Market Structure

The oil industry has proven to be an oligopoly market structure. There is only a few firms dominating where the market is only shared between a few firms and is said to be highly focused and the product is either identical or differentiated. In this case, the product is identical. Even though the firms are only a few, there are also a lot of smaller firms operating in the market. For example, there are Petronas, Shell, Caltex and also Petron but the ease of new firms to enter the industry is low as the set-up costs are very high including marketing and advertising costs and other fixed costs. (economicsonline, 2015)

A firm operating in a market with just a few competitors must take the potential response of its neighbouring competitors into account when making their own decisions. For example, if Petronas as a petrol retailer desires to rise its market share by reducing the price it must be aware that it may be possible if other competitors like Petron or Caltex reduce their price too.

Strategy in oligopoly is extremely important when it comes to being interdependent. Firms can never act independently because they must expect the possible response of a competitor when the price of petrol is changing which means they need to have planning out of the range in guessing the ways competitors will react as the goal of every firm is to maximize profit.

Oligopoly market structure has to make extraordinary and out of the box decision which is whether to raise, lower or keep the price of the petrol constant which is a very risky decision. Besides, they also have to implement new strategy first or wait till the competitors react and adapt to the situation. If there are strategies launched by the competitors, they have to find ways to improve themselves or weaken the competitors by implementing a stronger strategy.

In oligopoly market structure, buying a good in one market and resell it in another market with a higher price is identified as arbitrage and the profits earned is identified as arbitrage profits. (economist, 2011) As people take advantage of different profits earned in two different market, the supply and demand will eventually change accordingly. For example, Saudi Arabia is one of the cheapest oil producer. The gasoline market in Brazil will start buying the gasoline in Saudi Arabia and ships it to their own country and resell it at a higher price. Thus, earning an arbitrage profits. If arbitrage occurs, the demand and supply of gasoline in the two different countries will totally differs. If the gasoline in Saudi Arabia is cheaper, the demand of the goods will increases whereas the demand of the gasoline in Brazil will decreases as people tend to choose for the best price. If the transport fee is completely free from transporting gasoline from Saudi Arabia to Brazil, the price will be expected to be the same in each location. This is identified as “law of one price”. There is also transaction costs where the resources and time incurred in the process of exchanging a goods or services. If the transaction cost are zero and the reselling of the goods is possible, the law of one price will be hold perfectly.

In a nutshell, oil industry has an inelastic demand and categorized as oligopoly market structure and the implementing of price ceiling will cause excess demand or supply shortage.