How do oligopolies establish prices and output for the purpose of maximizing profits?
Oligopolies can be either good or bad for the consumer, depending upon whether there is active collusion with regard to production and pricing strategies, which go hand in hand. For purposes of this discussion, the focus will be on the negative consequences of oligopolies being allowed to develop.
Oligopolies by definition represent a small number of producers of a certain category of goods or services. Ideally, their small number creates a more intense competition that results in lower prices and higher quality goods -- the consumer's dream. When those producers succeed in coordinating their production and pricing schedules, however, the consumer suffers. Because of the fundamentals of market economics -- i.e., supply and demand -- instances where oligopolies conspire to fix prices for the purpose of maximizing profits involves agreement among the companies to limit production so that it remains well-below demand. In a free market system, when supply falls short of demand, prices increase. When prices increase despite a drop in production costs, profits increase.
In the United States, the government monitors the evolution of certain industries closely to guard against the development of oligopolies or monopolies. Because oligopolies can be difficult or impossible to prevent, however, the government monitors their activities for signs of collusion. When it determines collusion is occurring, it takes legal action against the offending companies.
Internationally, the dynamics are more complex, as the most important oligopoly in the world has demonstrated. The Organization Petroleum Exporting Countries (OPEC) is the ultimate example of an oligopoly in practice. OPEC, which represents most major oil producers, seeks to set global oil prices through control of the means of production. Because it involves a number of sovereign countries, the rest of the world has had to live with its control of vast amounts of the global oil supply. Fortunately, OPEC members frequently disagree about production limits, and some countries have been known to cheat on quotas, which benefits the consumer.