Oligopoly is the market organization in which there are a few or small number of firms in an industry and they produce the major share of the market. The word ‘a few’ or small number is vague. The economists therefore refer to oligopoly as that market situation in which the number of firms is small but each firm in the industry takes into consideration the reaction of the rival firms in the formulation of price policy. The number of firms in the industry thus may be only two or more than two say 5, 10, 20. The basic condition for the existence of oligopoly is that a firm in the ‘group product’ formulate its price policies with an eye to their effects on its rivals.
There is thus a great deal of interdependence between or among the small number of firms. The oligopolistic industries are classified in a number of ways. If there are only two giant firms in an industry and they produce identical products. It is called perfect on pure duopoly. In case the goods produced by the two firms are differentiated, the duopoly is said to be imperfect or impure. When the number of firms dominating the product market is so small (more than two) that each firm takes into consideration the reactions of the rivals firms in formulating its own policy, the industry is said to be oligopolstic. The oligopoly like duopoly can also be pure or improve. If firms sell identical products like, cement, steel etc. the oligopoly is said to be pure. But if the products of the firms are not standardized and so are not perfect substitutes of one another, the oligopoly is called impure or differentiated.
Cause of Oligopoly
The main reasons which give rise to oligopoly are as follows:
1. Economies of Scale: If the productive capacity of few firms is large and are able to capture a greater percentage of the total available demand for the product in the market, there will then be a small number of firms in an industry. The firms in the industry with heavy investment using improved technology and reaping economies of scale in production, sales promotion etc. will complete and stay in the market. The firms using outdated machinery and old techniques of production will not be able to compete with the low units costs producing firm and eventually wipe out from the industry. Oligopoly is, thus promoted due to the economies of scale.
2. Barriers to Entry: In many oligopolies, the new firms cannot enter the industry as the big firms have ownership of patents or control over the essential raw material used in the production of an output. The heavy expenditure on the advertising by the oligopolistic industries may also be a financial barrier for the new firms to enter the industry.
3. Merger: If the new firms in the industry smell the danger of entry of new firms, they then immediately merge and formulate a joint policy in the pricing and production of the products. The joint action of a few big firms discourages the entry of new firms into the industry.
4. Mutual Interdependence: As the number of firms is small in an oligopolistic industry, therefore they keep a strict watch of the price charged by rival firms in the industry. The firm generally avoid price war and try to create conditions of mutual interdependence.