Conditions for an Oligopolistic Market

Oligopoly is the least understood market structure; consequently, it has no single, unified theory. Nevertheless, there is some agreement as to what constitutes an oligopolistic market. Three conditions for

oligopoly have been identified. First, an oligopolistic market has only a

few large firms. This condition distinguishes oligopoly from monopoly,

in which there is just one firm. Second, an oligopolistic market has high

barriers to entry. This condition distinguishes oligopoly from perfect

competition and monopolistic competition in which there are no barriers

to entry. Third, oligopolistic firms may produce either differentiated or

homogeneous products. Examples of oligopolistic firms include automobile

manufacturers, oil producers, steel manufacturers, and passenger airlines.

As mentioned above, there is no single theory of oligopoly. The two

that are most frequently discussed, however, are the kinked-demand

theory and the cartel theory. The first one applies to oligopolistic markets

where each firm sells a differentiated product. It illustrates the high degree

of interdependence that exists among the firms that make up an oligopoly.

The kinked-demand theory, however, is considered an incomplete theory

of oligopoly for several reasons. First, it does not allow for the possibility

that price increases by one oligopolist are matched by other oligopolists,

a practice that has been frequently observed. Second, the theory does

not consider the possibility that oligopolists collude in setting and price.

The possibility of collusive behavior is captured in the alternative theory

known as the cartel theory of oligopoly.

A cartel is defined as a group of firms that get together to make output and price decisions. The conditions that give rise to an oligopolistic market are also conductive to the formation of a cartel; in particular, cartels tend to arise in markets where there are few firms and each firm has a significant share of the market. The organization of petroleum-exporting countries (OPEC) is perhaps the best-known example of an international cartel; OPEC members meet regularly to decide how much oil each member of the cartel will be allowed to produce.

Oligopolistic firms join a cartel to increase their market power, and members work together to determine jointly the level of output that each member will produce and/ or the price that each member will charge. By working together, the cartel members are able to behave like a monopolist. Once established, cartels are difficult to maintain. The problem is that cartel members will be tempted to cheat on their agreement to limit production. By producing more output than it has agreed to produce, a cartel member can increase its share of the cartel's profits. Hence, there is a built-in incentive for each cartel member to cheat. Of course, if all members cheated, the cartel would cease to earn monopoly profits, and there would no longer be any incentives for firms to remain in the cartel. The cheating problem has plagued the OPEC cartel as well as other cartels and perhaps explains why so few cartels exist.

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