Oligopoly

The term oligopoly designates a market form in which few sellers dominate the market

sector. This originates a disequilibrium in the market, which impacts its efficiency and affects the

whole of society.

In an ideal free-market economy, firms operate in perfect competition: each product is

produced at the lowest possible cost and purchased at the lowest possible price. In an oligopoly, on

the contrary, many parameters which characterize perfect competition are not fulfilled: products and

services are differentiated, buyers and/or sellers miss information about prices and goods which are

traded, there are strong entry barriers for sellers and lack of independence for individual buyers and

sellers.

Product differentiation is the process of distinguishing a product or service from those of

competitors, with the aim of making it more attractive. Indeed, often differentiation is achieved by

means of changes which are not related to the product itself, but only to its packaging, distribution

and marketing.

However, buyers may perceive these small differences as important. Therefore, a large

firm’s marketing strategy is to produce a variety of similar goods. Retailers are interested in

showing a wide variety of merchandise; if many of the offered goods are produced by the same

firm, this firm obtains a competitive advantage over its rivals.

Therefore, in many sectors, few firms exercise a dominating influence over the market, and

this, in turn, contributes to an increase in their market share. In fact, an oligopoly can be defined as

a market structure in which the four largest firms in the industry have a market share above 40%.

Competition for market share contributes to the growth of oligopolies, because large firms with

great financial power have the opportunity to turn minor producers out of the market.

Thus, firms seek to grow, either on the domestic or on the international market. On the

internal market a firm can expand by increasing sales, mergers and acquisitions. Abroad, a firm can

develop by buying local brands and/or introducing brands to new markets. When a leader firm
enters foreign markets, its rivals follow suit: this behavior, called “oligopolistic reaction”, increases

the number and size of multinational corporations. This form of enterprise, which characterizes

firms which manage production establishments or deliver services in at least two countries, may

threaten job security in a country.

As the decisions of one firm influence and are influenced by the decisions of its competitors,

there is a high risk of collusion. Explicit collusion, in which competing firms cooperate, for instance

in raising prices, is illegal in many countries. However rival companies can enact friendly

competition: they can tacitly collude by monitoring each other's prices and setting them at the same

level. This behavior, aimed at avoiding a price war and/or excessive advertising costs, benefits the

colluding firms and damages the purchasers.

In western countries there are oligopolies in many sectors of the economy. In the United

States, for instance, oligopolies can be found in the soft drinks, cookies, razor blades, commercial

jet aircrafts, and comic books industries.

Alessandra Padula

See also

Global Economy; Megamergers; Monopolies

Further Readings

Puu, Tönu and Irina Sushko, ed. 2002. Oligopoly Dynamics: Models and Tools. Berlin: Springer-

Verlag.

Shapiro, Carl 1989. “Theories of Oligopoly Behavior.” in Handbook of Industrial Organization,

vol. 1, pp. 329-414, edited by R. Schmalensee and R.D. Willig. Amsterdam: North-Holland.