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Oil Cartels and Marginal Cost curve problem

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This problem is designed to help you appreciate the joys and tribulations of cartels. Let D in Figure 11-1 be the demand for oil and MC be the sum of the marginal-cost curves of all oil producers. Ignore for now the line labeled H.

(a) If oil producers are price takers because there are thousands of them and they have no effective cartel, why will the price of oil move toward \$9 per barrel? What will occur if the price is much above or below \$9?

(b) Now assume that one party acquires control over all producing oil wells and hence the power to control the price by controlling output. How many millions of barrels per day (mb/d) will be pro¬duced if the goal is to maximize net revenue? What price will be set?

(c) Change the above assumption slightly. The oil wells remain under the ownership and control of the thousands of original owners, but each owner agrees to sell only at the price determined by the Organizer of Prices to Exploit Consumers (OPEC). This is an agent hired by the oil producer to determine and announce the price for oil that will be most advantageous to oil producers collectively. OPEC announces that the price shall be \$29 per barrel. What must occur if this price is to hold?

(d) Why will the individual oil producers want to sell individually a quantity of oil that sums in aggregate to far more than 13 mb/d?

Solution Summary

The expert examines oil cartels and the marginal cost curves.

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This problem is designed to help you appreciate the joys and tribulations of cartels. Let D in Figure 11-1 be the demand for oil and MC be the sum of the marginal-cost curves of all oil producers. Ignore for now the line labeled H.

(a) If oil producers are price takers because there are thousands of them and they have no effective cartel, why will the price of oil move toward \$9 per barrel? What will occur if the price is much above or below \$9?
Solution: In a perfectly competitive market (as in this case), the price is almost equal to the Marginal Revenue, i.e., the additional revenue obtained by selling just one more unit of the product. Hence the demand curve D in effect resembles the Marginal Revenue curve. As a condition of profit ...

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