The system was supposed to bring stability by keeping exchange rates between currencies fixed. This would be achieved by ‘pegging’ each currency to a reserve currency. At the request of the US and also because of the reason that it was a dominant economic and military power, the US Dollar was made the reserve currency. From the bottom of the chain, each currency was ‘pegged’ to the US Dollar and 1% variation on each side was allowed. US Dollar was pegged to Gold at $35 per ounce. The US government committed to exchange dollars for gold at that rate, which along with the strength and credibility of the US economy made the dollar as good as gold. This eliminated the problem which was faced by the Gold Standard System since printing money was much cheaper than finding and mining limited gold resources.
Fixed exchange rates were supposed to encourage and stabilize world trade. The International Monetary Fund consisted of a fixed pool of national currencies and gold. Its aim was to manage individual trade deficits so that no deflationary pressures for any currency would arise. If a country experienced a current account deficit and was short of reserves it could borrow from the IMF. Should a fundamental economic disequilibrium arise in any country it was allowed to adjust its currency value by 10%. Such action would be carried out by the IMF through an international agreement.
The World Bank (The International Bank for Reconstruction and Development) was mainly supposed to speed up the recovery of world’s economy after the war. It had a capitalization of $10 billion and was supposed to loan this money in order to achieve its goal.
After the war, US were running huge balance of payments surpluses. Since the dollar became the reserve currency there arouse an immense need for it to flow out of the US economy. This had to be done since the world economy suffered from a tremendous dollar shortage. Policymakers alerted the natural state of things and created US balance of payments deficits. This was carried out through the creation of credit facilities and grants to the recovering Europe.
In general Bretton Woods attempted to create stability by making the US utilize the dollar-gold peg to trade with developing countries for a profit and then using this profit to fund European and Japanese recovery. These economies, growing on the inflow of US dollars, would then sell their products to the US and then buy from the developing countries. This triangular trade system reinforced US as the main country responsible for financial stability.
Bretton Woods achieved its aim of promoting world trade and encouraging the post-war recovery.
Collapse of the system Bretton Wood system was a good short run solution for the international monetary system. However, in the long run it was programmed to collapse based on many weaknesses that the system consisted of.
A major weakness of the Bretton Woods system was the dependence of the United States’ ability to maintain a balanced ratio between its outstanding liabilities and gold stock. If the United States’ outstanding liabilities exceed its gold stock, it would lead to the fear of the depreciation of the dollar value and thus affect the reverse values of those countries that fixed its exchange rate with the dollar. On the other hand, if U.S. deficits were eliminated, the world would be deprived of its major source of reserve growth, with depressing effects on world trade and economic activity. (Robert, p32). In 1953, U.S. gold reserves exceeded foreign liabilities by three-fold. But dollarization of the world economy proceeded apace and the liability/gold ratio became equal by 1964 as the United States inflated its money supply and exported dollars overseas. By the time President Nixon took office in 1969, debt attributed to the Vietnam War effort reversed the monetary position of the United States. By 1970, foreign liabilities were five times greater than gold reserves. By 1960 the Bretton Woods fixed exchange rate system came under pressure when gold traded above its official dollar peg of $35 an ounce on the London gold market.
A second weakness of the Bretton Woods system was the balance of payments adjustment process. When an individual country encountered deficits, the problem was dealt with on an individual basis by providing credit, usually through the Fund, rather than reviewing if the balance of payments policies and the aims of individual countries were compatible with each other and with a stable international monetary system. (Robert, p32).
A third weakness, which was the failure of the system to cope with large unequilibrating capital flows. Both France and Britain had experienced major speculative outflows in the 1950’s; furthermore, it was becoming evident that interest rate differentials could induce sizable movements of capital. The Fund’s Articles had assumed that controls would suppress such flows but in the reality, it is not possible for most of countries to control capital flows without controlling all international transactions. Leads and lags in commercial payments had already shown up as a potent disequilibrate force.
However, as the U.S. external deficits increases, the demand on dollar started to exceed the U.S. gold stock, and thus it ultimately undermined the ability of the U.S. to maintain the exchange rate between the dollar and gold at the rate of $35 per ounce. For instance, in 1960, the value of U.S. gold stocks at the official parity of $17.8 billion fell short of the $18.7 billion of outstanding liquid foreign dollar claims. To avoid changing the dollar parity, many different measures were implemented to overcome the shortage of dollar. For instance, in 1967, the IMF created a facility called “special reserve drawing right” (SDRs) in the Fund to provide an alternative to the dollar in countries’ reserves. The SDRs were implemented to create accounting entries in the IMF accounts to settle payments imbalances between members. Furthermore, the IMF also introduced new methods of calculating the U.S. balance of payments on the basis of liquidity balances.
Despite all these efforts to safeguard the system, the gap between international claims on dollar and U.S gold stock continued to widen. For instance, U.S. gold stocks by 1971 had fallen to just over $10 billion against outstanding claims of more than $60 billion. Since, the dollar was tremendously overvalued in comparison to gold, in 1971 gold was allowed to float. Nevertheless by then the international community lost its faith in the US ability to control its balance of payments deficits and as the gold appreciated more and more countries withdrew from the fixed exchange rate agreement. Ultimately in 1973 the Bretton Woods market collapsed and a floating exchange rate regime was implemented.
Reasoning on the discussion of the introduction of the new version of the system Discussion is common on the proposal to reintroduce a new version of Bretton Woods System. Bretton woods System is perceived by many to have achieved its intended mandate after its formation in1944 (Bordo
Opecs oligopolistic market and effects on oil prices
The main focus in this essay is to explain the characteristic of the Oligopoly Market Model and explain how the dynamics of the Oligopolistic market can influence the price of a product and different strategies used by firms together to create an inelastic demand for the product to optimize profits
The second part of the essay concentrates on how OPEC as organizations has control on the world’s Oil prices. Different scenarios are enumerated in the following report, where OPEC has used strategies to control the market and capitalized on the Oligopoly model
TABLE OF CONTENTS Sr. No. Particulars Page No. 1.
2. Introduction 4 3.
Characteristics of the Oligopoly Market Model
Analysis on how OPEC as an Organization manipulates the World’s Oil prices
Recent news on OPEC and its control on oil production , whilst the instability in Middle East and the African region
Reference list / Bibliography
Introduction: Microeconomics entails the economic activity of consumers, producers or group of producers and consumers and the market in which they interact. It is study of buyers, sellers, prices and profits. Market economy refers to the developed and the industrialized economies in the world. Market economy is in which people specialize in the production of array of goods and services and meet their food and material needs through exchange (http://www.referenceforbusiness.com/encyclopedia/Man-Mix/Microeconomics.html)
Market economies can vary based on the supply and demand and it is the best determinant to analyze the Market. While most of the developed nations can be classed as having a mixed economies because they allow market forces to drive most of their activities like the government interactions in order to provide stability. (http://www.investopedia.com/terms/m/marketeconomy.asp)
There are a number of market structures like: Perfect Competition Model; Monopolistic Model; Monopoly and Oligopoly with each having their own characteristics for the economists to understand why each business behaves differently in that market. However the objective of this assignment is to understand what happens in Oligopoly market structure.
The latter part of the assignment, we are going to analyze how the OPEC is acting as oligopoly in the petroleum industry and the impact it has on the oil prices and how it has impacted the economy of the world.
Analysis OF Oligopoly MARKET MODEL An oligopoly is a market dominated by a few producers, each of them has control over the market. The word ‘Oligopoly’ is derived from Greek words oligio, meaning ‘few’ and polein, meaning ‘to sell’. The few leading dominant firms have a high level of market concentration in the Oligopoly structure. Oligopoly is best defined by the behavior of the firms within a market than its market structure. Generally an oligopoly exists when the few leading firms have nearly 60% of the market share and when the demand is inelastic and accounts for the maximum sales.
Few Characteristics of an oligopoly Although there is no definite method to predict how firms determine the price and the output in Oligopoly, but generally an oligopoly exhibits the following features:
Product branding: Each firm in the market sells a differentiated product and has its own niche in the market.
Entry barriers: There are significant entry barriers for smaller firms in an oligopoly market, which prevents the dilution of competition in the long run and maintain enomorous amount of supernormal profits for the dominant firms. Smaller firms generally operate on the periphery of the market, but is not significant enough to make the impact on output and market prices.
Interdependent decision-making: Dominant firms collude with each other and determine the price and taken into account the reaction of their rivals to change in market price or output
Non-price competition: Non-price competitions are a consistent characteristic of the competitive strategies of oligopolistic firms.
There are two types of Oligopoly namely collusive and un collusive oligopoly. In collusive oligopoly, Firms directly collude with each other and forms cartels to have a control on the market price. In Tacit collusion, firms have a mutual understanding to cut out competition. Price leadership is where the dominant firm has the power tro change the price and then the rest of the market follows suit. In un-collusive oligopoly Game Theory is used where the firm makes a strategic decision to either make immediate profits or destroy the rivals market share, which in turn has a huge effect on the market.
Diagram of the firm and the Market in an Oligopoly http://rds.yahoo.com/_ylt=A2KJkK4Us69NsmAABdKjzbkF/SIG=122htrmi5/EXP=1303389076/**http:/www.foolonahill.com/mbaairoligopoly.jpg
The Kinked Demand Curve Theory: Paul Sweezy, an American, developed the Kinked Demand Curve Theory in the late 1930s. Normally in an oligopoly market the firms are in consensus to maintain a standard and constant price of the product, which creates inelastic demand and generates supernormal profits. If a firm decides to increase its price, without colluding or collaborating with the other dominant firms, the other firms in the market decides retain the same price. In this case the firm that has increased the price will soon lose its market share and a considerable amount of revenue. On the other hand, if that firm in the oligopoly market decides to lower its price, the other firms in the industry too will have to do the same to retain their market share and then all firms will lose its revenue. It is then better to remain at a constant price to avoid losing revenue or market share. This is what Price Rigidity means. If there is a change in the price , the demand curve will kink around the prevailing market price as it will undergo further stabilization of the price when the firms will take care of the changes in the cost. In the figure shown below, the MR curve is discontinuous because at ‘a____b’ there will be no change in demand as the production and the price is the same. When the cost increases, the marginal cost curve moves upward from MC 1 to MC 2 and the demand curve kinks. Thus the firm can maximize profit only at price P and quantity q.
Dollars per unit MC2 p Kink curve MR¢ MR D D¢ MC MC1 b a q q/t 0 The kinked demand curve model predicts periods of relative price stability under an oligopoly and businesses will focus on non-price competition to reinforce their market position and to boost sales , revenues and profit.
The importance of non-price competition under oligopoly Non-price marketing strategies have two separate aspects :
Product differentiation strategy is used by firms to convince the buyers their products are different from those of competitors.
Product variation strategy involves in creating minimal variation to the product to attract buyers
Non-price competition also involves huge amount of advertising and marketing strategies like special packaging, promotional events, sponsorship, having a Brand ambassador for the product, which will boost the brand image to attract demand and generate brand loyalty among consumers.
Price leadership Many economists, such as Stigler (1947b) , Bain ( 1960) have described various type of price leadership. These have been classified by Scherer (1970) into three types: dominant, collusive and barometric price leadership. The dominant type is considered to describe where the dominant firms, which are larger in size and has the major chunk of market share establishes the price leadership position and the other minor firms being the followers . In the collusive type, the principal firms set prices, which are then followed by the other minor firms and the price level is rather monopolistic than competitive. Scherer ( 1970 p170 ) has stated that the price leaders temper their price policies in order to suppress intra – industry conflicts in this case . Finally in the Barometric price leadership the price is set around the competitive level (Ono, Y. (n.d.). Price Leadership: A theortical Analysis. In Economica (pp. 49, 11-20). Musashi University).
Explicit collusion under oligopoly In the collusive Price leadership, in order to curb market uncertainty, dominant firms engage in some form of collusive behaviour and decide to engage in price fixing agreements or cartels. The aim of this is to maximise joint profits .This behaviour is considered as illegal by the UK and European competition authorities.
Collusion is often deemed as a desire to achieve joint-profit maximisation within a market, to control supply and to prevent price fluctuations in an industry.
It can be concluded that cartel as a whole is maximising profits, but the individual firm’s output is unlikely to be at their profit maximising point and if any of the firms breaks their agreement with the cartel, there will be excess supply in the market and sharp decline in the price.
Collusion in industry is easier to achieve when:
There are only a small number of firms in the industry.
Entry barriers are protected by larger firms
Demand is fairly inelastic in price and the market demand is not too variable
Output of the firms in the cartel is easily monitored and to keep a control on the total supply and it will be easy to identify if any of the firms are trying to cheat on their output quota
Most cartel arrangements experience difficulties and tensions among them and some producer cartels collapse completely . There are several factors that can create problems within a collusive agreement between suppliers:
Falling market demand during a slowdown or recession puts pressure on individual firms to reduce prices to gain profits or least maintain their revenue.
Exposure of illegal price fixing by market regulators
Vested interest: The firm in the cartel aims finds it profitable to raise its own production to gain more profits and not adhere to the cartel output quotas. Disputes among the cartel how to share out the profits. (http://tutor2u.net/economics/revision-notes/a2-micro-oligopoly-overview.html)
Followed is Analysis how OPEC as an organisation has collusively collaborated to form a cartel to control the world’s oil prices, thereby depicting the Oligopoly Market model. The Organization of the Petroleum Exporting Countries (OPEC) is a intergovernmental organization, consisting of 12 oil producing and exporting countries. The members are Algeria, Angola, Ecuador, the Islamic Republic of Iran, Iraq, Kuwait, the Socialist People’s Libyan Arab Jamahiriya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates