The Concept of an Oligopoly in the Modern World - Essay Example

Business Economics Assignment 1- Explain with reference to average costs, why the market for cars in the European Union is dominated by oligopoly rather than perfect competition An oligopoly is "a market in which control over the supply of a commodity is in the hands of a small number of producers and each one can influence prices and affect competitors". Such a situation goes quite contrary to the situation of Perfect Competition where no producer or consumer has the market power to influence prices. Average cost is the total cost divided by the number of units produced. Before I go further I would like to clarify that firms maximize profits by considering the marginal cost, not the average cost. Secondly as the figure below illustrates (diagram is courtesy of wikipedia) the demand curve in an oligopoly will be a "Kinked" demand curve which may be similar to the traditional demand curves in the Perfect competition, as they are downward-sloping but it will have a kink or a bend. In relation to costs it shows that in an oligopolistic market firms will not raise their prices because even a small price increase will cause them to lose many customers and at the same time a large price decrease by the owners will gain only a few customers because such an action will begin a price war with other firms. The curve is therefore more price-elastic for price increases and less so for price decreases. In a kinky demand curve as in an oligopoly marginal costs could change without necessarily changing the price or quantity. Being an Oligopoly the EU car market will be experiencing an average cost curve that will represent benefits from substantial economies of size. These firms have actually become large and powerful and with the increased output they have low processing and operating costs. The EU car industry clearly has just a few ruling firms in the industry which will be watching each others pricing and output strategies very closely. Moreover it should be noted that the EU car industry might actually be benefiting through its oligopolist structure(although the practice of price discrimination cannot be applauded).The car industry has to maintain its factories and pay its workers regardless of the amount of output /cars it produces every year. They can probably not afford a perfect competition situation where there would be price competitions and losses which would have an adverse effect on the safety and quality of the cars. This diagram shows that the car industry being a technically differentiated oligopoly(different types of cars) produces at a profit maximizing level of output where marginal cost equals marginal revenue. The firm finds the price it will charge customers at the profit maximizing level of output (Qm) from the demand curve, and sets price to Pm. As we can see, the firm is earning economic profits since price exceeds the average costs at the profit maximising level of output. Now coming back to the issue the question addresses , it is a fact that for many years there is large scale price discrimination in the European Car Market. For example figures show that in 2001the pre-tax price of a Mazda 323 was 10,525 in the UK ,7,404 in Greece and 6,266 in Denmark ( European Commission, July 2001. )This has largely been blamed upon the fact that the European Car Industry is exempt from European competition law. .This situation has allegedly led to a rather oligopolistic arrangement by the persons involved in the car industry as they operate a rigid network of national or regional dealers which are chosen by car manufacturers, to flourish. Allegedly this is also where British car buyers have been particularly discriminated against. The European Car market is not a freely competitive market. As an oligopoly then the EU car industry experiences downward sloping long run average cost curve. The tactic that this industry uses is to increase profits by expanding output and/or merging to take advantage of economies of scale. As a result the average costs fall because marketing costs are reduced through shared advertising and shared research and development strategies. This is totally the opposite of average costs in perfect competition as each firm is on its own there. As oligopolies they utilise a number of tactics to control their average costs and as large enterprises they have the advantage of higher debt capacity and ability to withstand the risks of cyclical downturns. Moreover in perfect competition the price is directly influenced by a firm's average costs. The average costs of a firm will determine the price of its product. But the EU car industry is a rather cleverly devised monopoly. Any major car producer who tries to sell above or below the price will suffer and even the car dealers feel penalised if they try and sell the cars below the monopoly price. In many cases it can also be seen that the competition is non-price competition. There is less of a price war which generally oligopolies do not afford (as it often culminates into cut throat pricing which is lethal for profits) and more of a move towards brand loyalty by the producers. In conclusion the lack of tougher competition laws acting against predatory oligopolies like that of the EU car industry will open these markets to more competition. Currently new laws are underway to avoid cartel type behaviour in the predominantly oligopolistic EU car industry. This will prevent them from exploiting through price discrimination .More importantly the abolition of block-exemption for car dealerships within the EU should also help to make the retail car market more contestable in the UK in particular and may help to bring down further the prices of new cars. ________________________________________________________________ Use supply and demand econmic theory to explain why the real price of oil is currently so high The question requires the reason for the real price of oil to be so high. Oil prices are currently heading towards and exceeding $90 a barrel and there is speculation that this has something to do with the falling value of the dollar. Since the question requires a discussion of real prices therefore the following discussion concerns the involvement of supply and demand in the oil price hike. The difference between nominal price and relative or real price is that nominal price can be quoted in monetary terms but the real price ignores the effects of inflation or of the depreciating dollar currency in this case. The diagram below shows the predicted oil increase in the coming months. Crude Oil Price Forecast West Texas Intermediate Spot Price. USD/bbl. Average of Month. Nov 2007 Dec 2007 Jan 2008 Feb 2008 Mar 2008 Apr 2008 Forecast Value 89.4 81.5 78.0 73.7 73.1 50% Correct 2.1 2.6 2.9 3.2 3.4 3.6 80% Correct 3.5 4.3 4.8 5.3 5.6 5.9 Updated Wednesday, November 14, 2007 In the oil market both demand and supply are highly inelastic as there is no real substitute for it. For example ships and airplanes cannot move from diesel oil and kerosene for their fuelling needs. Oil is needed for home heating requirement as well as industry use. Scientists have attempted tirelessly to create solar and CNG run cars and there has been an attempt to harness nuclear power at all levels of the industrial use. However such a change needs much more scientific research work to be done and until then oil will dominate industrial and transport usage. The short-term demand curve for oil therefore would look like the following diagram which shows that a large change in price has a small impact on demand. As far as the supply of oil is concerned it is also relatively inelastic not because the crude oil itself is expensive but the costs of refining and the associated infrastructure that has to be put in place. The very maintenance of these is very expensive as the oilfields will cost roughly the same to operate whether or not it is being fully utilised. As a result e small changes to the supply or demand curve cause large changes to the clearing price of oil. As an example in 1973 because of US support for Israel the OPEC cartel announced that it would boycott the US, and would restrict its overall oil output. This situation affected the supply curve because the OPEC was a major oil producer. In other words, for any given price level, there would be less oil supplied.Another factor of oil prices fluctuating may even be natural causes like the Hurricane Katrina which affected production in the Gulf of Mexico and caused the supply curve to shift to the left and a subsequent price increase. Crude Oil Prices: The diagram shows the likely effect of the decreasing demand and supply factors on the real oil prices The rise of emerging markets has also increased the demand for oil to meet their industrial needs. The diagram below shows that at any given level of price, more oil is demanded and the price increases.However in this regard it should be noted that the long term dynamics of oil demand and supply are indispensable to this analysis. In the long-term oil demand and supply are very much elastic. A short term disaster may change consumer behaviour but if long-term expectations for oil prices rise, then both the demand and supply will be affected After the 1970's fuel crisis America encouraged fuel efficient cars and certain speed limits. Also electricity generators chose to build nuclear or coal-fired power stations rather than oil-fired ones. Moves towards energy efficiency and towards alternative power sources are slow to ramp up, but their effect on the demand curve cannot be over-stated. There have been moves to utilise nuclear and solar power as well. When the oil prices rose in the 1970s they spurred investment in exploration and production in areas that had previously not been cost efficient. After the Saudis banned the oil supply of the US other sources were explored as a result of which the oil supply curve moved to the right. The impact of a supply curve that moved right (more supply at any given price), and a demand curve that moved left (less demand at any given price) was a collapse in the market clearing price. By 1985, the real oil price had fallen down as compared to 1973. In conclusion the real oil prices are affected by the supply and demand in the short term but in the long term many other factors take over. These factors involve consumption trends and investment in far off areas fro the purposes of finding news supplies of oil. There is not just one answer to the reasons behind the rising real oil prices. This has become an issue much influenced by war and politics..Much of this has to do with the current Middle East situation.Furthermore some of the implications of the recent Iraq and Afghanistan war involve the changing control of the oil supply which will increasingly be in American hands.However for the time being the real price will increase following other factors like the falling dollar and inflation.Todays supply of oil seems less to do with demand and supply factors despite the ones pointed out above and more with extraneous circumstances.It should be noted that there are new oil bases being explored in Asia currently and once their supply enters the market the OPEC cartel will be facing an entirely new challenge. _____________________________________________________ Bibliography 1. Static Models of Average-Cost Pricing ,C. E. Ferguson,Southern Economic Journal, Vol. 23, No. 3 (Jan., 1957), pp. 272-284,doi:10.2307/1054217 2. http://209.85.129.104/searchq=cache:oLHdNvxojZcJ:intranet1.sutcol.ac.uk:888/NEC/MATERIAL/PDFS/ECONOM/A2_ECO/07U4_T3.PDF+eu+car+market+average+cost+and+oligopoly&hl=en&ct=clnk&cd=10&gl=uk 3. March 2006, Vol. 4, No. 1, Pages 216-251,Liberalizing A Distribution System: The European Car Market,Randy Brenkers and Frank Verboven 4. http://www.theoildrum.com/node/2899 5. Economics Explained ,Maunder Peter Collins, Revised Third Edition 1995 ________________________________________________________________ Read More