The case for and against oligopoly

Key terms

Oligopoly: Oligopoly is a market in which a few large firms make all or most of an industry's sales.
Monopoly: A monopoly is a single firm selling all or nearly all of a market's goods or services, so it faces the market demand curve.

Economies of scale can leave room for only a few low-cost firms

In some industries a firm must be large before it reaches its lowest average cost, and the market's total sales are only two or three times that output. The market then has room for only two or three firms producing at low cost. A smaller firm would have higher average costs and could not compete, while an extra large firm would add so much output that it could not sell it at a profitable price. Where an oligopoly comes from economies of scale like these, or from patented inventions, it can bring considerable benefits to consumers: a few large firms make each unit more cheaply than many small ones could.

A small firm producing Q1 has average cost C1. A firm producing Q2 reaches the lowest point of LRAC, at C2. Market sales are three times Q2, so the market has room for about three firms producing at C2, and no more.