What Is Oligopoly?

Oligopoly refers to a market structure in which a small number of firms compete with each other, often resulting in limited competition and higher prices, as described by Cournot's oligopoly model, 1838.

Definition

Oligopoly is characterized by a few large firms that dominate the market, resulting in barriers to entry for new firms, which can lead to higher prices and reduced innovation.

How It Works

The oligopoly market structure is often the result of economies of scale, where large firms can produce goods at a lower cost than smaller firms, making it difficult for new firms to enter the market. For example, Boeing and Airbus dominate the commercial aircraft market, with Boeing producing ~800 aircraft annually (Boeing annual report). This dominance can lead to price leadership, where one firm sets the price and other firms follow, resulting in higher prices for consumers.

The kinked demand curve model, developed by Paul Sweezy in 1939, describes how firms in an oligopoly market adjust their prices in response to changes in demand. When demand increases, firms are reluctant to lower their prices, as they fear that their competitors will not follow suit, resulting in a loss of market share. Conversely, when demand decreases, firms are also reluctant to raise their prices, as they fear that their competitors will not follow suit, resulting in a loss of sales. This model helps to explain why prices in oligopoly markets can be sticky, or resistant to change.

Oligopoly markets can also be characterized by non-price competition, where firms compete with each other through advertising, product differentiation, and other forms of competition that do not involve lowering prices. For example, Coca-Cola and PepsiCo engage in intense advertising and marketing campaigns to differentiate their products and attract consumers. This type of competition can lead to higher costs for firms, which can be passed on to consumers in the form of higher prices.

Key Components

• Barriers to entry: High start-up costs, such as the cost of building a new factory or developing a new product, can make it difficult for new firms to enter an oligopoly market.
• Economies of scale: Large firms can produce goods at a lower cost than smaller firms, making it difficult for new firms to compete.
• Price leadership: One firm sets the price and other firms follow, resulting in higher prices for consumers.
• Kinked demand curve: Firms in an oligopoly market adjust their prices in response to changes in demand, resulting in sticky prices.
• Non-price competition: Firms compete with each other through advertising, product differentiation, and other forms of competition that do not involve lowering prices.
• Interdependence: Firms in an oligopoly market are interdependent, meaning that the actions of one firm can affect the actions of other firms.

Common Misconceptions

Myth: Oligopoly markets are always characterized by perfect competition.

Fact: Oligopoly markets are often characterized by imperfect competition, where firms have some degree of market power and can influence prices.

Myth: Firms in an oligopoly market always engage in price wars.

Fact: Firms in an oligopoly market often engage in non-price competition, such as advertising and product differentiation, rather than price wars.

Myth: Oligopoly markets are always inefficient.

Fact: While oligopoly markets can be inefficient, they can also be efficient if firms are able to innovate and reduce costs.

In Practice

The commercial aircraft market is a classic example of an oligopoly market, with Boeing and Airbus dominating the market. Boeing produces ~800 aircraft annually (Boeing annual report), while Airbus produces ~700 aircraft annually (Airbus annual report). The two firms engage in intense non-price competition, with Boeing spending ~$1.5 billion on research and development (Boeing annual report) and Airbus spending ~$1.3 billion on research and development (Airbus annual report). The resulting innovation has led to more efficient and safer aircraft, benefiting consumers and the environment. However, the barriers to entry in the commercial aircraft market make it difficult for new firms to enter, resulting in limited competition and higher prices.