At the time of that elaborately bugged meeting, no one company controlled the world lysine industry, but there were only a few major producers. An industry with only a few sellers is known as an oligopoly; a firm in such an industry is known as an oligopolist.

Oligopolists obviously compete with one another for sales. But neither ADM nor Ajinomoto were like a firm in a perfectly competitive industry, which takes the price at which it can sell its product as given. Each of these firms knew that its decision about how much to produce would affect the market price. That is, like monopolists, each of the firms had some market power. So the competition in this industry wasn’t “perfect.”

Economists refer to a situation in which firms compete but also possess market power—which enables them to affect market prices—as imperfect competition. As we saw in Chapter 13, there are actually two important forms of imperfect competition: oligopoly and monopolistic competition. Of these, oligopoly is probably the more important in practice.

Although lysine is a multibillion-dollar business, it is not exactly a product familiar to most consumers. However, many familiar goods and services are supplied by only a few competing sellers, which means the industries in question are oligopolies. For example, most air routes are served by only two or three airlines: in recent years, regularly scheduled shuttle service between New York and either Boston or Washington, D.C., has been provided only by Delta and US Airways. Four firms—Kellogg, General Mills, Post, and Quaker—control 85% of the breakfast cereal market. Three firms—Apple, HTC, and Samsung—control 65% of the smartphone market. Most cola beverages are sold by Coke and Pepsi. This list could go on for many pages.

It’s important to realize that an oligopoly isn’t necessarily made up of large firms. What matters isn’t size per se; the question is how many competitors there are. When a small town has only two grocery stores, grocery service there is just as much an oligopoly as air shuttle service between New York and Washington.

Why are oligopolies so prevalent? Essentially, oligopoly is the result of the same factors that sometimes produce monopoly, but in somewhat weaker form. Probably the most important source of oligopoly is the existence of increasing returns to scale, which give bigger producers a cost advantage over smaller ones. When these effects are very strong, they lead to monopoly; when they are not that strong, they lead to an industry with a small number of firms.

For example, larger grocery stores typically have lower costs than smaller ones. But the advantages of large scale taper off once grocery stores are reasonably large, which is why two or three stores often survive in small towns.

If oligopoly is so common, why has most of this book focused on competition in industries where the number of sellers is very large? And why did we study monopoly, which is relatively uncommon, first? The answer has two parts.

First, much of what we learn from the study of perfectly competitive markets—about costs, entry and exit, and efficiency—remains valid despite the fact that many industries are not perfectly competitive. Second, the analysis of oligopoly turns out to present some puzzles for which there are no easy solutions. It is almost always a good idea—in exams and in life in general—first to deal with the questions you can answer, then to puzzle over the harder ones. We have simply followed the same strategy, developing the relatively clear-cut theories of perfect competition and monopoly first, and only then turning to the puzzles presented by oligopoly.