Question

In mid-2010, Saudi Arabia and Venezuela (both members of OPEC) produced an average of 8 million and 3 million barrels of oil a day, repectively. Production costs were about $20 per barrel, and the price of oil averaged $80 per barrel. Each country had the capacity to produce an extra 1 million barrels per day. At that time, it was estimated that each 1-million-barrel increase in supply would depress the average price of oil by $10.

A. Fill in the missing profit entries in the payoff table:

Venezuela
3 M barrels 4 M barrels
Saudi 8 M Barrels_______,________ _______,________
Arabia 9 M Barrels_______,________ _______,________

B. What actions should each country take and why?

C. Does the asymmetry in the countries' sizes cause them to take different attitudes toward expanding output? Explain why or why not. Comment in whether or not a prisoner's dilemma is present.

Answer 1

a)

Profit of Venezuela

3 million Barrels; Profit = TR - TC

= 80*3 - 20*3

= 240 - 60

= $ 180 Million

When output is 4 Million Barrel:

= 4*70 - 20*4

= 280 - 80

= $ 200

Profit of Saudi Arabia;

8 Barrels; Profit = 8*80 - 8*20

= 640 - 160

= $ 480

9 Barrel, Profit = 9*70 - 20*9

= 630 - 180

= $ 450

B)

Venezuela profit rises when it increases output. Hence, it must increase output level.

Saudi Arabia profits fall from 480 to 450, hence it should not increase output level.

c)

There is asymmetry in countries size, hence Venezuela produces less quantity and relatively it profitable to increase output level. MR is relatively is greater in case of Venezuela.

this is not case of prisoner dilemma. Venezuela can maximize his profits by deviating from agreement. it continues to increase profits even if Saudi also goes with same strategy.