Fair Oil Prices
Subject Comparative Statics
Topic Oligopoly
Key Words Cooperation, OPEC, oil prices, prices, profit margins, production, output
News Story

The Venezuelan President, Hugo Chavez, is on a 21-day foreign tour to promote cooperation between nations in the Organization of Petroleum Exporting Countries (OPEC) and those outside. He has visited Saudi Arabia, and is now in Iran, and will travel to Russia shortly.

Oil prices have fallen due to the downturn in the world economy and the effect of the September 11 skyjackings. Motorists also tend to use less gas in the autumn, further depressing prices. These factors have resulted in gasoline prices being 27 cents a gallon lower than at this time last year. Profit margins have fallen as a consequence.

In Tehran, President Chavez announced that Saudi Arabia, Iran and Venezuela had agreed on a strategy to revive oil prices to what he termed "fair" levels. Chavez believes that oil prices should be between $22 and $28 a barrel, rather than the current price of $21.50. The plan is to reduce oil production: Venezuela has already cut its output by 10 percen.

(Updated December 1, 2001)

1. Draw a diagram of a joint-profit-maximizing monopoly in the world market for oil. Include the demand and marginal curves and the average total and marginal cost curves. Mark the initial equilibrium price and output.
a) Show the effect of the economic downturn on the world oil market price and output.
b) Given this, what do the members of the OPEC cartel have to do if they are to maximize profit?
c) What would happen if they did not act in this way?
2. President Chavez is attempting to increase cooperation between OPEC producers and non-OPEC producers.
a) What implications could this have in the world oil market? Refer to your analysis above.
b) If he fails, what might happen to the world price and output of oil?
Source The Associated Press, "Venezuelan leader says OPEC will prop up sagging oil prices," USA Today, October 22, 2001

Return to the Oligopoly Index

©1998-2002  South-Western.  All Rights Reserved   webmaster  |  DISCLAIMER