Think about the last place you purchased cookies. That store, be it online or brick-and-mortar, would almost certainly fit into one of two market-structure categories. If it was a small, independent grocery or convenience mart it probably was Monopolistically Competitive. Monopolistic Competition is characterized by many, independent firms selling differentiated goods in a market lacking any substantial barriers to entry.
But, if it were large chain grocer, it was likely part of an Oligopolistic industry. Oligopoly (like the term Oligarchy you hear now often) refers to domination by a few significant players. In politics, these are a cluster of powerful persons. In a market, it refers to a small group of large firms that dominate a market.
Where product differentiation was important in distinguishing Perfect Competition and Monopolistic Competition, this is irrelevant to Oligopoly. The non-differentiated oil industry is Oligopolistic. But so is the highly differentiated auto industry. Instead, it’s the presence of barriers to entry that most properly defines an Oligopoly.
What might these barriers be? For one, “economies of scale”. The large grocer is able to leverage its buying buyer to keep its inventory cost low. Until it gains a sufficient foothold, no new entrant will be able to match its cost, making it very difficult to enter the market. The grocery may also enjoy considerable brand awareness and loyalty as well an existing presence in all of the best locations. For all these reasons, most communities are dominated by no more than that few large grocery chains.
What makes Oligopolistic behavior a bit hard to pin down is the interaction effects between the firms. Remember there are only a few, large firms in an Oligopoly. And so, what any one of them does directly impacts the others making decision making becomes much more complex. If Virgin Atlantic decides to lower the price for flights originating at Heathrow Airport, how will its competitors react and how in turn will that impact the result of its decision?
Economists have developed many conceptual models to describe Oligopoly – each with its own underlying assumptions. Do I assume that my competitors will maintain the status quo until I make a change? Or do I assume they’ll anticipate my move and preempt me? One popular approach to describing such behavior is Game Theory. But there are more than a few others. Arguably, the entire discipline of Strategic Management exists solely to teach managers how to navigate the world of Oligopoly.
Unlike the other three market structures, there are no set implications for profitability or economic efficiency. In one conceptual model of Oligopoly, “Bertrand Oligopoly”, firms are described as actively competing on price. The result is not so much different from Perfect Competition. Sellers of wood pulp to paper manufacturers may well behave in such a way. While another model, “Cournot Oligopoly”, describes an industry where the participants reach some market share stasis and somehow avoid ruinous price competition. Milk wholesalers look much like this. And then there’s always the occasional appearance of a Cartel, where the participants effectively as if they were a Monopoly. And so, profits run the range from barely sufficient to maintain the participants to extraordinary profitability. Likewise, depending on the degree of product differentiation and competitiveness, Oligopolistic industries can be rather quite allocatively efficient or significantly underproduce in order to maintain price.