# Understanding Oligopolies: Market Structure, Characteristics, and Examples

> **Definition**
>
> An oligopoly is a market structure where a small number of firms have significant control over market prices and output, often leading to limited competition and potential collusion among the firms.

## What Is an Oligopoly?

An oligopoly is a type of [market](https://www.investopedia.com/terms/m/market.asp) structure in which a small number of firms control most of the market. In an oligopoly, producers can indirectly or directly restrict output or influence prices to achieve higher returns. A key characteristic is that no one firm can keep the others from having significant influence over the market. Oligopolies face challenges such as the risk of collusion or the strategic tension of the prisoner's dilemma. Historical and modern examples include OPEC and the U.S. airline industry.

### Key Takeaways

*   Oligopolies are stable market structures characterized by a small number of firms that collaborate to control prices and market share, often resulting in higher profits and restricted competition.
*   Economic, legal, and technological barriers, such as economies of scale, regulatory restrictions, and brand loyalty, can maintain or dissolve oligopolies, affecting new market entries and innovation.
*   The prisoner's dilemma is a significant challenge for oligopolies, as each firm is tempted to undercut others to capture more market share, threatening collaborative agreements.
*   Government regulations can either combat oligopolistic practices like price-fixing or, conversely, foster oligopolies through favorable policies.  
    

![Oligopoly](https://www.investopedia.com/thmb/P4HuFVrykVmwZTs4hPEl-RNWK_s=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/oligopoly-10a52aa9a9de45988ca1ac1e90d81ff1.jpg)

*— Investopedia / Ellen Lindner*

## Analyzing Market Dynamics in Oligopolies

Market structures come in different forms and sizes. The term is used to describe the distinctions between industries, which are made up of different companies that sell their products and services. Most market structures aim for [perfect competition](https://www.investopedia.com/terms/p/perfectcompetition.asp), which is a theoretical construct that doesn't actually exist.

These market structures are made up of a small number of companies within an industry that controls the market. Firms in an oligopoly [set prices](https://www.investopedia.com/terms/p/pricemaker.asp), whether collectively—in a [cartel](https://www.investopedia.com/terms/c/cartel.asp)—or under the leadership of one firm, rather than [taking prices](https://www.investopedia.com/terms/p/pricetaker.asp) from the market. Profit margins are thus higher than they would be in a more competitive market. 

Some of the [barriers to entry](https://www.investopedia.com/terms/b/barrierstoentry.asp) (that prevent new players from entering the market) in an oligopoly include [economies of scale](https://www.investopedia.com/terms/e/economiesofscale.asp), regulatory barriers, accessing supply and distribution channels, capital requirements, and brand loyalty.

Oligopolies in history include steel manufacturers, oil companies, railroads, tire manufacturing, grocery store chains, and wireless carriers. The economic and legal concern is that an oligopoly can block new entrants, slow innovation, and increase prices, all of which harm consumers.  

## Special Considerations for Oligopolies

Governments often use laws to combat price-[fixing](https://www.investopedia.com/terms/f/fixing.asp) and collusion in oligopolies. Still, cartels might fix prices if beyond government reach or with approval. Oligopolies that exist in [mixed economies](https://www.investopedia.com/terms/m/mixed-economic-system.asp) often seek out and lobby for favorable government policy to operate under the regulation or even direct supervision of government agencies.

The main problem that firms in an oligopoly face is that each firm has an incentive to cheat. if all firms in the oligopoly agree to jointly restrict supply and keep prices high, then each firm stands to capture substantial business from the others by breaking the agreement and undercutting the others. Such competition can be waged through prices, or through simply the individual company expanding its own output brought to market. 

> **Important**
>
> Companies in an oligopoly benefit from price-fixing, setting prices collectively, or under the direction of one firm in the bunch, rather than relying on free-market forces to do so.

## Key Traits of Oligopolistic Markets

Oligopolies are considered stable. One of the main reasons why they are is because participating firms need to see the benefits of collaboration over the costs of economic competition, then agree to not compete and instead agree on the benefits of cooperation.

The firms sometimes find creative ways to avoid the appearance of [price-fixing](https://www.investopedia.com/terms/f/fixing.asp), such as using phases of the moon. Price-fixing is the act of setting prices, rather than letting them be determined by the free-market forces. Another approach is for firms to follow a recognized [price leader](https://www.investopedia.com/terms/p/price-leadership.asp) so that when the leader raises prices, [the others will follow](https://www.investopedia.com/terms/f/follow-the-leader-pricing.asp).

The conditions that enable oligopolies to exist include high entry costs in [capital expenditures](https://www.investopedia.com/terms/c/capitalexpenditure.asp), legal privilege (license to use wireless spectrum or land for railroads), and a platform that gains value with more customers, such as social media.

The global tech and trade transformation has changed some of these conditions. For instance, offshore production and the rise of mini-mills have affected the steel industry. In the office software application space, Microsoft ([MSFT](https://www.investopedia.com/markets/quote?tvwidgetsymbol=MSFT)) was targeted by Google Docs, which Google funded using cash from its web search business.  

## The Role of Game Theory in Oligopolies

Game theorists have developed models for these scenarios, which form a sort of [prisoner's dilemma](https://www.investopedia.com/terms/p/prisoners-dilemma.asp). When costs and benefits are balanced so that no firm wants to break from the group, it is considered the [Nash equilibrium](https://www.investopedia.com/terms/n/nash-equilibrium.asp) state for oligopolies. This can be achieved by contractual or market conditions, legal restrictions, or strategic relationships between members of the oligopoly that enable the punishment of cheaters.

Maintaining an oligopoly and coordinating action among buyers and sellers in general on the market involves shaping the payoffs to various prisoner's dilemmas and related coordination games that repeat over time.

As a result, many of the same institutional factors that facilitate the development of market economies by reducing prisoner's dilemma problems among market participants, such as secure enforcement of contracts, cultural conditions of high trust and reciprocity, and laissez-faire economic policy, might also potentially help encourage and sustain oligopolies.

## Pros and Cons of Operating in an Oligopoly 

### Pros

One of the main benefits of having an oligopoly is that competition is very limited. That's because there are very few players in the market. Since there are few competitors, an oligopoly allows those who participate to net a higher amount of [profits](https://www.investopedia.com/terms/p/profit.asp).

### Cons

Oligopolies come with higher barriers to entry for new participants. This means that it can be difficult to enter the market because of the high costs associated with doing business, the regulatory environment, and the problems that arise when it comes to accessing supply and [distribution channels](https://www.investopedia.com/terms/d/distribution-channel.asp).

Because of the lack of competition, there may be very little incentive to innovate product and service offerings. With no diversity in offerings, consumers remain loyal to what they know best.  

Pros

*   Limited competition
    
*   Higher profits for companies
    
*   Greater consumer demand
    

Cons

*   High barriers to entry for new participants
    
*   Lack of innovation
    
*   Very little choice for consumers
    

## Real-World Oligopoly Example: OPEC

There are many examples of oligopolies in the market. But one of the major examples of a global oligopoly is the [Organization of the Petroleum Exporting Countries (OPEC)](https://www.investopedia.com/terms/o/opec.asp). The organization was founded in Baghdad in 1960 with five countries but expanded to 13 oil-producing countries in 1975.

One of the main reasons why OPEC is considered an oligopoly is because it has no overarching authority. Every member nation within the group also has a substantial portion of the group's market share. These countries also have a great deal of power together (not separately) when it comes to [supply and demand](https://www.investopedia.com/articles/economics/11/intro-supply-demand.asp) issues and pricing. So when the group lowers its supply as demand drops, prices rise. The opposite is true when demand rises.

## What Are Some Negative Effects of an Oligopoly?

An oligopoly is when a few companies exert significant control over a given market. Together, these companies may control prices by colluding with each other, ultimately providing uncompetitive prices in the market. Among other detrimental effects of an oligopoly include limiting new entrants in the market and decreased innovation. Oligopolies have been found in the oil industry, railroad companies, wireless carriers, and big tech.

## What Is an Example of a Current Oligopoly?

One measure that shows if an oligopoly is present is the concentration ratio, which calculates the size of companies in comparison to their industry. Instances where a high concentration ratio is present include mass media. In the U.S., for example, the sector is dominated by just five companies: NBC Universal; Walt Disney; Time Warner; Viacom CBS; and News Corporation—even as streaming services like Netflix and Amazon Prime begin to encroach on this market. Meanwhile, within big tech, two companies control smartphone operating systems: Google Android and Apple iOS.

## Is the U.S. Airline Industry an Oligopoly?

With just four companies controlling nearly two-thirds of all domestic flights in the U.S. as of 2021, it has been purported that [the airline industry is an oligopoly](https://www.investopedia.com/ask/answers/010915/what-are-most-famous-cases-oligopolies.asp). These four companies are Delta Airlines, United Airlines Holdings, Southwest Airlines, and American Airlines. According to a report compiled by the White House, "reduced competition contributes to increasing fees like baggage and cancellation fees. These fees are often raised in lockstep, demonstrating a lack of meaningful competitive pressure, and are often hidden from consumers at the point of purchase." Interestingly, in 1978, The Airline Deregulation Act was imposed, which stripped away the Civil Aeronautics Board the ability to regulate the industry. Prior to this time, the airline industry operated much like a public utility, while fare prices had declined 20 years before the deregulation was introduced. 

## The Bottom Line

There is no such thing as perfect competition in the market, but there are different market structures, including oligopolies, which are markets dominated by a small number of firms that can influence prices and output.

Oligopolies often have high barriers to entry, allowing firms to maintain stability and higher profits, though this can limit consumer choice and innovation. Government regulation plays a key role in addressing potential price-fixing or anti-competitive practices. Examples include OPEC and the airline industry, which also face challenges like the prisoner's dilemma as firms balance cooperation with incentives to compete.

> **Article Sources**
>
> 1.  Organization of Petroleum Exporting Countries. "[Brief History](https://www.opec.org/opec_web/en/about_us/24.htm)."
>     
> 2.  The White House. "[Fact Sheet for Executive Order on Promoting Competition in the American Economy](https://www.whitehouse.gov/briefing-room/statements-releases/2021/07/09/fact-sheet-executive-order-on-promoting-competition-in-the-american-economy/.)."
>     
> 3.  Congress.gov. "[S.2493 - Airline Deregulation Act](https://www.congress.gov/bill/95th-congress/senate-bill/2493)."