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OPEC from a Game Theory perspective - Term Paper Example

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Name Tutor Subject 25th Nov 2013 OPEC from a Game Theory perspective Introduction Game theory is a theoretical framework that is used to explain how decisions are made between parties. It was coined by Jonny Neumann who tried to explain how decisions can be made when people has concerns of other people…
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OPEC from a Game Theory perspective
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OPEC from a Game Theory perspective

Download file to see previous pages... The theory has its rules and game theorist uses them to predict equilibrium outcome. One of the world bodies that utilize game theory in its operation is OPEC. The study focuses to find the extent of game theory in OPEC and the effect of member’s and non member’s states on the strategies in production and market share. OPEC is an intergovernmental group formed by Venezuela, Kuwait and other countries in 1960. The organization aimed to seize the benefit of controlling the supply to maximize revenue of member states. The organization also aimed at stabilizing and bringing agreement in the marketplace of fuel to do good to both consumers and producers. This was a common strategy employed to try and influence the prices of crude oil. The idea of OPEC in the initial stages was to prevent the fall of prices after an all time high that enabled oil producing countries maximize on their utility. OPEC is referred to as a global cartel in the oil producing countries. Classical economist present a condition that monopolist utilize to maximize profit, MC= P (1-1/e) given that P is the price of oil, e is the elasticity of demand and MC represent marginal cost of oil production. Economist hint that oil price are inelastic in the short run, and OPEC can increase above the market price. (Source: Dye 2) Supposing that there are two firms in a cartel, the maximizing price would be where marginal cost 1 = marginal cost 2 = marginal revenue. The maximizing price would be where the two marginal costs meet marginal revenue. OPEC member’s state has a reserve of 79.3% of the world crude oil and was producing 63% of the global oil export in 2009. OPEC does not use market force s for marginal revenue and marginal cost to determine equilibrium price. Free market would result with some countries producing none while others benefiting so much to the extent of controlling production. For example, Saudi Arabia could benefit more than the rest of the country because it has vast oil reserves and therefore it can afford to increase production at a lower price. Therefore, free competitive market is not possible in the oil production industry and it explains the reason behind forming a cartel (Gambits 3). In order to maximize utility, OPEC considered strategies to control production through quotas system. Every nation state produces a certain percentage of production capacity. However, the challenges facing OPEC is on determining the actual or the maximizing quota that each member’s state produces. The solution to these challenges lies on game theory (Gately 1). The OPEC members have a duty to have the same opinion on a strategy to restrict output such that prices are prolonged at a high level. Nevertheless, some scholars like Friedman argued that Arab countries cartel on oil production would collapse because high prices of petroleum are not sustainable even if the output is put to zero. OPEC, unlike other bodies, is exceptional. The decisions agreed upon are of decisive to every member and failure to adhere has dire consequences. This strength of OPEC has ensured the sustainability of world prices today and will sustain even in the future. According to Osborne cartels faces inherent problem of cheating, and determining quotas and it is wrong to classify them as stable. Gately (3) says that the OPEC as a cartel is maintained at Nash equilibrium. At Nash equilibrium, every country ...Download file to see next pagesRead More
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