Assume that there are only two countries that produce crude oil, Saudi Arabia and Venezuela, that they produce the same grade of crude oil. First we are going to pretend that there are "regulators" that force them to behave as if they were perfectly competitive firms, and second, we are going to allow them to join OPEC, which is therefore a monopoly, and jointly maximize profits. Assume that the inverse demand curve for crude oil in the global market is given by
P-300- 5QD
where Q is measured in million barrels per day
Saudi Arabia is the low cost producer, with total cost function given by
CSA (QSA) 500 2Q5A
Venezuela's cost function is
Cy(Qy) - 800 + 4Q
A. Assume that Saudi Arabia and Venezuela are the only two countries that produce crude oil in the world, and they are forced to behave competitively despite being a duopoly. Under this assumption, derive the market supply curve for crude oil. (Hint the market supply curve is the horizontal sum of the individual firm supply curves since we are assuming the firms behave competitively. To sum the MC curves horizontally, solve each for each country's Q as a function of its MC, then add up the Qs and solve for overall MC.
B. Again, assuming that regulators impose competitive behavior on the production and pricing of the two countries, what will be the price and total quantity of crude oil produced? (don't worry about allocating total production between the two countries) Put a box or highlight over each answer so the TAs can find them in your work.
C. Now assume that OPEC "gets teeth" and is able to set quotas that restrict production among its members. For simplicity, we will make the additional assumption (which was once almost fairly realistic, but no longer is) that because OPEC's production costs are so low compared to other countries, it isa monopoly producer. OPEC therefore faces the demand curve given at the beginning of the problem. OPEC wl behave as a monopoly and face the market demand curve, then it will allocate the total, joint production among the two countries so as to maximize joint profits. Find total crude oil a. b. c. production, the amount produced by each country, and the equilibrium price.
D. Under the OPEC regime, does Venezuela produce crude oil in the short run, in the long run?