Monopoly, Oligopoly, Monopolistic competition, or Perfect competition - Essay Example

These barriers discourage new entrants in the oil industry as the existing firms can also take them down in price wars. The market for crude oil refining is an example of an oligopoly. Another significant feature of an oligopoly is that it is dominated by a few large firms which also holds true for the crude oil industry. It is dominated by major players like Kuwait Petroleum Corporation and BP (British Petroleum) Corporation etc. Firms in an oligopoly can decide to collude and act as a monopoly or stay as rivals and compete.

When firms in an oligopoly collude, they may agree on prices, market share, advertising expenditure etc. Collusion reduces uncertainty in market regarding prices and since firms do not go for price competition, the total industry profits are not reduced. A cartel like OPEC acts as a single firm or a monopoly and diagrammatically a profit-maximizing cartel can be explained as follows: Since there are few major players, each player exerts significant market power and the bargaining power of suppliers is more than the bargaining power of buyers due to this.

Also because of the interdependency feature, there is a lot of scope for collusion among the firms in an oligopoly. . Each firm’s demand curve is relatively elastic below the existing price line. This entices firms to cut their prices and win over their rival’s customers and increase the total revenue. However the rival’s response to the price cut can act as a hindrance because if rivals match the price cut, there will be very less room for increased total revenue. If a firm raises its price, then its rivals might not copy the price increase and a significant portion of sales will be lost to rivals.

Oil is a commodity that is used as a fuel for transportation, electricity generation, in industries as well as domestically. The world economy at large is dependent on oil and that is how large the demand for oil is. Since there is a cartel in the oil industry, OPEC, the world oil prices have shown an upward trend because OPEC has substantial power to drive up prices. Price elasticity is different in the presence of a cartel because the supply of oil is in the control of OPEC. Under a cartel such as OPEC, the producers try to fix the price and quantity.

The output in an oil industry just like any other oligopoly is allocated as per a quota system (Geoff Riley). The aim of this cartel strategy is to maximize profits. Each individual oil firm is given an output quota. But the output quota allotted to an individual firm might not be at its profit maximizing level (Geoff Riley). The only way an individual firm can make profit out of it is through cheating and going against the cartel. It can supply oil at a price lower than the cartel price. The demand for oil under a cartel is not that responsive or elastic to a price change because oil is an important raw material in many industries and also an essential fuel