The Difference Between Pure Competition and Oligopoly
Most economists agree that a market economy, in which millions of households and firms make decisions about resource allocation, is preferable to centralized government planning as a way to organize economic activity, according to Professor Greg Mankiw, a Harvard economist. However, various types of market economies exist. They range from monopolies, in which a single firm is the sole seller of a good or service, to perfect or pure competition, in which many buyers and sellers exist. Another form of market economy, existing between the extremes of monopoly and pure competition, is an oligopoly.
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Identification
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An oligopoly is a market structure in which only a small number of sellers offer a product or service. The small number of sellers contrasts oligopolies with pure competitive markets, in which many sellers exist. Mankiw, a former White House economics adviser, cites the markets for tennis balls and crude oil as examples of oligopolies. Four firms -- Dunlop, Spalding, Penn and Wilson -- produce almost all tennis balls sold in the U.S., according to Mankiw. Meanwhile, a handful of countries in the Middle East, including Saudi Arabia and Iran, control much of the world's oil reserves.
Features
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Under pure competition, in which many firms offer the same or similar products, no single firm is large enough relative to the entire market to influence the price of its product of service. Thus, each firm under pure competition takes the price as determined by the market. Mankiw calls such firms "price takers." In addition, firms are free to enter or exit the market under pure competition. For example, any person can start a software firm and any existing software maker can choose to leave the market. Under oligopoly, the limited number of companies in the market compete with each other but can influence the supply and price of what they sell. This means that oligopolistic firms are not price takers but do not have full control over price and supply that a monopoly holds.
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Effects
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Oligopolies can function like monopolies by forming an alliance among themselves to control the supply and price of a good. Mankiw refers to such arrangements as collusion. When firms act in unison, they are known as cartels. Oligopolistic firms often want to form cartels, enabling them to function as monopolies, but Mankiw points out that antitrust laws in the U.S. prohibit such arrangements. In addition, conflict among cartel members about how to share profits makes cooperation difficult.
Considerations
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Although antitrust laws are intended to prevent monopolistic behavior by oligopolies, Mankiw points out that the use of these laws can be controversial because some anti-competitive practices may have legitimate business purposes. Mankiw cites predatory pricing, in which one firm charges prices so low as to drive competitors out of the market, as an example.
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References
- "Principles of Economics (3rd ed.)"; N. Gregory Mankiw; 2004
