The word is derived, by analogy with "monopoly", from theGreek oligoi 'few' and poleein 'to sell'. Because there are few sellers, each oligopolist is likely to be aware of the actions of the others. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by oligopolists needs to
take into account the likely responses of the other market participants.
Description
Oligopoly is a common market form. As a quantitative description of oligopoly, the four-
firm concentration ratio is often utilized. This measure expresses the market share of the
four largest firms in an industry as a percentage. For example, as of Q42008, Verizon,
AT&T, Sprint Nextel, and T-Mobile together control 89% of the US cellular phone
market.
Oligopolistic competition can give rise to a wide range of different outcomes. In some
situations, the firms may employ restrictive trade practices (collusion, market sharing
etc.) to raise prices and restrict production in much the same way as a monopoly. Where
there is a formal agreement for such collusion, this is known as a cartel. A primary
example of such a cartel is OPEC which has a profound influence on the international
price of oil.
Firms often collude in an attempt to stabilize unstable markets, so as to reduce the risks
inherent in these markets for investment and product development. There are legal
restrictions on such collusion in most countries. There does not have to be a formal
agreement for collusion to take place (although for the act to be illegal there must be
actual communication between companies) - for example, in some industries, there may
be an acknowledged market leader which informally sets prices to which other producers
respond, known as price leadership.
In other situations, competition between sellers in an oligopoly can be fierce, with
relatively low prices and high production. This could lead to an efficient outcome
approaching perfect competition. The competition in an oligopoly can be greater than
when there are more firms in an industry if, for example, the firms were only regionally
based and did not compete directly with each other.
Thus the welfare analysis of oligopolies is sensitive to the parameter values used to
define the market's structure. In particular, the level of dead weight loss is hard to
measure. The study of product differentiation indicates that oligopolies might also create
excessive levels of differentiation in order to stifle competition.
Oligopoly theory makes heavy use of game theory to model the behavior of oligopolies:
I.Stackelberg's duopoly. In this model the firms move sequentially.
II.Cournot's duopoly. In this model the firms simultaneously choose quantities.
III.Bertrand's oligopoly. In this model the firms simultaneously choose prices.
Characteristics
Profit maximization conditions: An oligopoly maximizes profits by producing where
marginal revenue equals marginal costs.
Ability to set price: Oligopolies are price setters rather than price takers
Entry and Exit: Barriers to entry are high. The most important barriers are economies
of scale, patents, access to expensive and complex technology and strategic actions by
incumbent firms designed to discourage or destroy nascent firms.
Number of firms: "Few" - a "handful" of sellers. There are so few firms that the actions
of one firm can influence the actions of the other firms.
Long Run Profits: Oligopolies can retain long run abnormal profits. High barriers of
entry prevent sideline firms from entering market to capture excess profits.
Product differentiation: Product may be standardized, steel, or differentiated,
automobiles.
Perfect Knowledge Assumptions about perfect knowledge vary but the knowledge of
various economic actors can be generally described as selective. Oligopolies have
perfect knowledge of their own cost and demand functions but their inter-firm
information may be incomplete. Buyers have only imperfect knowledge as to price, cost
and product quality.
Interdependence: The distinctive feature of an oligopoly is interdependence. Oligopolies
are typically composed of a few large firms. Each firm is so large that its actions affect
market conditions. Therefore the competing firms will be aware of a firm's market
actions and will respond appropriately. This means that in contemplating a market action
a firm must take into consideration the possible reactions of all competing firms and the
firm's countermoves. It is very much like a game of chess or pool in which a player must
anticipate a whole sequence of moves and countermoves in determining how to achieve
his objectives. For example, an oligopoly that is considering a price reduction may wish
to estimate the likelihood that competing firms would also lower their prices and possibly
trigger a ruinous price war. Or if the firm is considering a price increase it may want to
know whether other firms will also increase prices or hold existing prices constant. This
high degree of interdependence and need to be aware of what the other guy is doing or
might do is to be contrasted with lack of interdependence in other market structures. In a
PC market there is zero interdependence because no firm is large enough to affect market
price. All firm's in a PC market are price takers information which they robotically follow
in maximizing profits. In a monopoly there is quite simply no competitors to be oncerned
about. In a monopolistically competitive market each firm's effects on market conditions
is so negligible as to be safely ignored by competitors.
All "big" business is in the oligopoly form of market. Being a major corporation almost
automatically implies that the company has means of controlling its market.
