ASSIGNMENT-4

MUHAMMAD HASAN
14607

1. Is opec a monopoly or an example of collusive oligopoly?

Justify your answer?

Answer: The governments of the OPEC countries agreed to coordinate with petroleum firms
(both state owned and private) in order to manipulate the worldwide oil supply and therefore the
price of oil.

When firms agree to collude, that is they agree to a certain price and quantity for a good
or service, they create a cartel. A cartel is a type of oligopoly. As cartels are formed and
operate in secret, it is up to the members of the cartel to keep their agreement in tact.
The firms must trust each other not to drop their price to undercut the others or increase
their output.[4] This is difficult to ensure as firms may have different production costs and
therefore require more of the profit to meet their costs. Because of this, there is less
control over the market than there would be under a monopoly structure.

2. Explain the economic logic behind OPEC’s decision to reduce

output?

Answer: We focus on the unavoidable uncertainty regarding the underlying parameters

that characterize the world oil market (price elasticities, income growth rates), and the
sensitivity of discounted OPEC revenue to changes in these parameters, for various pricing
strategies. In 1979-80, OPEC chose a high-price strategy, which could have yielded good
results (like many other price-paths) if the market's underlying parameters had been more
favorable. But the price elasticities of demand and non-OPEC supply were much higher
than anticipated, so that OPEC did very poorly—not only in absolute terms, but abo relative
to what it could have achieved if it had set its price more cautiously. We search for a robustly
optimal strategy for OPEC in the future, which will serve it well relative to other strategies,
regardless of the true parameter values underlying the market (within some plausible
range). We conclude that OPEC's interests will be served best by a policy of moderate
output growth, at a rate no faster than that of world income growth. This will require that
OPEC slow its rate of output growth since 1985, cutting it at least in half Slowing its output
growth will allow OPEC gradually to regain the market share lost after its disastrous 1979-80
price doubling, but without jeopardizing its revenue, as might a policy of more rapid
increases in output. This will yield a consistently good result for OPEC, relative to alternative
strategies, over a fairly wide range of demand and supply conditions.

3. What factors may reduce the demand for OPEC oil overtime?
Answer: Dynamic forces of oil supply and demand led to all excess supply in
world markets since 1980, which in turn led to a de facto decline in the price of oil
even before OPEC's London agreement of March 1983 in which the official price was
reduced by approximately 14 percent. This oil glut in world markets was the result of
at least three mutually dependent dominant forces: high oil prices, increase in
production, and reduction in demand

4. How can the oil companies boost their profit if they have little
control over market price?

Answer:  Oil companies can force oil prices to boost and thereby enjoy
greater profits than if its member countries had each sold on the world market
at the going rate.