In many oligopolies, however, firms produce products that consumers regard as similar but not identical. A $10 difference in the price won’t make many customers switch from a Ford to a Chrysler, or vice versa. Sometimes the differences between products are real, like differences between Froot Loops and Wheaties; sometimes, they exist mainly in the minds of consumers, like differences between brands of vodka (which is supposed to be tasteless). Either way, the effect is to reduce the intensity of competition among the firms: consumers will not all rush to buy whichever product is cheapest.

As you might imagine, oligopolists welcome the extra market power that comes when consumers think that their product is different from that of competitors. So in many oligopolistic industries, firms make considerable efforts to create the perception that their product is different—that is, they engage in product differentiation.

A firm that tries to differentiate its product may do so by altering what it actually produces, adding “extras,” or choosing a different design. It may also use advertising and marketing campaigns to create a differentiation in the minds of consumers, even though its product is more or less identical to the products of rivals.

A classic case of how products may be perceived as different even when they are really pretty much the same is over-the-counter medication. For many years there were only three widely sold pain relievers—aspirin, ibuprofen, and acetaminophen. Yet each of these generic pain relievers were marketed under a number of brand names. And each brand used a marketing campaign implying some special superiority.

Whatever the nature of product differentiation, oligopolists producing differentiated products often reach a tacit understanding not to compete on price. For example, during the years when the great majority of cars sold in the United States were produced by the Big Three auto companies (General Motors, Ford, and Chrysler), there was an unwritten rule that none of the three companies would try to gain market share by making its cars noticeably cheaper than those of the other two.

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But then who would decide on the overall price of cars? The answer was normally General Motors: as the biggest of the three, it would announce its prices for the year first; and the other companies would adopt similar prices. This pattern of behavior, in which one company tacitly sets prices for the industry as a whole, is known as price leadership.

Interestingly, firms that have a tacit agreement not to compete on price often engage in vigorous nonprice competition—adding new features to their products, spending large sums on ads that proclaim the inferiority of their rivals’ offerings, and so on.

Perhaps the best way to understand the mix of cooperation and competition in such industries is with a political analogy. During the long Cold War between the United States and the Soviet Union, the two countries engaged in intense rivalry for global influence. They not only provided financial and military aid to their allies; they sometimes supported forces trying to overthrow governments allied with their rival (as the Soviet Union did in Vietnam in the 1960s and early 1970s, and as the United States did in Afghanistan from 1979 until the collapse of the Soviet Union in 1991). They even sent their own soldiers to support allied governments against rebels (as the United States did in Vietnam and the Soviet Union did in Afghanistan). But they did not get into direct military confrontations with each other; open warfare between the two superpowers was regarded by both as too dangerous—and tacitly avoided.

Price wars aren’t as serious as shooting wars, but the principle is the same.