OLIGOPOLY

An oligopoly is a market condition in which the production of identical or similar products is concentrated in a few large firms. Examples of oligopolies in the United States include the steel, aluminum, automobile, gypsum, petroleum, tire, and beer industries. The introduction of new products and processes can create new oligopolies, as in the computer or synthetic fiber industries. Oligopolies also exist in service industries, such as the airlines industry.

An oligopoly may be categorized as either a homogeneous oligopoly or a differentiated oligopoly. In a homogeneous oligopoly the major firms produce identical products, such as steel bars or aluminum ingots. Prices tend to be uniform in homogeneous oligopolies. In a differentiated oligopoly, similar but not identical products are produced. Examples include the automobile industry, the cigarette industry, and the soft drink industry. In differentiated oligopolies companies attempt to differentiate their products from those of their competitors. To the extent that they are able to establish differentiated products, companies may be able to maintain price differences.

Being part of an oligopoly affects a company's competitive behavior. In a competitive market situation that is not an oligopoly, firms compete by acting for themselves to maximize profits without regard to the reactions of their competitors. In an oligopoly, a firm must consider the effects of its actions on others in the industry. While smaller firms may operate at the fringes of an oligopoly without affecting the other firms in the industry, the actions of a major firm in the oligopoly typically cause reactions in the other firms in the industry. For example, if one company in the oligopoly attempts to undersell the others, then the other firms will respond by also lowering prices. As a result, price cuts in oligopolies tend to result in lower profits for all of the firms involved.

Prices in oligopolistic industries tend to be unstable to the extent that companies will shade, or lower, their prices slightly to gain a competitive advantage. It must be remembered that collusion between firms to fix prices is illegal under U.S. antitrust laws, so oligopolies must reach industry agreements on pricing indirectly. Companies can signal their pricing intentions indirectly in a variety of ways, such as through press releases, speeches by industry leaders, or comments given in interviews. In some cases there is a recognized price leader in the oligopoly, and other firms in the oligopoly set their prices according to that of the industry's price leader.

Industrial concentration is a matter of degree. This means that there is no absolute definition of an oligopoly in terms of the number of firms accounting for a certain percentage of an industry's output. In the United States the Census of Manufacturers reports on each industry's four-firm concentration ratio. This figure indicates what percentage of an industry's output is accounted for by its four largest companies. It is not uncommon for the four largest firms to account for 30 percent or more of an industry's output, and in some cases they account for more than 70 percent of production.

In the United Kingdom, for example, the top four food retailers accounted for 45 to 67 percent of the nation's $150 billion grocery market in 1998. In Russia, economic development under Boris Yeltsin has been described as a "new oligarchy," in which government officials and business leaders join together to gain control of industries such as banking, television, the business press, and other companies.

Oligopolies tend to develop in industries that require large capital investments. Studies have shown that industries with high four-firm concentration ratios tend to have higher margins than other industries. In order to maintain an oligopoly, potential investors must be discouraged from establishing competing companies. Oligopolies are able to perpetuate themselves and discourage new investments in several ways. In some cases the oligopoly is the result of access to key resources, which may be either natural resources or some patented process or special knowledge. New firms cannot enter the industry without access to those resources.

The established, experienced firms in an oligopoly also enjoy significant cost advantages that make it difficult for new firms to enter the industry. These cost advantages may be the result of the large scale of production required as well as of experience in keeping manufacturing or operating costs down. Another factor that tends to perpetuate oligopolies is the difficulty of introducing new products into an oligopoly characterized by a high degree of product differentiation. Prohibitively large expenditures would be required of a new firm to overcome consumer reluctance to try a new product over an established one. Finally, oligopolies perpetuate themselves through predatory practices such as obtaining lower prices from suppliers, establishing exclusive dealerships, and predatory pricing aimed at driving smaller competitors out of business.