Oligopoly

The term oligopoly designates a market form in which a few sellers dominate the market sector. This creates disequilibrium in the market, affecting both its efficiency and the entire society.

In an ideal free-market economy, firms operate in perfect competition, producing each product at the lowest possible cost and selling it at the lowest possible price. In an oligopoly, however, many parameters that characterize perfect competition are unfulfilled: products and services are less differentiated, buyers and/or sellers lack information about prices and traded goods, entry barriers exist for new sellers, and individual buyers and sellers lack independence.

Product differentiation is the process of distinguishing a product or service from those of competitors, with the aim of making it more attractive. Indeed, often differentiation is achieved by means of changes related not to the product itself, but only to its packaging, distribution, and marketing. However, buyers may perceive these small differences as important. Therefore, a large firm's marketing strategy is to produce a variety of similar goods. Retailers are interested in showing a wide variety of merchandise; if the same firm produces many of the offered goods, this firm obtains a competitive advantage over its rivals.

In many sectors, a small number of firms exercise a dominating influence over the market, and this in turn contributes to an increase in their market share. In fact, an oligopoly exists when four firms in the industry have a market share above 40 percent. Competition for market share contributes to the growth of oligopolies, because large firms with great financial power have the opportunity to force minor producers out of the market.

Thus, firms seek to grow, either on the domestic or on the international market. In an internal market a firm can expand by increasing sales, mergers, and acquisitions. Abroad, a firm can expand by buying local brands and/or introducing brands to new markets. When a leader firm enters foreign markets, its rivals follow suit: this behavior, called “oligopolistic reaction,” increases the number and size of multinational corporations. This form of enterprise, characterizing firms that manage production establishments or deliver services in at least two countries, may threaten job security in a country.

As the decisions of one firm influence and are influenced by the decisions of its competitors, there is a high risk of collusion. Explicit collusion, in which competing firms cooperate, for instance, in raising prices, is illegal in many countries. However, rival companies can enact friendly competition: they can tacitly collude by monitoring each other's prices and setting them at the same level. This behavior, aimed at avoiding a price war and/or excessive advertising costs, benefits the colluding firms and damages the purchasers.

In Western countries, oligopolies exist in many sectors of the economy. In the United States, for instance, oligopolies can be found in the soft drink, cookie, razor blade, commercial jet airline, and comic book industries.