OPEC can be described as an oligopoly for several reasons. It fits with the condition of being dominated by more than two large firms; in this case it's eleven. It also practices price rigidity as they agree on both level of output and therefore the price of oil is influenced by the agreement of a certain supply. The goods they provide are also homogenous. In oligopolies firms also don't choose to maximise profits, and this can be clearly shown in the OPEC case as they aim was to "secure fair and stable prices for producers, and ensure an efficient and regular supply of oil".
There is also barriers to entry which is described in the case study which states that the oil industry has "high fixed costs and risk" associated with it, this Is another characteristic of an oligopoly. It can be argued however, that it is also a monopoly. This is due to the fact that OPEC has 60% of control over the oil that it traded internationally. Usually, a monopoly is classified as anything which has a market share of over 25%, OPEC has almost triple that which suggests it may be a monopoly.
However, due to the fact it doesn't price discriminate and aims to "secure fair and stable prices for producers, and ensure an efficient and regular supply of oil", suggests it can't be a monopoly. Also, the fact that a cartel is made and decisions are made on the level of output clearly suggests that OPEC doesn't have total price control. So, in conclusion OPEC is an oligopoly as it fulfils most of the conditions which classify an oligopoly. Q2. Explain the economic logic behind OPEC's decision to reduce output. Due to the price elasticity of demand being relatively low for oil, it means that OPEC has a product which is relatively inelastic.
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This is due to the fact that it has no close substitutes and if fairly necessary for many countries day to day running. This means by restricting the supply, they won't affect demand too greatly due to the fact that the product is inelastic. OPEC can manipulate prices more now with lower risk due to the price elasticity of the product. In recent events, the price of oil has been on its lowest for years, this could be due to the fact that the war in Iraq has opened up new opportunities which would increase world supply and therefore reduce prices, and that's what has happened to today's oil prices.
Q3. What factors may reduce the demand for OPEC oil over time? Due to recent changes and improvement in technology, it may be that the previous barriers to entry such as high fixed costs could be reduced and mean that the market would open up to new entrants into the market. There could also be an improvement in technology which would reduce overall energy consumption fuelled by oil. For example, more and more people especially in this part of the world could use solar energy more often. This would have an adverse affect on the demand for oil.
In the near future more substitutes would be created for oil, with even oil companies such as Shell having specific research departments to deal with alternatives for oil. The introduction of the electronic car in the last ten years has meant that people do have alternative to using petroleum run cars, if these cars were made more widely available and more appealing to all customers in the near future, this would certainly reduce the demand for oil specifically in western countries as they are the ones which consume the most oil.
A reduction in the demand for oil could be due to an economic downturn; however this would only be in the short term due to the economic cycle. There could be an increase production of oil from a non-OPEC supplier, which could mean that OPEC's demand would drop as a competitor drops their prices. As the products are homogenous and no such branding on consumers, people will simply chose the oil with the lower price. Q4.
How can the oil companies boost their profits if they have little control over the market price? They could increase their profit margin in the short run and this would boost profits temporarily, however this may be difficult as this has to be agreed with the other members of the cartel, and in the long run this would have a negative impact on the long run as they would be sanctions from OPEC and fines if the prices are increased simply for boosting profits.
Companies could ensure they achieve a boost in profits by controlling retails outlet of fuel and petrol and offer a wide range of convenience goods, this would ensure a wider product range a new market for them which would boost profits due to the volume of goods sold rather than the profit margin itself. OPEC and other oil companies could announce future cuts in output which would reduce supply, and won't affect demand as much due to the inelasticity of oil.
Due, to the eleven members controlling 100% of the market prices, consumers would have no choice but to purchase the oil at that price. This would work in the short term, however in the long term their would be sanctions from one of the superpowers demanding lower prices, USA also have a new supply of potential oil which has been achieved through the overthrowing of Iraq and if required their Alaskan reserve could be drilled into for oil.
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