Oligopolistic Market

Refers to a market where there are only a small number of firms operating

Author: Adin Lykken
Adin Lykken
Adin Lykken
Consulting | Private Equity

Currently, Adin is an associate at Berkshire Partners, an $16B middle-market private equity fund. Prior to joining Berkshire Partners, Adin worked for just over three years at The Boston Consulting Group as an associate and consultant and previously interned for the Federal Reserve Board and the U.S. Senate.

Adin graduated from Yale University, Magna Cum Claude, with a Bachelor of Arts Degree in Economics.

Reviewed By: Manu Lakshmanan
Manu Lakshmanan
Manu Lakshmanan
Management Consulting | Strategy & Operations

Prior to accepting a position as the Director of Operations Strategy at DJO Global, Manu was a management consultant with McKinsey & Company in Houston. He served clients, including presenting directly to C-level executives, in digital, strategy, M&A, and operations projects.

Manu holds a PHD in Biomedical Engineering from Duke University and a BA in Physics from Cornell University.

Last Updated:January 31, 2024

What Is An Oligopolistic Market?

An Oligopolistic market is a market condition in which a small number of sellers (oligopoly) control the market. It is a market structure that combines monopoly and perfect competition characteristics and is closer to a monopoly structure.

Its distinguishing trait is that a few firms dominate a certain industry's market, and their output accounts for a large fraction of the overall output of the whole industry, thus controlling the industry's product supply.

A duopoly is a specific example of an oligopoly in which only two firms in an industry compete with each other.

The production and technical characteristics of particular products determine the formation of oligopoly. Steel, automobiles, oil, and other industries are oligopolistic businesses with highly concentrated output.

Such enterprises can establish an oligopolistic market by taking exclusive methods to maintain their standing, apart from the government's favorable policies for particular oligopolistic firms.

In industry, for example, only one corporation runs a business, leaving consumers and other upstream and downstream industries with no choice but to trade with them or accept their goods or services. 

This is referred to as a monopoly. These corporations are known as oligopolists. An oligopoly is formed when the two are combined.

Key Takeaways

  • An oligopolistic market involves a small number of firms controlling the industry, impacting product output and pricing. It blends monopoly and competition attributes and is typified by interdependence among firms. 
  • Oligopoly formation comes with high barriers for entry and exit, demanding substantial capital, technology, and adherence to established market rules. A limited number of suppliers exist in oligopoly, leading to varied market types like duopoly, poly oligopoly, and monopolistic competition.
  • Interdependence governs oligopolistic decisions; larger firms often set prices as leaders, while others follow. Pricing and output decisions are shaped by game theory.
  • Oligopolistic markets yield relatively stable prices due to controlled output, with large-scale production contributing to consistent product supply.

Characteristics of oligopolistic market

These markets are characterized by differentiated products and independency from each other; in industry, only a few firms produce; they have a greater degree of control over prices, and entry into the industry is difficult.

An oligopoly is a market structure that includes monopoly and competition factors but is closer to a monopoly.

1. High barriers

Once the oligopoly market is formed, it will be difficult for other manufacturers to enter, and the oligopolists already in the market will not easily exit. 

On the one hand, the oligopoly market has high requirements for new entrants in terms of capital, technology, reputation, scale, etc., so it is difficult for ordinary manufacturers to meet the conditions for entry. 

On the other hand, the existing oligopolists often have established market rules that all parties abide by. New entrants often break the existing rules and divide up the vested interests of the existing oligopolists. 

When "foreign invaders" come, these oligopolists tend to form alliances and erect barriers to prevent new entrants. 

Similarly, if one of the oligopolists withdraws from the market, it will inevitably lead to fierce competition among the remaining oligopolists to capture its market share, resulting in market instability.

2. A limited number of suppliers

Only a few enterprises exist in the market, and their decisions will significantly impact product output and pricing. 

The market can be classified into duopoly, poly oligopoly, and monopolistic competition, depending on the number of oligopolists in the market. 

  1. Duopoly means there are only two competitors in the market, and their market forces are comparable. 
  2. poly oligopoly market refers to a small number of firms producing or consuming the same product. Still, more than two, this type of oligopoly is much more common in reality. 
  3. The monopolistic competitive market's number of firms has grown even more. This market type exists between an oligopolistic and a perfectly competitive market. 

Each oligopolist has a certain amount of market power in such a market, but no oligopoly exists. Because it has significant market strength, there is usually more intense competition in such competition.

3. Interdependence

When making decisions in such a market, each firm must consider the reaction of its competitors. 

If an oligopolist's market power is significantly greater than other oligopolists, the larger oligopolist often becomes the price leader, while other smaller oligopolists become price followers.

That is, the larger oligopolist sets the price first, and the other oligopolists set prices based on the larger firm's price: if no firm has the dominant market volume, the oligopolists will set the final price through game theory.

4. Stable Price

The reason for forming an oligopolistic market is that the output of items (services) will be more constant under this market structure rather than as volatile and cyclical as in a competitive market.

Such a market arises because the production of certain products depends on economies of scale, which means that large-scale production yields better economic benefits when the cost is low enough.

The development and existence of oligopolists are inextricably linked to the government's assistance and backing.

The reason for the emergence of the oligopolistic market

The monopoly is due to market competition, that is, the market monopoly obtained by enterprises through their competitive advantages, such as Microsoft's monopoly in the field of operating system software.

Due to the government's statutory administrative monopoly. The government gives a certain enterprise in the industry monopoly power through laws and regulations and, at the same time, imposes certain controls on it to improve efficiency. 

This market form mainly occurs in some industries with natural monopoly attributes, such as water supply and pipeline gas.

1. Determination: Output

In such a market, when there is no collusion, each oligopoly adjusts its output according to the output decision of other oligopolists and the principle of profit maximization.

When there is collusion between oligopolists, the output is determined by negotiation among the oligopolists. The determined result is beneficial to those who depend on the strength of each oligopolist.

2. Determination: Price

The coordinated behavior of the oligopolists usually determines prices in an oligopolistic market. This coordination can take many forms.

The price leadership system refers to the product price of an industry, which is usually set by a leader first, and the rest of the firms follow to determine the selling price of their respective products.

Models of An oligopolistic market

There are many theories and models for the behavior of oligopolists in the market. The oligopoly theory is much more complicated than other market model theories.

There are three classic models of oligopoly, the Cournot model, the Sweezy model, and the cartel.

Among them, the Cournot model and the Sweezy model assume that the oligopolists do not collide, while the cartel belongs to the oligopolistic model with formal collusion.

1. Cournot Model

The Cournot model was proposed by the French economist Antoine Augustine Cournot in 1838. It is the earliest version of the Nash Equilibrium application.

The Cournot model is often used as the starting point for the analysis of oligopoly theory. The Cournot model is a simple model with only two oligopolistic firms, also known as the "duopoly model" or duopoly theory. 

The model illustrates how the output decisions of competing but not coordinating firms interact to produce an equilibrium outcome between perfect competition and perfect monopoly. 

The conclusions of the Cournot model can easily be generalized to the case of three or more oligopolistic firms.

2. Sweezy Model

Paul M. Sweezy proposed this model as an economic model to explain the phenomenon of price rigidity in oligopolistic markets.

Assumptions of the Sweezy model: Because oligopolistic enterprises are conscious of their interdependence, when one raises prices, its competitors do not raise prices to keep its market share.

Nevertheless, when one reduces prices, its competitors also drop prices to avoid losing market share. As market share declines, a curved demand curve emerges.

Since the manufacturer's curved demand curve, its marginal revenue curve is discontinuous. Therefore, the same product can be obtained as long as the position of the marginal cost curve does not vary beyond the vertical discontinuity range of the marginal revenue curve.

Also, because equilibrium quantity and price stay unchanged when the level equals the marginal revenue, the price can be kept constant.

3. Cartel

The cartel model is a market in which a competitive market can become a monopoly.

The cartel's principal purpose is to broaden its overall interests. To achieve this, the cartel will enter into a series of agreements to set its overall output and product prices and assign each firm's sales and sales territories.

When making choices, the cartel is similar to a monopoly. 

Here, the ideal total output and matching price is determined by the demand curve and total cost curve faced by the entire cartel, using MR = MC, and is distributed among the member firms. At the same time, this total output instructs member firms to apply the cartel's prices.

Allocating output here follows the same idea as allocating output in multi-factory production, i.e., making each member firm's marginal cost equal.

To form a cartel in a market, three conditions must be met:

A) The cartel must be able to boost industry pricing. 

Businesses will be enticed to join if the cartel is projected to raise and maintain high pricing. The cartel's ability is proportional to the price elasticity of demand it faces. The cartel's capacity to raise prices is higher with the lower elasticity.

B) Cartel members are less likely to anticipate the government penalizing them. 

Cartels can only form if members are unlikely to be apprehended and harshly punished by the government, as the cartel's estimated worth will plummet due to hefty predicted fines.

C)  The organizational costs of setting and enforcing cartel agreements must be low

Competition in an oligopolistic market

An oligopoly's most prominent feature is a perceived strong interdependence or fierce rivalry between firms. 

There is also a certain interdependence between monopolistic competition enterprises, but relatively, the interdependence of them is weak, so monopolistic competitors hardly recognize them. 

In a monopolistic competition industry, there are a large number of enterprises, and each enterprise only occupies a small market share, so the changes in the production and sales of a single enterprise have a negligible impact on other competitors.

Suppose a company decides to lower the price of its product slightly; other competitors will certainly lose some customers, but the company's increased sales will have a small share of the entire market, so other competitors do not feel this effect appreciably. 

In this sense, there is a certain degree of interdependence among monopolistically competitive firms because the outcome of their price cuts is related to whether all other competitors cut their prices.

However, the relevant decisions of monopolistic competitors can be made independently of each other. That is, they often do not consider the reaction of their opponents when making decisions. This is because there are too many competitors, and it isn't easy to consider them.

In an oligopolistic market, this interdependence is recognized. When a company lowers prices or expands sales, other companies will be significantly affected, and corresponding countermeasures will be made. 

As a result, when any company makes a decision, it must consider its competitors' reactions and estimate them.

Due to the strong interdependence between oligopoly enterprises, it has an important feature different from other types of enterprises in operation. That is, the result of a certain oligopoly decision depends entirely on its opponents' reaction. 

Therefore, the outcome of competition among oligopolists is highly uncertain. For enterprises in practice, this uncertainty makes decision-making more difficult. In this sense, competition in oligopolistic markets is more intense than in other market structures.

Oligopolistic Markets FAQs

Researched and authored by Yiqing Qiao | LinkedIn

Reviewed and Edited by Parul Gupta | LinkedIn

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