Oligopoly is a market structure in which a small number of firms account for all or most sales, and each major firm’s decisions materially affect its rivals. Its defining feature is strategic interdependence: firms choose prices, output, investment, and advertising while anticipating competitors’ responses. Unlike perfect competition, oligopoly does not treat individual sellers as negligible; unlike monopoly, it involves rivalry among multiple important suppliers. It can produce vigorous competition, coordinated behavior, or outcomes between these extremes. (openstax.org)
Characteristics and origins
Oligopolistic firms may sell similar goods or differentiated products. A market dominated by two suppliers is called a duopoly. There is no universal numerical cutoff separating oligopoly from other structures: the importance of each seller’s actions matters alongside the number of sellers. Monopolistic competition, by contrast, ordinarily involves many differentiated sellers rather than a few strategically significant rivals. (ocw.mit.edu)
Barriers to entry help explain why only a few firms persist. Economies of scale can make efficient production possible only at a size large relative to total demand. Patented technologies and product differentiation can also limit the number of effective competitors. These conditions may allow established firms to retain market power, although concentration does not necessarily prevent intense rivalry. (openstax.org)
An oligopoly describes a market structure, not an agreement. Its existence therefore does not establish that firms have formed a cartel or violated competition rules. Analysis distinguishes the number and size of suppliers from their actual conduct and the resulting prices, output, and quality. (oecd.org)
Models of strategic competition
Game theory provides the principal analytical framework. Firms’ profits depend on both their own choices and those of competitors. A Nash equilibrium is a set of strategies in which no firm can improve its payoff by changing its strategy alone, given the others’ choices. Different assumptions about timing, products, costs, and information yield different oligopoly outcomes. (ocw.mit.edu)
Three benchmark models illustrate these differences:
- Cournot competition: Firms choose quantities simultaneously, treating rivals’ quantities as given when selecting their own. In the standard homogeneous-product model, equilibrium output is below the competitive level and price exceeds marginal cost. With otherwise comparable firms, adding competitors reduces the equilibrium markup. (ocw.mit.edu)
- Bertrand competition: Firms choose prices simultaneously. With identical products, equal constant marginal costs, and sufficient capacity to serve demand, even two sellers can produce an equilibrium price equal to marginal cost. Product differentiation can soften this result by making buyers less willing to switch between suppliers. (ocw.mit.edu)
- Stackelberg competition: A leader commits to output before a follower chooses its quantity. In the standard model, the leader anticipates the follower’s response and obtains a first-mover advantage. This illustrates how commitment and the order of decisions can change equilibrium outcomes. (ocw.mit.edu)
These are conditional models rather than universal descriptions. Real markets can combine price competition, capacity commitments, differentiated products, and repeated interaction. Consequently, the same number of suppliers need not imply the same degree of competition. (ocw.mit.edu)
Collusion and repeated interaction
Collusion occurs when competitors coordinate to reduce rivalry, for example by restricting output or maintaining higher prices. A cartel is an organized arrangement among firms to coordinate competitive behavior. Members may collectively benefit from limiting supply, yet each has an incentive to undercut the agreed price or expand sales while others maintain restraint. (openstax.org)
The prisoner’s dilemma captures this tension: individually attractive actions can undermine an outcome that would give the firms higher joint profits. Cooperation among sellers is not necessarily beneficial to purchasers, who may face higher prices and reduced output. (openstax.org)
In a repeated game, firms consider future responses as well as immediate gains. Coordination can be sustained when the expected loss from subsequent retaliation outweighs the short-term benefit of deviation. Tacit collusion describes coordination sustained without an explicit agreement. Its feasibility depends on conditions such as firms’ ability to monitor rivals, detect deviations, and respond effectively; it is not an inevitable consequence of oligopoly. (oecd.org)
Measuring concentration
Market concentration summarizes how sales or other relevant activity are distributed among firms. A concentration ratio, such as the four-firm ratio, reports the combined share of the largest suppliers. The Herfindahl–Hirschman Index incorporates all firms by summing their squared market shares:
With shares expressed as percentages, a monopoly scores 10,000. Four equally sized firms score 2,500. Larger values indicate greater concentration, not direct proof of collusion. (justice.gov)
Measurement requires an appropriate product and geographic market. Shares based on revenue, quantities, or capacity can convey different information. Concentration measures are therefore evidence about competitive structure, not substitutes for examining substitution, entry, costs, and actual competitive behavior. (justice.gov)
Economic effects and competition policy
When oligopolistic competition leaves prices above marginal cost and restricts output, it can reduce consumer surplus and create deadweight loss relative to the competitive benchmark. The standard Cournot model illustrates this outcome; the basic Bertrand model shows why it cannot be inferred from a small supplier count alone. (ocw.mit.edu)
Competition law distinguishes market structure from prohibited conduct. In the United States, a naked agreement among competitors to fix prices is almost always unlawful. Similar prices, however, do not by themselves establish an agreement: firms may independently respond to common costs or market conditions. Merger analysis also uses concentration evidence to assess whether combining suppliers threatens competition, rather than treating every oligopolistic market as unlawful. (ftc.gov)