In an oligopoly, markets are structured with a finite number of major firms. They are simultaneously in competition and unable to remove the influence of competing firms. Each firm has different market shares.
While the amount of firms is not fixed in an oligopoly, it must be more than one (monopoly) or two (duopoly). In general, the firms must also be few enough to each have a significant impact on the market.
Commercial real estate markets thrive on an oligopoly, where a low number of firms can fix market prices, collaborate, or restrain output to increase their market returns. This structure encourages creating and maintaining allegiances both with other firms and with the government. The more control one firm can maintain in a mixed economy, the more they can use the government to increase their market returns in an oligopoly, compared to their competition.
The Drawbacks of Oligopolies
Other notable oligopolies include the steel and oil industries, tire manufacturers, airlines and wireless phone and internet providers. Because firms within an oligopoly can set their prices, some economists fear that they cause innovation and competition to stagnate while increasing prices for their own gain.
Profit margins in an oligopoly can be higher than those in a competitive market, especially when legal privileges enter the equation. A famous example would be the railroad industry. These companies acquired land through government purchases to use among a finite number of firms, establishing a service no one else could offer.
Why Do Oligopolies Persist?
Despite drawbacks, oligopolies can be stable if the separate firms can balance their inherent need for cooperation with the implicit opportunities to game the system for their own benefit. Firms can devise different strategies to encourage cooperation and avoid a market collapse, such as price-fixing or choosing a price leader.
In both cases, prices are pre-determined, either by each firm or by a chosen industry leader. This limitation leads to what is termed a “prisoner’s dilemma” in oligopolies, due to the difficulty of maintaining mutually beneficial price manipulation. In such a dilemma, each firm will be biased against cooperation by the suspicion of being betrayed by the other. This tension results in a situation where mutual cooperation would lead to mutual benefit, yet rational self-interest leads each firm to betray every other.
Contractual or legal restrictions can change each firm’s ability to choose in such a dilemma, in an attempt to level the field. Left to their own devices, oligopolies can persist, despite the presence of fixed prices that game or “cheat” the system and the difficulty of maintaining mutually beneficial cooperation.
Cultural and Legal Responses to Oligopolies
Oligopolies may function differently in different cultures, such as those with more entrenched trust values or a cultural precedent for reciprocity. More laissez-faire policies could also perpetuate oligopolies because government controls would have less power to influence them.
On the other hand, governments can mount legal responses to price-fixing in prolonged oligopolies. This risk spurs firms to lobby for government preference, potentially leading to uneven regulation. It is often the goal of oligopolies to operate outside of the government’s influence, like a cartel, where prices can be changed independently.
A modern example of an oligopoly can be seen in the United States airline industry where four firms control 70% of flights in the country. In response, the Airline Deregulation Act of 1978 prevented the Civil Aeronautics Board from regulating industry prices. Before this deregulation, prices had been steadily declining for decades. The introduction of regulations led to external forces of control over the then-stable oligopoly.