The term “oligopoly” refers to a situation when a market is controlled by a limited number of participants (producers and sellers), and each action of one participant has a direct impact on others, and there is no possibility for one participant to dominate the market due to various reasons. It is usually not difficult to notice an oligopoly of a market, but for precise detection a special measurement called a concentration ratio is used.
The concentration ratio determines the relation between sizes of the biggest companies in the market and the whole market in general. Its low number indicates high competition in the market, while a number of more than 60% clearly indicates an oligopoly.
Oligopoly key features
The main distinctive feature of an oligopoly is that the market in which it has developed is mostly controlled by a few producers, whose products are homogeneous or nearly homogeneous. This situation allows this limited pool of producers to set prices, rather than use the prices defined by the free market.
Another important attribute of an oligopoly as a system is that the producers involved in it are interconnected by the market and affect each other’s policies and decisions. For instance, if there are only three companies in a certain segment of the market, one company isn’t able to set higher prices than the others, otherwise it would lose profits, as the products they sell are interchangeable for the most part.
That may result in a cooperation or in an active competition, and each situation has its own advantages and disadvantages, but most likely an oligopoly would result in higher prices, less innovation and more difficulties for new producers in entering the market. Having in mind the abovementioned example with the three producers, it’s easy to see a possibility for those producers to choose what price is acceptable for them rather than for customers, as the producers control the biggest part of the market, and customers have no other choice.
At the same time, that necessity to coordinate actions with other participants in the oligopoly might lead to a problem called a Prisoner’s Dilemma, which tempts the participants to cheat and make selfish decisions resulting in an outcome unsatisfying for every participant.
Main reasons of Oligopoly development
Oligopoly often appears in the spheres where the following conditions are found:
- A new business in that sphere requires large initial investments, and it’s practically impossible to start it from a scratch.
- The production of goods or services in that sphere requires legal permission, and it’s often a challenging procedure to go through. This is sometimes backed or paralleled with the necessity of owning large territories for the production.
- Businesses in that sphere traditionally has access to a platform allowing to attract a significant number of consumers.
Several markets work under most of these conditions, for example, railroad and airline spheres, mining, oil and gas industries, wireless connection providing, electronics production, etc. So, a vast number of national and international markets of the mentioned products are oligopolies. Although, the rapidly changing economic conditions and upcoming technical possibilities might change some of these conditions and bring diversity to some markets.
Positive and negative aspects of Oligopoly
In some cases, an oligopoly might result in a market structure that is beneficial for both consumers and producers. This state is close to a perfect competition structure, where the producers compete over the benefits, constantly enhancing their products, accepting prices based on the law of supply and demand rather than setting exaggerated prices, and providing the consumers with the full and actual information on the products.
Such a situation can be constructed if there is no collusion between the producers, which might be achieved in different ways. Governments often make attempts to regulate economic activities of oligopolies by setting price limits or even fixing the price for a certain type of products, restricting merging and anti-competitive activities, and providing benefits for new businesses to make the market more diverse and incentivize a competition.
At the same time, heavy government control might result in an economic stagnation, and some countries tend to let a market develop independently, thus allowing oligopolies to appear and operate under their own rules.
A crucial negative feature of any oligopoly is that there is a high possibility of collusion, especially in price setting, when producers set unreasonable prices for the products only they can supply, leaving no choice to the customers. Legal restrictions aimed at avoiding such occasions are often creatively evaded by several techniques, including appointing a price setter who artificially raise prices and make others follow the example, or changing prices by an unobvious pattern imitating market fluctuations, and some others.
In some cases, producers involved in an oligopoly might even seek government support, and sometimes oligopolistic tendencies are legally backed by the country’s authorities, with the whole market segment operating under the government supervision, which might soften some of its negative traits, although in some instances it also can worsen the situation with prices and supply.