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What is an Oligopoly?

Definition: An oligopoly is a market form with limited competition in which a few producers control the majority of the market share and typically produce similar or homogenous products. Due to the small number of firms and lack of competition, this market structure often allows for partnerships and collusion.

What Does Oligopoly Mean?

What is the definition of oligopoly? Oligopolistic firms are price setters that seek the best partnership to define prices higher than their marginal cost, thus maximizing their profits. Oligopoly is the result of lack of competition in the product price. If a firm lowers the price of a product and achieves significant sales growth, competitive firms will enter a price war to match the lower price; therefore, oligopolistic firms do not lower their prices, but they rather spend significant amounts of money for advertising and research for the improvement of their product.

Furthermore, the entrance of new firms in an oligopolistic industry is too difficult because the existing oligopolies offer well-established products through solid distribution systems. Thus, entering an oligopolistic industry requires substantial funds due to the economies of scale almost ensuring the industry status quo will always stay the same.

Letís look at an example.

Example

Company A and Company B are responsible for the 90% of the water produced in Orange County. If Company B raises its prices, consumers most likely will shift to Company A for their water provision. But, if Company A raises its prices too, then both Companies will control the entire water market through their pricing setting ability.

The same is true for the U.S. cellular market where AT&T, Sprint Nextel, T-Mobile, and Verizon control 90% of the industry. Barclays, Halifax, HSBC, Lloyds TSB and Natwest control the U.K. banking sector. Boeing and Airbus dominate the airliner market. In all of these industries, only a few firms control their respective markets and provide almost indistinguishable goods and services. Thus, they can collude and set their prices.

In a truly competitive market, all these companies would not be able to set their prices, but they would rather be price takers to stay in business. Instead, under the oligopoly structure, these companies are interested in increasing their long-term profits by monopolizing the market and maintaining a competitive edge.

Most countries have laws put in place to prevent price fixing and other practices of collusion for this reason.

Summary Definition

Define Oligopoly: An oligopoly in economics is a market that is dominated by a few companies that produce standardized products.

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