Page 351 - The Principle of Economics

the number of producers from which each consumer can choose, and this increased competition keeps prices closer to marginal cost. Thus, the theory of oligopoly provides another reason, in addition to the theory of compara- tive advantage discussed in Chapter 3, why all countries can benefit from free trade.
CASE STUDY OPEC AND THE WORLD OIL MARKET
Our story about the town’s market for water is fictional, but if we change water to crude oil, and Jack and Jill to Iran and Iraq, the story is quite close to being true. Much of the world’s oil is produced by a few countries, mostly in the Mid- dle East. These countries together make up an oligopoly. Their decisions about how much oil to pump are much the same as Jack and Jill’s decisions about how much water to pump.
The countries that produce most of the world’s oil have formed a cartel, called the Organization of Petroleum Exporting Countries (OPEC). As origi- nally formed in 1960, OPEC included Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. By 1973, eight other nations had joined: Qatar, Indonesia, Libya, the United Arab Emirates, Algeria, Nigeria, Ecuador, and Gabon. These coun- tries control about three-fourths of the world’s oil reserves. Like any cartel, OPEC tries to raise the price of its product through a coordinated reduction in quantity produced. OPEC tries to set production levels for each of the member countries.
The problem that OPEC faces is much the same as the problem that Jack and Jill face in our story. The OPEC countries would like to maintain a high price of oil. But each member of the cartel is tempted to increase production in order to get a larger share of the total profit. OPEC members frequently agree to reduce production but then cheat on their agreements.
OPEC was most successful at maintaining cooperation and high prices in the period from 1973 to 1985. The price of crude oil rose from $2.64 a barrel in 1972 to $11.17 in 1974 and then to $35.10 in 1981. But in the early 1980s member countries began arguing about production levels, and OPEC became ineffective at maintaining cooperation. By 1986 the price of crude oil had fallen back to $12.52 a barrel.
During the 1990s, the members of OPEC met about twice a year, but the car- tel failed to reach and enforce agreement. The members of OPEC made produc- tion decisions largely independently of one another, and the world market for oil was fairly competitive. Throughout most of the decade, the price of crude oil, adjusted for overall inflation, remained less than half the level OPEC had achieved in 1981. In 1999, however, cooperation among oil-exporting nations started to pick up (see the accompanying In the News box). Only time will tell how persistent this renewed cooperation proves to be.
QUICK QUIZ: If the members of an oligopoly could agree on a total quantity to produce, what quantity would they choose? N If the oligopolists do not act together but instead make production decisions individually, do they produce a total quantity more or less than in your answer to the previous question? Why?
OPEC: A NOT VERY COOPERATIVE CARTEL
CHAPTER 16
OLIGOPOLY 357