Oligopoly

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 a market with only one producer, a duopoly has two firms, and an oligopoly consists of 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.

Understanding Oligopoly

Oligopolies in history include steel manufacturers, oil companies, railroads, 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, all of which harm 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. 

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 (such as 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.

Why Are Oligopolies Stable?

An interesting question is why such a group is stable. The firms need to see the benefits of collaboration over the costs of economic competition, then agree to not compete and instead agree on the benefits of co-operation. The firms have sometimes found creative ways to avoid the appearance of price-fixing, such as using phases of the moon. Price-fixing is the act of setting prices, rather than letting them be determined by the free-market forces. Another approach is for firms to follow a recognized price leader; when the leader raises prices, the others will follow.

The Prisoner's Dilemma

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. This can be achieved by contractual or market conditions, legal restrictions, or strategic relationships between members of the oligopoly that enable the punishment of cheaters.

Companies in an oligopoly benefit from price-fixing, setting prices collectively, or under the direction of one firm in the bunch, rather than relying on free-market forces to do so.

Special Considerations

It is interesting to note that both the problem of maintaining an oligopoly and the problem of coordinating action among buyers and sellers in general on the market involve shaping the payoffs to various prisoner's dilemmas and related coordination games that repeat over time. As a result, many of the same institutional factors that facilitate the development of market economies by reducing prisoner's dilemma problems among market participants, such as secure enforcement of contracts, cultural conditions of high trust and reciprocity, and laissez-faire economic policy, might also potentially help encourage and sustain oligopolies.

Governments sometimes respond to oligopolies with laws against price-fixing and collusion. Yet, a cartel can price fix if they operate beyond the reach or with the blessing of governments. OPEC is one example of this since it is a cartel of oil-producing states with no overarching authority. Alternatively, in mixed economies, oligopolies often seek out and lobby for favorable government policy to operate under the regulation or even direct supervision of government agencies.

What is an oligopoly?

An oligopoly is when a few companies exert significant control over a given market. Together, these companies may control prices by colluding with each other, ultimately providing uncompetitive prices in the market. Among other detrimental effects of an oligopoly include limiting new entrants in the market and decreased innovation. Oligopolies have been found in the oil industry, railroad companies, wireless carriers, and big tech.

What is an example of a current oligopoly?

One measure that shows if an oligopoly is present is the concentration ratio, which calculates the size of companies in comparison to their industry. Instances where a high concentration ratio is present include mass media. Here, 90% of media in the U.S. is dictated by five companies — NBC Universal, Walt Disney, Time Warner, Viacom CBS, and News Corporation. Meanwhile, within big tech, two companies control smartphone operating systems: Google Android and Apple iOS.

Is the U.S. airline industry an oligopoly?

With just four companies controlling 70% of all domestic flights in the U.S. as of 2019, it has been suggested that the airline industry is an oligopoly. The four companies are Delta Airlines, United Airlines Holdings, Southwest Airlines, and American Airlines. Interestingly, in 1978, The Airline Deregulation Act was imposed, which stripped away the Civil Aeronautics Board the ability to regulate the industry. Prior to this time, the airline industry operated much like a public utility, while fare prices had declined 20 years before the deregulation was introduced.