Com­pared to the monop­o­lis­tic mar­ket, an oli­gop­oly mar­ket has higher bar­ri­ers to entry. Its key fea­ture is that a few firms, often only a hand­ful, con­trol most of the mar­ket. In addi­tion, these firms are inter­de­pen­dent for pric­ing deci­sions, which means a price change by one firm leads its com­peti­tors to change their prices too. A firm that does not respond quickly to a rival's price cut may lose cus­tomers and mar­ket share.

Col­lu­sive agree­ments help com­pa­nies decide the sup­ply of a prod­uct and get a bet­ter price for their prod­ucts. Since only a few com­pa­nies are present in these types of mar­kets, the chances of firm col­lu­sion are very high. Col­lu­sion raises the firms' profit mar­gins and makes their future cash flows more cer­tain. Such col­lu­sive agree­ments between a group of com­pa­nies are called car­tels.

Main char­ac­ter­is­tics of an oli­gop­oly mar­ket

Profit max­i­miza­tion con­di­tions: An oli­gop­oly max­i­mizes prof­its by pro­duc­ing where mar­ginal rev­enue equals mar­ginal costs.

Abil­ity to set price: Oli­gop­o­lies are price set­ters rather than price tak­ers.

Entry and exit: Bar­ri­ers to entry are high. The most impor­tant bar­ri­ers are economies of scale, patents, access to expen­sive and com­plex tech­nol­ogy, and strate­gic actions by incum­bent firms designed to dis­cour­age or destroy nascent firms. Addi­tional sources of bar­ri­ers to entry often result from gov­ern­ment reg­u­la­tion favor­ing exist­ing firms mak­ing it dif­fi­cult for new firms to enter the mar­ket.

Num­ber of firms: "Few" – a "hand­ful" of sell­ers. There are so few firms that the actions of one firm can influ­ence the actions of the other firms.

Long run prof­its: Oli­gop­o­lies can retain long run abnor­mal prof­its. High bar­ri­ers to entry pre­vent out­side firms from enter­ing the mar­ket to cap­ture excess prof­its.

Prod­uct dif­fer­en­ti­a­tion: Prod­uct may be homo­ge­neous (steel) or dif­fer­en­ti­ated (auto­mo­biles).

Per­fect knowl­edge: Assump­tions about per­fect knowl­edge vary but the knowl­edge of var­i­ous eco­nomic fac­tors can be gen­er­ally described as selec­tive. Oli­gop­o­lies have per­fect knowl­edge of their own cost and demand func­tions but their inter-firm infor­ma­tion may be incom­plete. Buy­ers have only imper­fect knowl­edge as to price, cost and prod­uct qual­ity.

Inter­de­pen­dence: The dis­tinc­tive fea­ture of an oli­gop­oly is inter­de­pen­dence. Oli­gop­o­lies are typ­i­cally com­posed of a few large firms. Each firm is so large that its actions affect mar­ket con­di­tions. There­fore, the com­pet­ing firms will be aware of a fir­m's mar­ket actions and will respond appro­pri­ately. This means that in con­tem­plat­ing a mar­ket action, a firm must take into con­sid­er­a­tion the pos­si­ble reac­tions of all com­pet­ing firms and the fir­m's coun­ter­moves. It is very much like a game of chess or pool in which a player must antic­i­pate a whole sequence of moves and coun­ter­moves in deter­min­ing how to achieve his or her objec­tives. For exam­ple, an oli­gop­oly con­sid­er­ing a price reduc­tion may wish to esti­mate the like­li­hood that com­pet­ing firms would also lower their prices and pos­si­bly trig­ger a ruinous price war. Or if the firm is con­sid­er­ing a price increase, it may want to know whether other firms will also increase prices or hold exist­ing prices con­stant. This high degree of inter­de­pen­dence and need to be aware of what other firms are doing or might do is to be con­trasted with lack of inter­de­pen­dence in other mar­ket struc­tures. In a per­fectly com­pet­i­tive (PC) mar­ket there is zero inter­de­pen­dence because no firm is large enough to affect mar­ket price. All firms in a PC mar­ket are price tak­ers, as cur­rent mar­ket sell­ing price can be fol­lowed pre­dictably to max­i­mize short-term prof­its. In a monop­oly, there are no com­peti­tors to be con­cerned about. In a monop­o­lis­ti­cally com­pet­i­tive mar­ket, each fir­m's effect on mar­ket con­di­tions is so small that it can as to be safely ignored by com­peti­tors.

Non-Price Com­pe­ti­tion: Oli­gop­o­lies tend to com­pete on terms other than price. Loy­alty schemes, adver­tise­ment, and prod­uct dif­fer­en­ti­a­tion are all exam­ples of non-price com­pe­ti­tion.

Exam­ple of Oli­gop­oly Mar­ket

A well-known exam­ple is the Orga­ni­za­tion of the Petro­leum Export­ing Coun­tries (OPEC), where a small group of oil-pro­duc­ing coun­tries meet to decide how much crude oil to sup­ply, and so indi­rectly influ­ence world crude oil prices.

Com­mon ques­tions

Why are there only a few firms in an oli­gop­oly?

Firms in an oli­gop­oly need to invest huge sums to enter and sur­vive, and to cope with swings in demand, sup­ply and mar­gins. Because any change in pol­icy or pric­ing by one firm changes the game for all the oth­ers, each must stay alert and a step ahead. So there are few com­peti­tors, but the com­pe­ti­tion among them is fierce.

What are some exam­ples of oli­gop­oly mar­kets?

Exam­ples include the avi­a­tion, auto­mo­bile, music, oil, steel, tyre and phar­ma­ceu­ti­cal indus­tries, and large gro­cery chains.