Definition
An oligopoly is a market dominated by a small number of large sellers — typically three to ten firms — whose pricing and output decisions are mutually interdependent. Each firm must account for how rivals will respond when setting its own strategy. This strategic interdependence — the defining feature that distinguishes oligopoly from both perfect competition and monopoly — means no firm has an optimal strategy in isolation. What is best for firm A depends on what firm B does, and vice versa.
Oligopoly is the most common market structure in advanced economies. Airlines, automobiles, telecommunications, pharmaceuticals, and banking are all oligopolistic industries. The behavior of these markets — whether firms compete aggressively or coordinate quietly — has major implications for prices, innovation, and consumer welfare.
Why it matters
Collusion versus competition
The game-theoretic structure
The Prisoner's Dilemma in oligopoly
The classic representation of cartel instability is the Prisoner's Dilemma: both firms do better cooperating (high prices) than competing (price war), but each firm has a dominant strategy to defect regardless of what the other does. If your rival holds prices and you cut, you capture their customers; if your rival defects and you hold, you lose share. The dominant strategy is to defect — and so the Nash equilibrium is mutual defection, even though both firms would prefer mutual cooperation.
This explains why cartels rely on mechanisms that change the payoff structure: price-matching commitments that eliminate the gain from defection; transparent pricing that enables rapid detection of defectors; strong retaliation threats that make defection unprofitable in repeated interactions.
Price rigidity
The kinked demand curve model offers an intuitive explanation for why oligopoly prices tend to be sticky. If a firm raises its price above the current level, rivals will not follow — they gain share by staying put. If a firm cuts its price, rivals will follow — they cannot afford to lose share. This asymmetry produces a kink in the firm's perceived demand curve and a corresponding range of marginal costs over which the optimal price is unchanged, making price rigidity rational.