An oligopoly is a market dominated by a small number of firms. A cartel is an oligopoly that is able to maximize its joint profits by limiting competition and producing the monopoly quantity.

The OPEC cartel remains important but its influence on the price of oil has diminished due to cheating, new entrants, and substitute products. Most market cartels are not stable either. Either businesses cheat on the cartel agreement or new competitors enter the market. Governments break up some cartels, but they also enforce many others. When you observe a harmful cartel, you should ask whether some governmental rule or regulation might be at fault.

Oligopolies form when there are significant barriers to entry such as control of a key resource or input, economies of scale, network effects, or government barriers. Although firms in an oligopoly are unlikely to be able to produce the joint profit-maximizing quantity, neither are they likely to produce as much as in a highly competitive market. Prices in an oligopoly, therefore, tend to be below monopoly prices but above competitive prices.

Game theory is the study of strategic interaction. A dominant strategy is a strategy that has a higher payoff no matter what the other player(s) do.

The prisoner’s dilemma game explains why cheating is common in cartels and more generally how individual interest can make cooperation difficult even when cooperation is better for everyone in the group than noncooperation. Firms use a variety of strategies to reduce competitive pressures. An analysis of price matching guarantees and customer loyalty programs shows that they can reduce competition and raise prices. Innovation and product differentiation can also reduce competitive pressures but at the same time are part of a dynamic economy that discovers valuable new goods and services.