Question

1. As reported in the Wall Street Journal in November 2016, the 11 countries that make up the oil cartel OPEC agreed to each cut their oil production over 2017 by 2% in an effort to raise the price of oil and increase their profits (since the demand for oil is inelastic). Let’s use a simplified one-off game with only two countries (Iran and Saudi Arabia) to analyze the strategic interaction between the countries and the likely impact on oil revenues of their agreement. Suppose that each country can produce either a high or a low quantity of oil:

• If both countries reduce oil production to the low quantity, Iran earns 86 billion and Saudi Arabia earns 126 billion in profits.
• If Iran produces the high quantity and Saudi Arabia the other the low quantity, Iran earns 142 billion in profits and Saudi Arabia loses 29 billion.
• If Saudi Arabia produces the high quantity and Iran the other the low quantity, Saudi Arabia earns 202 billion in profits and Iran loses 17 billion.   
• If both produce the high quantity Iran earns profits of 5 billion and Saudi Arabia earns 12 billion in profits.

1. Fill in the payoff matrix for this game. Be sure to carefully label each country’s strategies.

		Iran’s Decision
Saudi Arabia’s Decision

2. Identify each country’s dominant strategy (if there is one) and provide a 1-2 sentence explanation supporting your choice(s). What is this game’s Nash equilibrium

3. Is there an outcome that would be better for both countries than the Nash equilibrium? If so, could it be achieved if this was a repeated game rather than a one-off game as above? Support your answer with no more than two sentences.

Answer 1

If Iran produces high quantity, best strategy for Saudi Arabia is to produce high quantity and if Iran produces low quantity, best strategy for Saudi Arabia is to produce high quantity(Best payoffs are highlighted in blue).

So, dominant strategy for Saudia Arabia is to Produce High Quantity.

Similarly,dominant strategy for Iran is to Produce High Quantity. The best strategy for Iran is to produce high quantity irrespective of what Saudi Arabia does.(Best payoffs are highlighted in green)

The nash equlibrium is :- Both Coutries producing high quantity(the cell highlighted in gray).

Yes, there is an outcome that will be better for both the countries and that outcome is both countries producing low quantity.

If the game is played repeatedly, both the countries will realise about the short term gain and possible long term incentives of their actions. So, both of them can collaborate together to produce low quantity and reach at a better outcome.