Oligopoly Definition: How an Oligopoly Works

An oligopoly occurs when multiple companies, businesses, or firms in a specific industry become so influential that it discourages the creation of new firms. The oligopolists have power as a group but cannot do enough on their own to shift the balance of power within the oligopoly. This means that while there is some form of competition, the group can still fix pricing and set prices against each other, a situation that avoids creating a price leader. The companies might not be literally colluding, as they might or might not have intended to create an oligopoly.

An oligopoly is similar to a monopoly or a duopoly. The difference is that a monopoly is an industry or market with one company; a duopoly is an industry or market with just two companies; and an oligopoly has more than two companies.

When an oligopolistic market forms in an industry, the companies involved create what is called “a perfect competition” that in reality benefits them all. If one company wants to make a price change to a good or service, the others make the same price change to the same good or service. They do not act as a result of market conditions or market share but instead for their own profits.

Economists believe oligopolies exist because their formation—whether intentional or unintentional—makes it easier for companies in the same industry to control prices. This results in new-to-market firms’ inability to potentially change the price competition. While antitrust laws work to an extent to stop tacit collusion with regard to pricing and to encourage a free market, a lack of specificity in regulatory laws can still make it possible for oligopolies to exist. Sometimes the market structure is such that monopolists and oligopolists form regardless, making it difficult to tamp down an oligopolistic industry.

Game theory asserts that companies that want to exit an oligopoly are financially trapped because they cannot act independently without affecting the other participants—for the largest firms, this interdependence is both a strength and a weakness. This kind of situation is often called a “catch-22” or a “prisoner’s dilemma.”

Oligopoly markets create anti-competitive markets that are harmful to consumers in the following ways:

• Lack of innovations: In an oligopolistic industry, large firms do not typically encourage innovation, nor do they leave much space in the industry for new entrants that might have better goods or services.
• Lack of companies: Smaller companies trying to break into the business space with new goods or services often find it’s not truly a competitive market and have to drop out—meaning consumers can only shop with a handful of businesses and might lose out on what could have been higher-quality goods or services.
• Higher prices: Since all of the companies involved in the oligopoly sell similar services, product differentiation becomes minimal while price increases become the norm.

Wireless carriers, oil production, and automobiles are all industries that contain past examples of oligopoly. The airline industry in the US has also had past instances of oligopoly. Any industry is in danger of oligopoly if it contains a small number of firms considered to be major players, whose prices affect the rest of the industry. For example, if one airline were to raise prices, it’s possible price wars could occur, but it’s more likely the other firms would raise their prices to match—resulting in high prices for consumers.

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