Question

The Organization of the Petroleum Exporting Countries (OPEC) is a group of oil producers that have entered into an agreement aimed at controlling the world supply of oil. They behave like a monopolist, seeking to maximize profits by restricting output and increasing price. Suppose that the inverse demand curve for oil over the next five years is P = 165 − 2.5Q, where Q is millions of barrels per day. OPEC’s marginal cost is $15/barrel, or C(Q) = 15Q.

a. What is OPEC’s profit-maximizing level of output? What is the price of oil?

b. Business consultants believe that maximizing short-run profit is counterproductive for OPEC in the long run. They suggest that high oil prices push consumers to conserve energy and find cheaper alternatives. High oil prices also lead to innovation and new competition that increases the overall supply of oil in the future. It is estimated that demand will stay the same if oil prices stabilize at around $65/barrel or below, and if oil price exceeds $65/barrel then demand in the long run (over a second five-year period) will decrease to P = 135 − 2.5Q. Suggest what OPEC should do if their goal is to maximize total profit over the next 10 years.

Answer 1