Why do oligopolies often exhibit interdependent behaviour due to market power?

Oligopolies often exhibit interdependent behaviour due to market power as their decisions significantly impact each other's outcomes.

In an oligopolistic market structure, a small number of firms dominate the market, each holding a significant share. This gives them considerable market power, meaning they have the ability to influence the price and other market outcomes. However, because there are so few firms, each one's actions can significantly affect the others. This leads to a high degree of interdependence among the firms.

For instance, if one firm decides to lower its prices, it could attract a large number of customers away from the other firms. This would force the other firms to either lower their prices in response or risk losing a significant portion of their market share. Similarly, if one firm decides to invest in a new advertising campaign or a new product development, the other firms must consider how this could affect their own sales and decide whether they need to respond in kind.

This interdependence can lead to a variety of strategic behaviours. Firms may engage in price wars, where they repeatedly lower their prices in an attempt to undercut each other. They may also engage in collusion, where they agree to set their prices or output levels at a certain level in order to maximise their joint profits. Alternatively, they may engage in non-price competition, where they try to differentiate their products or services in order to attract customers.

The degree of interdependence in an oligopoly also makes the market more unpredictable and volatile. A decision by one firm can set off a chain reaction of responses from the other firms, leading to rapid changes in prices, output levels, and other market outcomes. This can make it difficult for firms to plan for the future and can lead to inefficient outcomes for the market as a whole.

In conclusion, the market power held by firms in an oligopoly leads to a high degree of interdependence, as each firm's decisions can significantly impact the others. This can lead to a variety of strategic behaviours and can make the market more unpredictable and volatile.