Price or rise in its price.'(BusinessDictionary.com. (2017)) When the

Price elasticity of demand is a way in which we can
measure how responsive the quantity demand of a good that is proceeding a
change in price. The formula for price elasticity in demand is the percentage
change in quantity demanded divided by the percentage change in price. By using
this formula any business can find out how a change in price can affect the
demand for their goods.

‘Inelastic
is a situation in which the demand for a product does not increase or decrease
correspondingly with a fall or rise in its price.'(BusinessDictionary.com.
(2017)) When
the supply curve shift to the left the price increase while the quantity
decreases. This is because the prevention of surplus at a certain price,
restricts OPEC (Organisation of Petroleum Exporting Countries) group by coming
on agreeing with an amount. The decrease in output was only relatively small
because the short-run for demand for oil was highly inelastic. The situation is
desirable because price and total revenue are directly related therefore an
increase in price increases total revenue despite a fall in the quantity
demanded from the supplier’s point of view. An example of a product with
inelastic demand is oil. Oil is an essential scarce of non-renewable resource. The
reason why the demand for oil is relatively inelastic is because it has few
substitutes and there are still no cost effective alternatives to oil for
producing fuels like petrol and diesel.

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OPEC’s produces
and controls a large amount of the population’s oil. In Figures 1 shows how prices
climbed up rapidly in the 1970’s, soaring from about $5 a barrel in early 1973
to over $35 a barrel in 1980. After oil prices shot up in 1973 because of the
political chaos
in the Mideast, OPEC decided to cut production. As a result firms began
shifting to less energy-intensive ways of manufacturing goods and services making
demand inelastic.

 

 

 

 

 

 

 

A
cartel is a group of producer firms that agree among themselves to act as if
they were a single seller to protect their interests. They are created to, so
producers can cooperate with the aspects of their market. The cartels then set
fixed prices for members, so competition price is avoided. They can also
restrict output released onto the market, e.g. OPEC and oil production, this is
due to the members agreeing to limit output onto the market to meet their oil
quotas. They set these rules and regulation in the oligopolistic market to
govern the behaviour of the other members. Competitive behaviour among
oligopolists may lead to a non-cooperative equilibrium.

To increase their market power “the cartel is able
to behave live a monopolist” (Cliffsnotes.com. (2017)). For example, when a
firm in an oligopoly sells oil the demand curve will be horizontal at the
market price. However, the oil firms in OPEC determine their output and price
making a downward sloping demand curve, like a monopolist. OPEC’s profit?maximizing
result is the same as that of a monopolist, as figure 2 shows. The members in
OPEC chose their combined output at the level where their combined MR (Marginal
Revenue) equals to their MC (Marginal Cost). OPEC’s price is determined by
market demand curve at the level of output, while the area labelled from a to b
in the rectangular box represents that OPEC’s profits are equal

 

 

In the
short-run profits are maximised when MC=MR with other market structures. Figure
3.1 suggests it’s also for monopolists, apart from the AR and MR curves shows
that it will be more elastic. Figure 3.1 also shows that the firm is earning
economic profits. The equilibrium point for the firm is at price Ps and
quantity Qs and is shown by the 2 yellow dots. The area Ps, ACs and the 2
yellow dots are given as the economic profit. The strength of demand depends on
how much profit the firm makes which change the positioning for elasticity of
the demand curve. ‘the further to the right the demand curve is relative the AC
curve, the less elastic the demand curve is’ (Sloman, J., Garratt, D. and
Hinde, K. (2013)) therefore firms short-run profit will be greater. ‘Fresh entry will continue to enter as long as there
are profits’ (BDON.
(2017)). As soon as the super normal profit is competed away by new firms,
equilibrium will be attained in the market and no new firms will be attracted
in the market.

 

In the
long-run under monopolistic we can tell in Figure 3.2 that LRAC is the long run
average cost curve and LRMC the long run average marginal curve. We can assume
that other firms are making profit in the market, in situation like this new
firms can be attracted to the market. They will be able to sell similar
products but not the exact same products like the other firms. As long as there
are economic profits the entry of new profits can continue because the outcome
shows there will be an ‘increase in the number of close substitutes available
in the market and hence the demand curve would shift downwards’ (BDON. (2017)).
in a monopolistic market there’re no barriers to entry exist in a monopolistically
competitive market hence why it’s easier for new firms to enter the market in
the long?run. In Figure 3.2 monopolistically competitive firm’s long?run
equilibrium situation is illustrated. If the firm’s economic profits are zero
there will no longer be any reason for new firms to enter the market. Thus in
the long?run, ‘the competition brought about by the entry of new firms will
cause each firm in a monopolistically competitive market to earn normal profits’
(Cliffsnotes.com. (2017)), just like a
perfectly competitive firm.

 

OPEC
has a large share of the market and entry by competitors is slow. Moreover, in
some periods, price has increased substantially. These factors support a monopoly.
On the other hand, the cartel agreement appears to break down regularly,
resulting in prices below the profit-maximizing level. The positive thing is when
firms do this (i.e. maximise collective
profit), they practise monopoly pricing and get monopoly profits. This means
the simple monopoly model is enough. The
negative could be that practise is illegal in most countries. Also,
there is an incentive to cheat. So usually, firms will not cooperate, and a
more complex model is needed.

 

Overall
in the short term the demand for oil is inelastic while in the long term for
oil, the demand will become more price elastic due to the fact that people will
start looking for alternative resources. A simple solution for the market price
and quantity is possible if the firms decide to cooperate. To protect each and
every single one of their interest, a cartel group like OPEC needed to set fix
prices, rules and regulation so producers can cooperate with the aspects of
their oligopolistic market to avoid competition from other competitors. Cartels
can cooperate which can lead to cooperative equilibrium and monopoly profit. If
they don’t cooperate it can lead to non-cooperative equilibrium therefore the
monopoly profit will be lower than the previous one. Firms in perfect and monopolistic competition engage in
non-strategic behaviour, which means they make decisions based on their own
costs and their own demand curves without considering any possible reactions
from their large number of competitors.

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