Oligopoly

An oligopoly is a market dominated by a small number of large firms, each big enough that its decisions on price, output or investment noticeably affect the others. That interdependence is the defining feature: an oligopolist must guess how rivals will react before it acts. Oligopolies are common in industries such as telecommunications, airlines, banking, cloud computing, auditing and energy.

The word comes from the Greek for "few sellers". A market with two dominant firms is a duopoly, a special case. Oligopoly lies between perfect competition and monopoly on the spectrum of competition, and the buying-side counterpart, a few dominant buyers, is called oligopsony.

Picture three supermarkets in a medium-sized town. When one announces a price cut on milk, the other two hear about it within hours and usually follow, because nobody wants to look expensive. When one tries a price rise, it waits to see whether the others follow; if they do not, it backs down.

The result is a market where nobody can act alone. Each shop watches the others, and prices often move together. Sometimes the three compete hard on offers and loyalty cards; sometimes they settle into a comfortable pattern where nobody rocks the boat. Economists study oligopolies to work out which of these outcomes is likely and why.

• High barriers to entry. Large fixed costs, economies of scale, licenses, patents, brand loyalty and network effects keep new firms out.
• Interdependence. Each firm's best strategy depends on its rivals' choices, so behavior is analyzed with game theory.
• Non-price competition. Because price cuts are quickly matched, firms often compete through advertising, product features, service and loyalty schemes.
• Sticky prices. Prices in oligopolies often stay unchanged for long periods even when costs move, consistent with the evidence on sticky prices.

Several models explain oligopoly behavior. In the Cournot model firms choose quantities and in the Bertrand model they choose prices; both lead to a Nash equilibrium where no firm wants to change course alone. The kinked demand curve, proposed by Paul Sweezy in 1939, suggests rivals match price cuts but not price rises, which makes firms reluctant to change prices at all. Price leadership describes markets where one firm, usually the largest, sets prices and others follow.

The central tension is captured by the prisoner's dilemma. All firms would earn more if they kept prices high and output low, but each has an incentive to undercut. When firms agree explicitly to restrain competition, they form a cartel, which is illegal in most countries. Tacit collusion, where firms reach similar results without communicating, is harder to prove and is one of the hardest problems in antitrust enforcement. Researchers have also asked whether pricing algorithms could learn to sustain high prices without human agreement.

The French economist Jean Tirole received the 2014 Nobel Memorial Prize in Economic Sciences for his analysis of market power and regulation, much of it about how to regulate concentrated industries.

Authorities measure oligopoly with the concentration ratio and the Herfindahl–Hirschman Index (HHI). The HHI adds up the squared market shares of all firms:

• $s_i$ is the percentage market share of firm $i$.
• $N$ is the number of firms.

Worked example: five firms with shares of 30%, 25%, 20%, 15% and 10% give $900 + 625 + 400 + 225 + 100 = 2{,}250$. If the two smallest merged, the new firm would hold 25%, and the HHI would become $900 + 625 + 625 + 400 = 2{,}550$, an increase of 300. Under the US 2023 Merger Guidelines, still in force after the agencies confirmed them in February 2025, a merger producing an HHI above 1,800 and an increase above 100 is presumed to lessen competition substantially.

• Credit ratings. S&P Global, Moody's and Fitch issue the large majority of credit ratings worldwide.
• Audit. The Big Four firms (Deloitte, PwC, EY and KPMG) audit most of the world's largest listed companies.
• Oil. Supply decisions coordinated through OPEC and its wider OPEC+ group are a textbook case of producer coordination in a concentrated market.
• Mobile networks and banking. Many countries have three or four mobile operators and a handful of large banks, partly because licensing and capital requirements limit entry.

Oligopolies are not necessarily harmful. Large firms can fund research, invest in infrastructure and exploit economies of scale that small firms cannot, and competition among a few determined rivals can be intense. Critics argue that rising concentration in many economies has widened profit margins, weakened investment and encouraged lobbying for favorable rules, a concern linked to regulatory capture. Policy responses include merger control, lower barriers to entry and, in digital markets, rules for large platforms.

• OpenStax Principles of Economics: Oligopoly
• The Nobel Prize: Economic Sciences 2014 (Jean Tirole)