What is an oligopoly? How does oligopolistic firms' interdependence shape the firms' behavior? What problems does this raise for public policy?

An oligopoly is a market form that is similar to a monopoly in terms of market power but also competitiveness. This implies that the market is shared between two or multiple, but very few firms. These firms are very dominant and set high prices or supply by considering themselves as monopolies (Cournot and Bertrand models). However, the competition among them is very stiff for supply and dominance in the market.

Each oligopolistic firm is interdependent on the other. They are cut-throat rivals until they collaborate. Suppose if firm 1 thinks of supplying say Q1 output, firm 2 would respond by supplying (1-Q1) if 1 is the whole market output. Again, if firm 2 supplies more than earlier, it will reduce the output of firm 1. Firm 1 would try to supply more by using some other tactic. This way they are interdependent for determining their strategies on what their rival is doing.

Through these rivalries, oligopolies also create some problems for public policies. The major problem is the forming of cartels secretly to skip taxes. Sometimes, few oligopolies realize they can earn more profit through collaborating and creating one cartel which would then behave as a monopoly. This creates regulation issues for policymakers.

Another problem is the inefficiency created. Due to dominance, the oligopolies may create pollution-like social costs and market inefficiencies. Oligopolies also try to block new entering firms.