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Figure 1. The headquarters of OPEC in Vienna, Austria[1]

The Organization of Petroleum Exporting Countries is an example of an international cartel. The organization was created at a conference in Baghdad, Iraq on September 10th-14th, 1960. The founding members which include Iran, Iraq, Kuwait, Saudi Arabia and Venezuela agreed to create an organization that could bring some degree of stability to the world oil market. OPEC agreed to coordinate energy policies to ensure a fair price for their exported oil and a steady supply to the market.[2] The governments of the OPEC countries agreed to coordinate with petroleum firms (both state owned and private) in order to manipulate the worldwide oil supply and therefore the price of oil.

When firms agree to collude, that is they agree to a certain price and quantity for a good or service, they create a cartel. A cartel is a type of oligopoly.[3] As cartels are formed and operate in secret, it is up to the members of the cartel to keep their agreement in tact. The firms must trust each other not to drop their price to undercut the others or increase their output.[4] This is difficult to ensure as firms may have different production costs and therefore require more of the profit to meet their costs. Because of this, there is less control over the market than there would be under a monopoly structure.[5]

Problems of OPEC

Although OPEC has the structure and intent of a cartel, it fails to function properly to achieve its objective of influencing global oil supply.

There are a series of problems that plague OPEC and make it inefficient as a cartel structure:

Market Share

The first problem that OPEC suffers from is that they do not control the majority of oil supply in the world, that is they don't have the market power.[6] The share of the global oil supply that OPEC controls has fluctuated over time, while it has 81% (1213.4 billion barrels, 2015) of the world's proven crude oil reserves it only produces about 40% of crude oil today (this number has fluctuated since its creation).[7][8] Without the control of the market, OPEC has to compete with non-OPEC nations such as Canada, U.S, Norway, Mexico, Brazil and others. This means that OPEC countries have to compete with other global players who are free to operate in the market as they please, whereas OPEC nations have to coordinate with each other.

Cooperation & Coordination

Since its inception, OPEC has had problems dealing with the inherent problem of coordinating their policies. The nature of a cartel depends on the members agreeing and coordinating their policies to ensure and equal share of the market and to discourage competition.[9] Many of the OPEC countries inhabit an area that is prone to geopolitical strife and conflict. There is an extensive list of events that affected OPEC and its cooperation since its existence such as numerous wars, assassinations, ongoing political conflicts, terrorism etc.[10]

OPEC, like all cartels, has to overcome the urge to compete with other members within the cartel. Quotas are one method that OPEC uses to limit competition and output in order to raise prices. OPEC countries often, if not always, agree to these quotas then break them by ramping up production in an attempt to capture more of the market for themselves. This practice both disrupts the cohesion of the cartel and reduces the amount of trust between the member nations.[11] Essentially, member nations 'cheat' to make more money. Proof of this is the defections of Ecuador and Gabon which both suspended their membership in OPEC for periods of time (1992-2007 and 1995-2016 respectively) seeking a release form the terms of the cartel. Both sought to increase their production levels free from quotas.[12]

Each member of OPEC has its own political and economic conditions that are unique to it. The combination of all these problems make coordination difficult as the interests on one country may run contrary to another or the organization itself.

Effect on Non-OPEC Producers

Cartels are normally considered to be a negative aspect of a market, they discourage competition, restrict supply and raise prices for consumers. In the Case of OPEC, non-OPEC producers do not necessarily oppose the cartel activities. Because OPEC attempts to keep the price of oil artificially high, the non-OPEC producers benefit as well as they can sell their oil at the same price. While there are different grades of crude oil, when crude hits the market it is essentially the same and they are all sold for more or less the same price. Some crude is more expensive to refine for market sale such as Canadian crude from the Alberta oil sands and some is cheaper however, the grade makes it to the market is undifferentiated from different crude of different origins.

OPEC Reserves

The map below shows the sizes of the oil reserves held by the OPEC member nations (Selected are member nations: Algeria, Angola, Ecuador, Gabon, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, Venezuela) Press the play button in the lower left hand corner to see how these reserves change with time (watch Venezuela specifically):

1. Briefly explain the content of the article.

2. What is a cartel as explained in this article.

3. Is OPEC efficient as a cartel structure? Why?

4. What is the effect of OPEC on non-OPEC producers.

Q2). A firm has the following short-run inverse demand and cost schedules for a particular product

P = 45 - Q

TC = 500 + 5 Q

A). At what price should the firm sell its product?

B). If this is a monopolistically competitive firm, what do you think would happen as the firm moves toward the long run? Solve for Q. (Remember in the Long Run P = AC)

C) If this is a perfectly competitive firm, what is the price the firm would charge? (remember for perfect competitive P = MC).

Q3). There are only two firms in a given industry. The total demand for their product is

?Q = 30 - 2 P

The two firms have identical cost functions

TC = 3 + 10 Q

The two firms agree to collude and act as though the industry is a monopoly. At what price and quantity will this cartel maximize its profit.

Q4). A company has estimated its demand function and total cost function to be as follows:

?Q = 25 - 0.05 P

?TC = 780 + 200 Q

Answer the following questions by solving the equations:

What will be the price and quantity if this company wants to:

A). Maximize profits.

B). Maximize revenue (i.e., MR =0).

[1] A perfectly competitive aluminum producer is currently producing a quantity where the market price is $0.67 per pound (i.e., 67 cents per pound), average total cost is $0.70, and average variable cost of $0.60 (which corresponds to the minimum point on the average variable cost curve). Would you recommend this firm expand output, contract output, or shut down in the short-run? Provide a graph to illustrate your answer. (2] Suppose the local crawfish market is perfectly competitive, with the following market demand and supply: Market Demand: QD = 6500 - 100P Market Supply: Qs = 1200P, where market quantity demanded (Qo) and market quantity supplied (Qs) are measured in pounds and price (P) is measured in dollars per pound. Assuming all firms have identical costs, suppose the typical firm in the market has the following short-run total cost (TC) and marginal cost (MC), with q being the quantity produced by the firm: Total Cost: TC = 722+ Marginal Cost: MC = 29 200 A. production? What is the price at which a firm is indifferent between producing in the short-run and shutting down B. Determine the market equilibrium price and quantity of crawfish, the output supplied by each firm, and the profit of each firm. How many firms must currently be in this market? C. Based on your answer to B, would you expect to see entry or exit in the long-run? How would this impact the price of crawfish over time, ceteris paribus? [3] A monopolist is operating in the short-run, facing a market demand given by the following: Q = 1000 - 2P, where Q is market quantity and P is market price. Suppose the firm's short-run total cost (TC) is: TC = 100-Q. Find the price and quantity that maximizes this firm's short-run profit. What is the level of profit? Determine the values of consumer surplus, producer surplus, and market welfare under monopoly. If the firm operated as if perfectly competitive (i.e., where P = MC), what would be the values of consumer surplus, producer surplus, and market welfare? What is the value of the deadweight loss in market welfare due to monopoly? [4] The market for lemonade in a town consists of two lemonade stands (i.e., firms), 1 and 2. An agricultural economist estimates the following demand for lemonade in this town: Q=300 - P, where Q is the market quantity and P is the market price. Total costs of the two firms are indicated below: TCI = 60Q1 TC2 = 40Q2 Acting as Cournot competitors, find and graph the reaction functions of each firm (indicating appropriate horizontal- and vertical-axis intercepts). Determine the Cournot equilibrium output of each producer, as well as the profit of each producer.4. A country which does not tax cigarettes is considering the introduction of a $3 per pack tax. The estimated demand and supply lnctions for cigarettes are given as: QD = 160,000 10,000P Qs = - 20,000 + 5,000P, where Q = daily sales in packs of cigarettes, and P = price per pack. The country has hired you to provide the following information regarding the cigarette market and the proposed tax. a. What are the equilibrium values in the current environment with no tax? b. What price and quantity would prevail after the imposition of the tax? What portion of the tax would be borne by buyers and sellers respectively? c. Calculate the deadweight loss from the tax. Could the tax be justied despite the deadweight loss? What tax revenue will be generated