What are Oligopolies?

What is an Oligopoly?

An oligopoly is a set of market conditions in which a limited number of companies produce goods and services, with each firm having a significant influence over their shared industry. Each market or industry is made up of a certain number of firms. The more firms producing goods in the market, the more competitive the industry. Oligopolies often have strict market parameters that prevent new players from entering the market, which limits competition. In an oligopoly, no one firm dominates the market. Instead, two or more firms share access to the market, which often leads to higher prices and less industry innovation.

What Are Oligopolies?

The term oligopoly refers to when two or more firms retain control of the market. There is no limit to the number of firms involved in an oligopoly, but the number must be low enough so that each company’s actions influence the others. A market becomes an oligopoly when a limited number of firms can produce products and services popular among the public, leaving these companies with a large market share. With limited competition, these firms can typically raise prices and enjoy higher than normal returns. Oligopolies can form for a number of reasons. Various economic, legal, and technological obstacles typically prevent new companies from entering the market.

Not all oligopolies look the same. The companies involved may share access to the market, with varying amounts of influence. In other cases, some companies may have sole access to a specific region based on local regulations and economic conditions.

The companies in an oligopoly keep close tabs on one another, as the actions of one firm are bound to affect the others. For example, if one company lowers its prices, the other companies will need to follow suit or risk losing their market share. Some oligopolies coordinate with one another in what could be described as a cabal-like situation when setting prices or influencing lawmakers to prevent other companies from entering the market.

Oligopolies usually have a negative effect on consumers. The average person only has so many choices when buying products and services in an oligopoly. Companies in an oligopoly are free to raise prices without seeing a decrease in consumer demand. In many cases, these products are unique or vital to the nation’s economy, leaving consumers no choice but to pay however much these companies charge.

Less competition also leads to less innovation. Companies in an oligopoly usually have little incentive to improve their products and services when there are few market players, which result in added profits. Innovation only occurs when the government allocates money for research and development, or another company disrupts the market by updating its technology.

What Helps Enable an Oligopoly to Form Within a Market?

Certain economic and legal factors need to come together for an oligopoly to form within a market. In most cases, the market comes with a high cost of entry. The companies in an oligopoly typically retain control of existing technology or infrastructure that gives them access to the market, such as railways, utility lines, airports, and manufacturing/distribution outlets, as well as raw materials like oil, minerals, and gold. New players would need to invest large sums of money or invent new technology to compete on the same scale as these companies.

Federal, state, and local laws may also prevent new companies from entering the market. Only a handful of companies may be able to comply with the latest government regulations. Companies in an oligopoly may have a government contract that guarantees them access to a particular share of the market. Companies also need to obtain licenses to operate within particular markets.

Branding and overall consumer demand can also help oligopolies come into existence. Some products may be particularly popular among consumers. Many companies in oligopolies rely on trade secrets, intellectual property, and even unique recipes that keep them in control of the market.

Companies in an oligopolistic market often work together or adjust their operations to keep current economic conditions in place. They may also work with the government or lobby against antitrust laws that encourage competition to retain control.

How Do Oligopolies Set Prices?

Oligopolies often lead to higher prices for consumers. The firms involved typically face few consequences for raising their prices. Companies may set prices in unison by coordinating with one another. They may use sophisticated algorithms and customer surveys to see how much they can raise prices before seeing a significant drop in demand. Once these companies agree on a price, they will usually announce the increase simultaneously. Companies may decide to raise prices during periods of inflation or at certain intervals to increase profits. 

In other situations, companies will raise their prices according to their competitors. Whenever a company decides to change its prices, the other companies will usually react by matching the price to retain their control of the market. This can lead to a price war as companies keep lowering prices to appeal to consumers.

Companies may also set prices according to government regulations. The local, state, or federal government may contract these companies to supply essential products and services at a specified rate. Once the contract expires, these parties will negotiate a new price.

Similarities Between Monopolies and Oligopolies

Oligopolies are similar to monopolies in several ways. Each is made up of a limited number of producers or suppliers, which leads to less competition, higher prices, and limited innovation.

In a monopoly, there is only one company or firm producing the products and services in the market. In an oligopoly, there are two or more firms in the market, and each has a significant influence over the industry.

A monopoly is dominated by one company, which gives the firm unparalleled control and influence over the market, while companies in an oligopoly often work in relation to one another to maintain market conditions. Both scenarios give companies the freedom to charge more for their products and services. Consumers have even fewer options in a monopoly, as they are faced with buying products and services from just one company.

Companies in both situations also face few incentives to invest in innovation, leaving consumers with the same products and services for years on end.

What Businesses Are Oligopolies?

There are several examples of oligopolies in the economy today.

The wireless communication industry remains the most notable example. Verizon, AT&T, and T-Mobile have the technology and infrastructure to provide cellular access to cellphone users. The same is true of internet providers. Optimum, Comcast, and the companies mentioned above are some of the only companies that provide internet access. Consumer options typically vary by geographic location.

The entertainment industry is another common example. Nearly all the content we consume comes from either Disney, NBCUniversal, Time Warner, Paramount, or new streaming platforms like Netflix, Amazon Prime, and Apple TV+.

Many parts of the food industry are dominated by large food and beverage manufacturers that enjoy a sizable share of the market. Pepsi and Coca-Cola have long dominated the soda industry, while Molson Coors, Budweiser, and imports like Heineken dominate the beer industry. The cereal industry is another example of an oligopoly. Post, General Mills, and Kellogg’s each retains a sizable share of the market.

The Bottom Line

Oligopolies can occur naturally or artificially by manipulating market conditions. They often spell trouble for consumers, but these companies usually enjoy higher than normal profit margins.

RELATED CATEGORIES: Global Economy