Question

OPEC is an intergovernmental organization of 13 nations. As of 2015, the 13 countries accounted for an estimated 42 percent of global oil production and 73 percent of the world's "proven" oil reserves, giving OPEC a major influence on global oil prices that were previously determined by American-dominated multinational oil companies.

Understanding this type of dynamic in which a few countries (or firms) dominate the market being able to set the price, yet unable to raise significant barriers to entry to keep smaller competitors from entering the market entails delving into a price leadership model.

Start with the following assumptions: The World Market demand for oil is given by P=100-X in which X is the aggregate market quantity of crude oil barrels. This market is served by OPEC, a dominant block, and a set of infinitely many countries with smaller oil reserves which act as price takers. in this simple example, OPEC is comprised of two dominating countries, denoted DC1 and DC2 with smaller efficiencies: constant marginal costs such that: MC_DC1 =MC_DC2 =50. The fringe countries have an aggregate marginal cost that can be expressed by MC_SC =50+X.

A. How much will each country at OPEC produce?

B. What is the resulting price of the barrel in the oil market?

C. How much are the other countries aggregately producing?

D. What is the HHI in the oil market?

Answer 1

Find residual demand for OPEC

RD = 100 - P - P + 50. This is found by subtracting fringe supply X = P - 50 from the market demand X = 100 - P

RD = 150 - 2P

Inverse demand function P = 75 - 0.5X

Marginal revenue = 75 - X

OPEC will produce where MR = MCD

75 - X = 50

X = 25 barrels

Price (set by OPEC and followed by two dominant countries of the block as well as by the fringe countries) = 75 - 0.5*25 = $62.5

Fringe supply = X = P - 50 or X = 62.5 - 50 = 12.5 barrels

A. How much will each country at OPEC produce?

12.5 barrels each (two dominant countries)

B. What is the resulting price of the barrel in the oil market?

$62.50 per barrel

C. How much are the other countries aggregately producing?

12.5 barrels

D. What is the HHI in the oil market?

HHI = sum of sqaures of market shares

= 10000[(25/37.5)^2 + (12/37.5)^2]

= 5468