Trying To Maintain Rationality

Thursday, February 02, 2006

Oil Industry Profitability

By the way, a couple tenets of efficient markets:

* new firms may enter the market at will (no "barriers to entry," in the econ vernacular)
* prices are determined by market forces (firms can't affect prices; that groovy "invisible hand")

So how is it that oil companies can cut production to protect profitability?

According to economic theory, what *should* be happening right now -- new firms *should* be entering the oil production market, sucking away at the teat of immense economic profits.

Thass no happeneeeeeeen

How come the free market isn't correcting itself? Just something to ponder.

2 Comments:

  • The oil industry is very capital intensive, thus difficult to enter. Economic principles texts teach about the market structure called oligopoly, a structure characterized by a very small population of firms (usually associated with strong barriers to entry, such as capital requirements). Each firm is aware of the others and makes its decisions in anticipation of their likely reactions. If there are few firms, they do not have to (illegally) collude to act in concert, such as reducing output to protect profit margins.

    The standard texts (at least those I have used over the years) eventually acknowledge that economists do not know how pricing and output decisions are made under oligopoly, but it is surely not in the (efficient) manner of the competitive structure.

    One more thing along this line. Count the number of industries that meet the competitive structural requirements, and those that are more visibly oligopolistic. Surely the economy is dominated by the latter. So, as economists are unable to explain their pricing and output decisions, they are unable to explain much of the operation of the real economy. And yet they are looked to as the providers of valuable knowledge about our world. nauretok

    By Anonymous Anonymous, at Friday, February 03, 2006 1:17:00 PM  

  • New firms cant hardly ever enter oligopolies without govt intervention.

    By Blogger Revolutionary Blogger, at Sunday, February 05, 2006 5:43:00 AM  

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