Firms fail to operate at their efficient level due to economies of scale and scope. The functioning of economy under oligopoly can be understood in the following manner.
1. Market Mechanism under Oligopoly:
Under oligopoly, prices are determined through oligopolists rather than demand-supply forces.
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Even then, oligopoly firm is influenced by market variations and reacts. In the event of rise in input prices and consequent upward movement of cost curve, oligopolist will reduce production and raise price.
But, in the event of rise in demand, increase in production is always possible. However, rise in administrative prices is an uncertain event. According to Lipsey, the market system reallocates resources in response to changes in demand and costs in roughly the same way under oligopoly as it does under perfect competition.
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2. Profit under Oligopoly:
Joint profits are maximised, when firms have cooperative behaviour, while individual profits are maximised under competitive behaviour. In the short run, oligopoly firm compete so intensively that they came closer to achieve competitive price and output. In the long run, oligopoly firms may earn profits till they are able to restrict the entry of potential entrants effectively.
3. Economic Growth under Oligopoly:
Schumpeter propounded the theory of creative destruction as an explanation of long-run growth of an economy. Oligopoly firms face strong competition from existing rivals and so to technological innovations. The new innovations are key to growth in the long run. New products are developed and new uses of existing products are explored. In this way, a variety of products of superior quality are made available to the consumers at competitive rates. Thus, oligopoly can be improved upon through competition rather than collusion.