Question

Suppose OPEC convened an emergency meeting to respond to the loss of Libyan oil. At the meeting, members proposed to adopt one of two choices: (1) leave all other countries' exports the same as before and enjoy the anticipated $92 price, or (2) allow each OPEC member (except Libya) to increase current production by 3 percent so as to bring world prices back to $90 per barrel. Venezuela could increase its output from its oil fields by spending $35 per barrel for each additional barrel produced. Saudi Arabia could increase its output from its oil fields by spending $15 per additional barrel. Iran could increase its output at a cost of $25 per each additional barrel. Which of the two options do you think each of the three countries would support? Explain why.

Answer 1

Marginal cost of adding extra Barrel is very low when compared to revenue.

Marginal cost of adding extra barrel is $ 15 for Saudi Arabia while Marginal revenue from extra barrel is $ 90

Similarly for Venezuela , MC = 35 and MR = 90

Iran, MC = 25 and MR = 90

Hence,

Now suppose that OPEC is producing 100 Million Barrel at 92, then TR = $ 9200

Further if oil production increases to 103 million and price drops to 90, then TR = $9270

Hence, OPEC will go with second option.