What is Oligopoly?
Oligopoly is an economic term that describes a market structure wherein only a select few market participants compete with each other. The competitive dynamics within an oligopoly are distorted to favor a limited number of influential sellers.
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How Does an Oligopoly Work in Economics?
An oligopoly is defined as a market in which the industry is dominated by a few companies that are each influential participants in the market.
There is no precise number of companies that qualifies a market as an oligopoly. But as a rough guideline, the number of sellers must exceed two yet be fewer than about five.
The oligopoly market structure forms from a limited number of companies possessing a substantial portion of the market, coupled with stiff competition and high barriers to entry.
Over time, the competition within the market reduces, resulting in only a handful of competitors controlling the market.
Since a market characterized as an oligopoly consists of just a few competitors, the decisions of each company directly influences the decisions of the rest of the market participants.
Given those market conditions, it should be intuitive as to why the formation of an oligopoly can easily become corrupt (and the participants are prone to collusion).
What Factors Cause an Oligopoly to Form?
An oligopoly is characterized by only a handful of influential companies competing in a given market, which can either occur by chance or deliberately.
Because the number of market participants is low enough that the actions of one competitor is noticed by the rest, one company diverging from cooperating with other competitors can swiftly set off a chain reaction.
In a sense, the companies are trapped in a prisoner’s dilemma scenario, where all the companies are in a state of mutual interdependence, i.e. the strategy of the participating companies are reactive with attempts to anticipate the moves of their rivals.
Each company has the resources to actively influence the market, such as raising prices or intentionally restricting output to create an artificial shortage.
Yet the companies involved rarely want to make the first move, as they want to minimize unnecessary regulatory oversight and avoid accusations of unethical practices such as “price fixing” (when the prices are not set by the free market but by the efforts of those in influential positions).
- Collusion: In a worst-case scenario, the companies involved in an oligopoly decide to cooperate and agree to collude, so their partnership effectively creates a monopoly.
- Passive Cooperation: If one company acts in their self-interest, there is a tendency for others to follow suit shortly – i.e. causing herd-like behavior despite a formal lack of uniformity – reflecting how the behavior of the market participants tends to be predictable (or at least their reactions to each other’s actions). In this case, the rivals are not actually cooperating, but are instead moving sequentially in a form of passive cooperation, whereby the dominant leader makes the first move and the others follow.
