Question

According to the U.S. Energy Information Administration, the United State, Saudi Arabia, and Russian together accounted for more than 40% of the global oil production in 2019. While the U.S. is the largest oil producer in the world, its production does not have much cost advantage and must import oil from outside to meet its domestic demand. Apply the duopoly or oligopoly model to explaining the oil price crash from the supply shock resulting from the geopolitical conflicts between Saudi Arabia and Russia.

Answer 1

An oligopoly is a market structure in which there are limited number of producers in the market and they have full control over the entire market place. Usually they regulate the prices in such a manner that the profits for each of the suppliers can be maximized. The oil market is one of the key examples of Oligopoly which have always existed and is used by economists for their explanation of the market type itself.

The Oil market is unique in itself because it cannot be replicated. The product being sold is such that it is manufactured and available for only a limited number of countries and on the contrary the global demand for oil products is very high.

The example, of political crisis between Saudi Arabia and Russia are a key example of what happens when price wars start within an oligopoly.

As countries within this market have full access to all customers, they aim for price cuts so that competitors can face tough action and they are the only ones left in the market which would be able to sell the produce itself.

In the Oil market, for dominance these two countries are lowering down the prices by increasing the supply of oil. The resultant is that the overall supply in the market is very high whereas the demand is constant. What this then does is that it limits the price and leads to losses for countries that find it difficult to produce at those levels.

Thus, we can conclude by saying, that the oil price crash has been caused by countries such as Russia and Saudi increasing their overall production levels. This happens as firms try to compete in oligopolies the end result is that the country with the least cost in producing the good has a higher chance of being the dominant player as the oligopoly tends to break apart and change the market type. In that situation, after a point of time one of the countries will have a higher price than other to curtail losses.

Such rivalries destabilize the market and lead to inefficiencies and price volatility over a period of time.