Oligopoly is defined as an industry in which there are a few firms. By a few, it is meant that the number of firms should be sufficiently small for there to be conscious interdependence, with each firm aware that its future prospects depend not only on its own policies but also those of its rivals. An industry is defined as a group of firms where the firm’s products are close substitutes for one another, that has a high and positive cross elasticity of demand.
The rise of oligopolies can be charted in a number of ways.
Competition and Collusion
Oligopolies are pulled in two different directions. The interdependence of firms makes them wish to collude with each other. By behaving as a monopoly they could maximize industry profits. On the other hand, they will be tempted to compete with their rivals to gain a bigger share of industry profits.
When an oligopoly is non-collusive the firm uses guesswork and calculation to handle the uncertainty of its rival’s reactions. However, another way of handling uncertainty in markets which are interdependent is by some form of central co-ordination. One form of collusion is to form a cartel. A cartel is the establishment of some central body with responsibility for setting the industry price and output. They are against the law in most countries including Britain.
When firms engage in collusion they may agree on prices, market share, advertising expenditure etc. The cartel will maximize profits if it behaves as a monopoly. Having agreed on the cartel price the members may then compete against each other using non-price competition to gain a bigger share of output or they may somehow decide to share the market with them.
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