What is an oligopoly? Definition and meaning
The definition and meaning of an oligopoly is a market sector in which very few firms compete or dominate – a highly-concentrated market. It does not mean there are just two, three or four competitors – there could be dozens of them – but there are only a few dominant ones. If a market has more than fifty competitors, but the top three dominate 90% of the market that is an oligopoly.
The dominant players in an oligopoly often work together – they collude – as if they were a single monopoly, and try to fix minimum prices, output volumes, and other terms of business.
When the oligopolists opt for non-price competition – where their prices remain unchanged and they compete using other factors such as packaging, customer service, or special delivery options – their aim is to avoid a cut-throat price war.
When there is an oligopoly, the dominant players collude to make it very hard for new companies to enter the market, their behaviors are quasi-monopolistic – they keep their prices artificially high, pursue non-price competition strategies, seek out merger and acquisition opportunities, and do everything they can to maintain their status quo.
Companies in oligopolies frequently collude in an attempt to stabilize a market that is unstable, in order to minimize the risks inherent in these markets for product development and investment. In all the advanced economies and many emerging ones, there are legal restrictions on such collusion.
For a firm to be colluding illegally, it must be caught communicating with a rival. In many cases, there is no formal or observable collusion taking place.
According to the Financial Times Lexicon, an oligopoly by definition is:
“When supply of a particular product is dominated by a few companies, which are therefore able to control prices and output – though they would normally have to take each other’s decisions into account.”
Sometimes, a market becomes an oligopoly because the dominant players collude to minimize competition, manipulate prices, and raise barriers of entry.
John Kenneth Galbraith (1908–2006) was a Canadian-American economist, diplomat and public official – he was also a leading proponent of 20th century American liberalism. He was a supporter of Post-Keynesian economics from an institutionalist perspective. (Image: Wikipedia)
In the majority of oligopolies, each dominant rival is aware of what every player is doing, because there are so few of them to keep an eye on.
Game theory states that the decisions of one major player in such a market influences the decisions of all the others, and vice-versa. When an oligopolist is considering planning and strategy, it must take into account how its rivals are likely to respond.
Oligopoly – examples
The United States
– Movie Studios: there are hundreds of them across the country. However, eighty-seven percent of all film revenues come from just six dominant players.
– TV and Fast Internet: seven firms – Comcast, Viacom, CBS Corporation, News Corporation, and the Walt Disney Company – dominate nearly the whole US market.
– Mobile Phone Communications: – eighty-nine percent of the market is controlled by just four wireless providers: AT&T Mobility, Verizon Wireless, Sprint Nextel and T-Mobile.
The United Kingdom
– Supermarket Chains: four companies – Morrisons, Sainsbury’s, Asda and Tesco – control 74.4% of the grocery market.
– High-Street Banks: this sector is dominated by Natwest, Lloyds, Santander, Barclays and HSBC.
– Detergent Market: this is virtually a duopoly – where there are just two main suppliers. Unilever and Procter & Gamble control more than four-fifths of the nation’s detergent market.
– Electricity Distribution: EDF Energy, Centrica, RWE npower, Scottish Power, E.on, Scottish and Southern Energy (SSE) control ninety-five percent of the market.
Oligopolies do not exist just within countries, but also in whole continents and across the globe.
Globally, three computer operating systems – Linux, Mac OS and Windows – control virtually the whole desktop computer market.
In the smartphone and tablet markets, Google Android and Apple iOS together have more than 90% market share.
Oligopoly – Herfindahl-Hirschman Index
The Herfindahl-Hirschman (HHI) Index or Herfindahl Index measures the extent to which market share is controlled by a few or many competitors. The Index measures the market concentration of the fifty largest companies in an industry in order to determine whether there is healthy competition or imperfect competition in that sector.
The HHI is calculated by squaring the market share of each player and summing the resulting numbers. For example, if there are four competitors with market shares of 30, 30, 20 and 20 percent, the HHI is 2,600 (the sum of 302 plus 302 plus 202 plus 202).
The HHI score can range from very near zero – more than 100 similar-sized competitors – to 10,000 – a monopoly.
A monopoly has 100% share of the market: 1002 = 10,000. A market with 100 competitors of similar size would be calculated as follows: 12 x 100 = 100. The larger the score, the more imperfect a market is.
Regarding the HHI scores and how US agencies rate them when monitoring possible antitrust issues, the Department of Justice says:
“The agencies generally consider markets in which the HHI is between 1,500 and 2,500 points to be moderately concentrated, and consider markets in which the HHI is in excess of 2,500 points to be highly concentrated.”
The word ‘oligopoly’ emerged in the English language with its current meaning in 1887 in Great Britain. It came from Medieval Latin Oligopolium, which originated from Greek Oligos, meaning ‘small, little’ (plural: ‘the few’). The suffix ‘poly’ comes from Greek Polein, which means ‘to sell’.
Video – Game theory and Oligopoly – Definition and Meaning
In this Crash Course video, Jacob and Adriene teach us about oligopolies.