In an oligopoly market structure, a small number of big corporations dominate the industry and frequently engage in collusion to limit competition. This results in reduced competition among the firms in the market, allowing them to wield significant monopoly power and generate higher revenue.
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Why do Oligopolies Exist?
Oligopolies often see companies cooperating to establish a fixed price or output, rather than engaging in direct competition, as this provides several economic advantages. By controlling prices, firms in oligopolies can deter potential new competitors from entering the market, safeguarding their own growth prospects. However, new companies may opt to undercut their prices, jeopardizing the established revenue streams of colluding firms.
Industries such as steel manufacturing, oil production, rail transport, aviation, and pharmaceuticals are common examples of oligopolies. In this market structure, companies prioritize the benefits of cooperation over competition, working together to set prices or appointing a leader to raise prices, with other firms following suit.
5 Features of Oligopoly
- Decision making are independent
- Rigidity in price
- Conflicting attitudes
- Power of monopoly
There are four primary market structures, namely pure competition, monopoly, oligopoly, and monopolistic competition. In this article, we will outline the defining characteristics of an oligopoly to differentiate it from other market forms.
Interdependence is a fundamental feature of decision-making in an oligopoly, where a small number of large firms cannot operate independently. For instance, if one firm decides to launch an extensive advertising campaign, its competitors will likely respond with countermoves. Since the products offered by firms in an oligopoly are homogeneous, they all have a significant impact on prices and output and cannot ignore the actions of their rivals.
Price rigidity is another defining trait of an oligopoly. In this market system, each firm must adhere to a set price. If one company reduces its price, its competitors will likely make more drastic reductions, leading to a price war where no one benefits.
Conflicting attitudes are also common in oligopolies, with two perspectives prevailing. In the first approach, firms understand that competition will not bring them benefits and, therefore, cooperate to maximize their revenue. In contrast, the second perspective emphasizes increasing profits, leading to conflict and antagonism.
Oligopolies also possess some monopoly power since a limited number of companies with significant market shares can control the price and output.
Advertising is a powerful tool in an oligopoly that a company can use to launch an aggressive campaign to capture a large portion of the market. In response, other firms will have to employ defensive advertising tactics.
Oligopolies offer advantages and disadvantages to the companies operating within them. As these firms are large and set standards to control prices and competition, oligopolies are widespread in industries such as mass media, tech, airlines, entertainment, and social media platforms. Here are some of the pros of this market structure:
- Low level of competition
- High potential for big profits
- A significant demand for products and services controlled through oligopolies
- Limited number of companies, making it easier for customers to compare and choose products
- More competitive prices
- Better quality of products and services since brands need to survive in the market
- Better customer support
- Price stability within the market
- More informative ads
However, oligopolies also have drawbacks, such as:
- Limited customer choice
- High barriers to entry
- Companies are less interested in innovation since the level of competition is low.
How Does Oligopoly Work?
Oligopolies operate through a sequential collusion process, which is necessary to determine the price and output or increase profits. This market structure is similar to a monopoly, as it comprises a few big companies that collude to achieve their desired results.
By increasing the price, they can earn higher profits while producing fewer goods. However, collusive oligopolies are risky since more efficient companies may break the agreement by lowering their prices to increase their market share.
Factors such as the threat of defection, low coordination, and illegal price-fixing hinder collusion. Thus, these companies often face the possibility that one of them may agree to collude, break the agreement, and undercut the revenue.
Now that you understand how oligopolies work, let’s move on to the differences between an oligopoly and a monopoly.
Oligopoly vs Monopoly
Let’s examine the characteristics of oligopoly and monopoly to distinguish between them.
Oligopoly is a market structure where two or more companies control the market. No firm can prevent others from influencing the industry and offering similar goods. Since no single company has absolute control, firms prefer to collude rather than compete. This strategy makes it difficult for other players to enter the market.
In contrast, a monopoly is a market structure where there is a single dominant firm that provides goods or services. The company has enough power and influence to prevent other competitors from entering the market. Various factors such as technology, patents, government regulations, or capital requirements can create barriers to entry in the industry.
In a monopoly, there is only one seller who can set high prices and reduce customer choice. However, buyers will pay the price since there are no substitute products available.
Types of Oligopoly
Marketing structures based on the relationships between companies within the market will be reviewed
- Perfect Oligopoly: With perfect oligopoly, implies that homogenous products offered by companies, for instance, the steel and aluminum industry.
- Imperfect Oligopoly: firms manufacture differentiated products for instance, soft drinks and cigarettes.
- Collusive oligopoly: this requires companies cooperation in setting the price and output.
- Non-collusive oligopoly : this appears when firms within an oligopoly market compete with each other.
How to Compete in the Oligopoly Market
What determines the way companies compete is the interdependence that exists. The behavior of other companies is due to the decisions on the price and the output of the firms within the market system.
Businesses that operate under the rules of an oligopoly can’t act independently. The actions of their closest competitors when making decisions is taken into account.
A firm’s objective is what determines how a firm competes in an oligopoly, the nature of their goods or services, and the contestability of the market. Some firms compete on the price, and others try to enhance the quality of their products.