Page 352 - The Principle of Economics

358 PART FIVE FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY
IN THE NEWS
The Oil Cartel Makes a Comeback
OPEC FAILED TO KEEP OIL PRICES HIGH during most of the 1990s, but this started to change in 1999.
An Oil Outsider Revives a Cartel
BY AGIS SALPUKAS
The price of crude oil has doubled since early last year. Higher prices for gaso-
line, heating oil, and other products are hitting every consumer’s pocketbook.
Is OPEC flexing its muscle again? Not exactly. There’s a new cartel in town, and after a shaky start two years ago, its members have achieved—for now, at least—the unity necessary to hold to their production quotas. And that means higher prices.
In a sense, this cartel is simply the 11 members of the Organization of Pe- troleum Exporting Countries plus two— Mexico and Norway. But the world’s oil-producing and exporting nations are wielding power this time around mainly because of a shove not from the Middle East but rather from Mexico—and espe- cially from its persistent energy minister, Luis K. Tellez. . . . Already, the price of
crude oil has more than doubled, to $23.45 a barrel from $11 early this year. Not that the coalition is home free.
Prices hit $24 a barrel last month, but slipped back when traders thought they saw hints of cracks in the cartel’s soli- darity. After all, if one country breaks ranks, the cartel’s tenuous grip on the world market could crumble.
For the moment, though, there seems little easing in the cartel’s united front or in rising oil prices.
SOURCE: The New York Times, Money & Business Section, October 24, 1999, p. 1.
game theory
the study of how people behave in strategic situations
GAME THEORY AND THE ECONOMICS OF COOPERATION
As we have seen, oligopolies would like to reach the monopoly outcome, but do- ing so requires cooperation, which at times is difficult to maintain. In this section we look more closely at the problems people face when cooperation is desirable but difficult. To analyze the economics of cooperation, we need to learn a little about game theory.
Game theory is the study of how people behave in strategic situations. By “strategic” we mean a situation in which each person, when deciding what actions to take, must consider how others might respond to that action. Because the num- ber of firms in an oligopolistic market is small, each firm must act strategically. Each firm knows that its profit depends not only on how much it produces but also on how much the other firms produce. In making its production decision, each firm in an oligopoly should consider how its decision might affect the pro- duction decisions of all the other firms.
Game theory is not necessary for understanding competitive or monopoly markets. In a competitive market, each firm is so small compared to the market that strategic interactions with other firms are not important. In a monopolized market, strategic interactions are absent because the market has only one firm. But, as we will see, game theory is quite useful for understanding the behavior of oligopolies.