Oligopolies set their prices primarily through strategic interactions among the few firms that dominate the market. Unlike in perfect competition, where prices are set by the forces of supply and demand, firms in an oligopoly must consider the potential reactions of their competitors when making pricing decisions.
Typically, oligopolistic firms engage in a practice called price leadership. In this scenario, one firm, often the largest or most dominant one, sets a price point that other firms in the market follow. This helps maintain stability within the market, as firms avoid engaging in price wars that could hurt all participants.
Additionally, firms may employ collusion, either explicitly or implicitly, to coordinate pricing strategies. In explicit collusion, firms may form agreements to set prices at a certain level, but this practice is illegal in many jurisdictions. Implicit collusion occurs when firms observe each other’s pricing behavior and adjust their own prices accordingly without a formal agreement.
Other factors that influence pricing in an oligopoly include the level of product differentiation, the elasticity of demand, and market conditions. Firms would also closely monitor costs, consumer preferences, and regulatory environments to make informed pricing decisions.