in which firms are reluctant to change prices because they fear that their competitors will not follow suit.
This leads to a kinked demand curve, which is a demand curve with two distinct segments. One segment is inelastic, meaning that a price change will not lead to a change in the quantity demanded.
The other segment is elastic, meaning that a price change will lead to a change in the quantity demanded.
How does the prisoner's dilemma play a role in oligopolies?
The prisoner's dilemma is a game theory problem that illustrates the problem of cooperation in an oligopolistic market. In the prisoner's dilemma, two firms are each considering whether to produce a high-priced product or a low-priced product.
If both firms produce a high-priced product, they will both make a profit. However, if one firm produces a low-priced product and the other firm produces a high-priced product, the firm with the low-priced product will make a higher profit.
Assuming the quality was the same, consumers will switch to the lower-priced product and the company that produced the higher-priced product will lose market share. This creates an incentive for each firm to produce a low-quality product, even though this is not in the best interest of either firm or the consumer.
It is essentially a race to the bottom with companies lowering the quality to be able to lower the price. This may save money for consumers but will lead to poorer quality and lower margins.
The prisoner's dilemma is a way to show how oligopolies can lead to suboptimal outcomes for both firms and consumers.
What are the benefits and drawbacks of an oligopoly?
There are both benefits and drawbacks to having an oligopoly market structure.
Benefits of oligopolies
Here are some of the benefits of oligopolies:
There is often less need for advertising as firms can rely on brand recognition to sell their products. This can help firms focus on production rather than sales which will, in turn, create more goods. Inflation can occur when there is too much currency to chase too few products. By producing more, oligopolies can help prevent inflation.
Firms in an oligopoly can cooperate to produce a product that would be too expensive for a single firm to produce on its own. This collaboration can lead to the creation of a large project that helps society. For example, a partnership between firms could lead to the development of a new life-saving drug.
Can oligopolies protect consumers?
Oligopolies can act as a barrier to entry for new firms, which can protect consumers from volatile prices. By providing a general understanding of a fair price per level of quality, oligopolies can help reduce the risk of new firms raising prices for the worst quality. These are a few benefits of oligopolies.
Overall, the benefits are case-dependent and not necessarily practiced by all firms in an oligopoly. There are also some drawbacks associated with oligopolies, such as:
Oligopolies can lead to higher prices for consumers as firms have the market power to set prices. If the oligopolies each decide they wish to increase prices, then consumers will have less to spend on other goods. This can lower the quality of life for citizens in a country.
Oligopolies can be less innovative as firms have little incentive to innovate when they are already making high profits. This is because no other firm is threatening its market share, so they do not need to innovate to stay ahead of the competition. This can lead to a slowdown in economic growth as firms are not investing in new technologies or processes. In the end, it is up to the government to decide whether the benefits of an oligopoly market structure outweigh the drawbacks.
Understanding the impact of oligopolies
As a consumer living in a society with oligopolies, it is important to be aware of the market power that these firms have. Entrepreneurs looking to start a new company in an industry ruled by an oligopoly may view it as a benefit because they can innovate and disrupt the market.
However, they may also have a negative perspective about their probability of success because it will be difficult to compete against large, established firms. Unfortunately, there are no easy answers when it comes to the benefits and drawbacks of an oligopoly.
Consumers may not have the same opinion as to the government and vice versa. It is important to have an open dialogue about the pros and cons of oligopolies so that everyone can make an informed decision.
What effect might the government have on oligopolies?
Lobbying by oligopolistic firms can result in government policies that are not in the best interest of citizens. For example, an oligopoly might lobby for fewer taxes for production, which would benefit the firms but not necessarily consumers. Oligopolies can be difficult to regulate as firms have the power to influence government policy.
The government might put in place legislation to prevent oligopolies from forming, and to ensure that consumers within the market are not being taken advantage of.
What helps enable an oligopoly to form within a market?
Government regulation or intervention is often the cause of an oligopoly market structure. For example, if the cryptocurrency industry is only allowed to have a handful of major exchanges, that would create an oligopoly.
This can also be common in healthcare because the government regulates who can provide certain services. Additionally, an oligopoly can form when there are high entry barriers to a particular industry.
For example, the telecommunication industry was an oligopoly for many years because the cost of starting a telecommunication company was so high. The amount of infrastructure required to provide service was cost-prohibitive for most startups.
In some cases, an oligopoly can also form when there are few suppliers for a particular resource. For example, if there is only one company that produces a certain type of computer chip, then that company would have an oligopoly in the market for that chip.
Oligopolies can also form when companies collude with each other to fix prices or divide up the market. This is illegal in many countries, but it can still happen. For example, if two companies agree to only sell their products in certain regions, that would be a form of collusion.
Finally, an oligopoly can also occur naturally if there are a small number of companies that produce similar products. For example, the airline industry is an oligopoly because there are only a handful of major airlines.
Nothing is stopping other companies from starting an airline, but the industry itself may not be very lucrative for new entrants.
Are oligopolies ethical?
When it comes to the ethical debate, there are three sides to the story. One argument is that they can lead to prices that do not match the quality and less innovation, which harms the consumer.
Another perspective is that oligopolies can provide stability in the industry and allow firms to cooperate instead of competing with each other. This can help employees and create a better work environment. The third perspective is that oligopolies can be efficient, meaning that they use resources in the most productive way possible.
This can lead to economies of scale and increased profits, which can be reinvested into the business or used to benefit consumers in other ways, like lowering prices. Ultimately it's up to the consumer to decide whether or not they think oligopolies are ethical. Some ways that oligopolies might abuse their power and lead to unethical behavior are:
- Predatory pricing
- Barriers to entry
This is when a firm charges a very low price for its products to drive competitors out of business. Once the competitors are gone, the firm can then raise prices.
Barriers to entry
This is when a firm makes it difficult for new firms to enter the market. This might be done by creating high entry costs, buying up key resources, or creating exclusive contracts with suppliers.
This is when firms in an oligopoly agree to work together instead of competing against each other. This might involve setting prices, dividing up the market, or sharing information. Collusion can lead to higher prices and less innovation for consumers.
How new companies can break into oligopolies
There are a few ways that new companies can break into oligopolies, such as:
- Offering something unique
- Being a low-cost leader
- Mergers and acquisitions (M&A)
Offering something unique
One way is by offering something unique that the large companies don't have. This can be a new product or a new service. This is commonly known as a “blue ocean strategy” in the business world.
One example of a company that has done this is Tesla. This new company broke into the automobile market by offering a unique product (electric cars) that the major companies didn't have.
Being a low-cost leader
Another way is by being a low-cost leader. This means that the new company offers lower prices than the other companies in the market.
This can be a difficult strategy to sustain in the long term, but it can work in the short term. One example of this is Amazon, which started out by offering lower prices than other online retailers.
Mergers and acquisitions (M&A)
A final way that new companies can break into oligopolies is through mergers and acquisitions. This is a more aggressive strategy and can be difficult to achieve, but it can be successful. One example of this is Google's acquisition of YouTube.
This helped Google to become a major player in the online video market. Oligopolies can be difficult markets to enter, but new companies can succeed.
By offering a unique product, being a low-cost leader, or through mergers and acquisitions, new companies can break into oligopolies and compete with large incumbents.
The main thing to remember is that oligopolies are not necessarily illegal. They are just another type of market structure, like monopolies and perfect competition. The key difference is that there are only a few firms in an oligopoly, which gives them more power than other types of businesses.
Some consumers are annoyed by them. Politicians may receive funding from them. And shareowners may benefit. It really all depends on your perspective. In conclusion, an oligopoly is a market structure with a small number of firms, which gives them more power than other types of businesses.
If each company within the oligopoly operates with ethics, works efficiently, and benefits the consumer; it can be a good thing. With that being said, not all oligopolies are ethical and they may abuse their power. Each oligopoly may differ and it is up to the leaders of each company to either support consumer interest or abuse their power for profits.