An oligopoly market structure is an economy in which only a small number of companies dominate a given market via their capacity to exercise highly effective market control. It has long been defined as the condition where some firms possess so much economic power that a relatively small number of other firms are left little or no room for meaningful competitive entry. The real economic benefits of this situation are therefore limited to the monopolists themselves. The rest of the market is put under considerable competitive pressure, leading to reduced prices, product quality problems, and inefficient distribution systems. A firm that possesses monopoly power enjoys a highly unproductive distribution system, and thus suffers from low productivity. This situation can be counter-productive to the overall economic recovery and growth.
A number of factors including oligopoly market structure, lower investment, slower population growth and the presence of fixed business costs contribute to the development of severe, unproductive oligopolistic tendencies. In fact, the problem is made worse by the fact that even when firms are subjected to a set of imperfect competition, they still tend to enjoy high levels of technological superiority, so that over time their market outcomes tend to suffer. Under normal conditions, the level of economic activity generally declines due to the reduced mobility of firms within an industry and the concentration of financial resources in the hands of the few.
The existence of a small number of large firms can also promote a form of centralization of decision making. A small number of highly productive firms can be concentrated in a single area to dominate the entire market. An example of a firm that could be centralized in an oligopoly market structure would be Apple Computer, which dominates the entire personal computer industry. The company's market dominance and the huge leverage it exercises over its competitors enable it to charge higher prices than its competitors. Due to its scale advantage, Apple is able to maintain price increases that are substantially above the competition's prices, which it then commands a massive market share.
The existence of a large number of relatively unprofitable, small firms also facilitates the emergence of price distortions, which lead to the creation of monopoly pricing structures. A perfect example of such a price distortion is the current widespread practice of price fixing, wherein some firms try to fix the price of a product at the market floor by subjecting it to set or fixed conditions, in order to prevent the entry of smaller competitors. Such price fixing techniques limit the amount of potential innovation that could occur, since only a small portion of potential innovations can actually get through the established channels. A number of other physical obstacles to innovation are also created by the existence of a large number of small firms, since the number of competitors poses a substantial barrier to entry.
The existence of numerous, technically competent firms also supports the development of price competition. Even if a firm is able to cut prices on popular products, it will still have to worry about establishing its own unique mark in the industry. Since the market for a particular good or service is very complex and intricate, the firm is forced to consider and weigh the extent of market saturation, imperfection of product specification, and the absence of any obvious substitutes. A market for any good or service, when laden with a large number of technically competent competitors, will tend to reduce choices and force the firm into a value-for-money tradeoff between innovations and profitability.
Price competition is not always sufficient to cause prices to fall, especially when a business operates in an oligopoly market structure. In such a structure, economies of scale advantages and lower product differentiation lead to price reductions that are too shallow to justify significant reductions in cost or profit. Thus, even when a firm does experience cost reductions that justify a revenue increase, the resulting increase in earnings per unit is usually below that of competitors. In an oligopoly market structure, the relative position of a firm within a given industry and geography also serves as one of the important drivers of pricing power.
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