Oligopoly

Definition

An oligopoly is a market structure characterized by a small number of firms that dominate the market, leading to limited competition and interdependent decision-making. In this scenario, the actions of one firm can significantly impact the others, resulting in strategic behavior such as price-setting and output decisions. This market structure can lead to higher prices and reduced consumer choices compared to more competitive markets.

5 Must Know Facts For Your Next Test

1. In an oligopoly, firms may compete on price, but they also often engage in non-price competition, such as advertising and product differentiation.
2. Oligopolistic markets can lead to collusion, where firms work together to set prices or production levels to maximize profits, often at the expense of consumers.
3. The kinked demand curve model is used to explain price stability in oligopolies, suggesting that if one firm raises prices, others will not follow, leading to loss of market share.
4. Oligopolies can create barriers to entry for new firms due to economies of scale, high capital requirements, and brand loyalty among consumers.
5. Examples of industries often characterized by oligopolistic structures include telecommunications, automotive manufacturing, and airlines.

Review Questions

• How do firms in an oligopoly interact with each other when making pricing decisions?
  • Firms in an oligopoly are interdependent; this means that the pricing decisions made by one firm directly affect the others. If one firm lowers its prices, competitors might follow suit to maintain their market share, leading to price wars. Conversely, if a firm raises its prices, others may choose not to match the increase to attract price-sensitive consumers. This strategic interaction makes pricing decisions complex and requires firms to carefully consider potential reactions from competitors.
• What role does collusion play in oligopolistic markets, and what are its potential consequences?
  • Collusion in oligopolistic markets occurs when firms cooperate to set prices or limit production instead of competing against each other. This behavior can lead to higher prices for consumers and reduced overall output. The consequences of collusion can result in significant regulatory scrutiny and legal penalties for the firms involved. Ultimately, collusion undermines the principles of free competition and can harm consumer welfare.
• Evaluate how the characteristics of oligopoly influence market outcomes compared to perfectly competitive markets.
  • Oligopoly affects market outcomes in several distinct ways compared to perfectly competitive markets. In perfect competition, many firms compete freely, leading to lower prices and optimal resource allocation for consumers. In contrast, oligopolistic markets typically result in higher prices due to limited competition and potential collusion among firms. The presence of only a few dominant players allows for greater control over pricing strategies and output decisions. Additionally, because of strategic behavior and non-price competition like branding and advertising, consumer choices may be more restricted in an oligopoly than in a perfectly competitive market.

Related terms

Monopoly: A market structure where a single firm controls the entire market, allowing it to set prices without competition.

Cartel: An agreement between competing firms to control prices or limit production, effectively reducing competition in the market.

Market Power: The ability of a firm or group of firms to influence or control prices and output in a market.