How does an oligopoly work

Oligopoly

The oligopoly is a type of market that is relatively common in practice. In a supply oligopoly, few suppliers face a relatively high number of buyers. The opposite is the case with a demand oligopoly, because there are few demanders who can fall back on a large number of providers. A bilateral oligopoly exists when few suppliers meet few buyers.

In this lesson we explain the most important characteristics of an oligopoly, the different variants and the typical behavior of the individual market participants. At the end of the lesson, we provide you with a few practice questions that you can use to deepen your knowledge.

Why should you know the oligopoly?

The oligopoly is a relatively common type of market in reality. Oligopolies exist, for example, in the automotive industry, with mineral oil manufacturers and in aircraft construction.

It is therefore important that you identify the oligopoly as such and derive the behavior of the individual market participants, especially the oligopolists, from it.

Features and variants of oligopoly: demand oligopoly & supply oligopoly

A distinction is made between demand, supply and bilateral oligopoly, depending on whether a few buyers face many suppliers, a few suppliers face many customers or a few customers face a few suppliers.

The individual forms of the However, oligopolies are so different from one another that there is no uniform model that describes how prices are set.

A typical feature of the oligopoly is that the Market power with a few providers lies. When setting prices, they not only have to keep an eye on their own prices, quantities and quality with regard to the customer, but also the reactions of competitors.

Demand oligopoly

In a demand oligopoly, there are only a few, relatively large demanders who face many relatively small suppliers. This constellation is also known as an oligopsony. The providers have a comparatively little influence on the pricing process.

An example of this can be found among the dairy farmers, of whom there are a large number, but who are faced with only a few dairy farms as consumers.

Supply oligopoly

The supply oligopoly is that most common form of oligopoly. The Although few providers have a correspondingly high level of market power, they always have to assess the possible reactions of their competitors to their own decisions can.

A typical example can be found among aircraft manufacturers, who face a relatively large number of airlines. The German electricity market also shows characteristics of a supply oligopoly. Few electricity suppliers meet a very large number of customers, with the latter having almost no influence on the pricing process.

Bilateral oligopoly

In a bilateral or bilateral oligopoly, few suppliers face few buyers. Accordingly, the market power of the individual market participants is balanced.

The automotive industry provides a good example: Few manufacturers of exclusive leather seats meet few automobile manufacturers who ask for these seats.

Behaviors of market participants

Price leader

In an oligopoly it can happen that one supplier has a higher market power than all the others. In this case, he will be recognized by the others as the price leader. This means that the price leader adjusts prices first and then all other oligopolists follow suit.

imitation

Another behavior that can often be observed in an oligopoly is imitation. The behavior of the competitor is imitated. If this is the price leader, the monopoly price can also be achieved in the case of an oligopoly with only two providers (duopoly).

Cartel formation

One danger with oligopolies is that of cartel formation. So price and quantity agreements are made between the oligopolists. This is particularly common in the case of homogeneous oligopolies. Homogeneous means that the products offered are perfect substitutes from the customer's point of view and consequently that there are no preferences whatsoever.

The petroleum industry is a good example. If the price is the same, it is irrelevant for most customers which of the five oil companies they fill up with. But the opposite case is also possible, because with oligopolies in particular, a price war for market share can quickly develop, which can lead to predatory competition.

Practice questions