An oligopoly the domination of a market by a few firms. A duopoly is a simple form of oligopoly in which only two firms dominate a market.
Where an oligopoly exists, a few large suppliers dominate the market resulting in a high degree of market concentration; a large percentage of the market is taken by the few leading firms.
An oligopoly usual depends on high barriers to entry. It often leads to a lack of price competition (although there may be fierce competition in terms of marketing etc) which is the problem from the point of view of consumers.
Because an oligopoly consists of a few firms, they are usually very much aware of each others' actions (e.g. changes to prices). This can lead to informal collusion as firms match prices to avoid provoking a price war. This has a similar effect to deliberate collusion, but is harder for regulators to control.
This also means that when price cuts do occur, the market tends to have to follow the lead of any one firm.
This leads to each firm experiencing a peculiar demand curve, the so-called kinked demand curve. An oligopolist faces a downward sloping demand curve but its price elasticity may depend on the reaction of rivals to changes in price and output. Assuming that firms are attempting to maintain a high level of profits and their market shares.
- Competitors will not follow a price increase by one firm, so a firm that raises prices will lose market share and therefore profits.
- Competitors have to match a price cut by one firm to avoid a loss of market share. That means that if one firm cuts prices, all will have lower profits.
This means that the demand curve for the oligopolist is not straight. It is flatter above the current price, with a sudden change of slope at the current price. This means that an oligopolist usually has little incentive to change its prices. It may cut prices where there are prospects of market share gains (i.e. when its rivals will not follow). It may increase prices if it feels sure that competitors will follow (or when the margin increase is sufficient to make up for the large loss in market share). Prices in an oligopoly therefore tend to be higher and change less than under perfect competition.
Examples of oligopolies may include the markets for petrol in the UK (BP, Shell and a few other firms) and soft drinks (such as Coke, Pepsi, and Cadbury-Schweppes).
The word oligopoly is derived from the Greek oligos, which means few.