The Advantages & Disadvantages of an Oligopoly

Industries that deal in products such as automobiles, cereals, sodas and motor oil have a few firms that control most of the market, known as an oligopoly. Despite the small number of major players, oligopolies can generate intense competition for business. The nature of an oligopoly and the size of the companies present certain benefits and drawbacks, especially depending on whether you're a shopper or an entrepreneur.

Even with a small number of firms in the market, consumers may find lower prices or higher discounts thanks to oligopolies. Generally, a business will fear losing customers should it raise prices, since the competitors will not follow suit. When a business lowers its price or offers a discount, the others likely will cut prices to avoid losing their share of the market. While lower prices benefit consumers, the firms might have to sacrifice some of their profits to keep customers or undercut rivals.

Oligopolies tend to breed cartels, in which the firms agree to fix prices – normally by raising them – and lower product quantities to increase their profits. The Organization of Petroleum Exporting Countries, known as OPEC, is an example of a legal international cartel that sets production limits and prices of oil. In the United States and many other countries, these arrangements generally are illegal. Companies in an oligopoly may take similar actions even if they do not formally agree to form a cartel. For example, the major fuel manufacturers might each raise gas prices during Christmas, Thanksgiving, Memorial Day weekend or other peak travel periods.

One of the advantages of an oligopoly is that companies within them compete for customers through advertising. These campaigns save consumers time and money in searching for and learning about products and services. Advertising can spur innovation, technological advances and improved products and services. For example, a computer tablet maker may respond to a competitor's advertisement by designing and developing a tablet with more features or greater memory. With successful commercials come greater demand, more quantity to make and sell, and the ability to spread costs over more product.

In terms of oligopoly disadvantages, the big one is that your enterprise will face difficulty taking flight if you forge into an oligopolistic industry. Advertising and branding by the large, established companies quashes exposure for newcomers. The economies of scale resulting from advertising-driven demand and market share place prospective entrants at a significant cost disadvantage. Other barriers to entry include patents and the inability to find suppliers of materials and components for products.