Oligopolies - Why can't Venezuela convince OPEC to act as a monopoly?

M. Jimena González-Ramírez, Manhattan College, jimena.gonzalez@manhattan.edu

Summary

Prior to class, students listen to:
  • https://www.npr.org/sections/money/2016/10/21/498867764/episode-731-how-venezuela-imploded. In this NPR Planet Money episode, an in-depth analysis about Venezuela's current crisis is provided. This analysis provides an important example of the risks of depending on high oil prices, which serve as a motivation for studying OPEC's inability to act as a monopoly.
Teams apply game theory to derive a payoff matrix and subsequent Nash Equilibrium that best explains why OPEC cannot act as a monopoly.

Context for Use

  • This exercise should come after the chapter on monopoly and oligopolies in a principles of microeconomics course.
  • A student should understand why oligopolies want to act as a monopolist.
  • A student should understand differences in production and price levels between oligopolies and monopolists (i.e. Qoligopoly>Qmonopolist and Poligopoly
  • There are no class size limitations
  • This activity will take up to a class period, depending on the discussion length.

Overview

Prior to class, students listen to:

  • https://www.npr.org/sections/money/2016/10/21/498867764/episode-731-how-venezuela-imploded. In this NPR Planet Money episode, an in-depth analysis about Venezuela's current crisis is provided. This analysis provides an important example of the risks of depending on high oil prices, which serve as a motivation for studying OPEC's inability to act as a monopoly.

In this activity, teams learn about one of the most important real world oligopolies: OPEC. At the same time, students learn about Venezuela's oil dependency and its current economic, political, and social crisis. If OPEC would act as a monopoly, Venezuela would face a less severe crisis as oil supply will be limited increasing oil price. Yet, game theory explains why acting as a monopoly is so hard for OPEC. In this activity, teams apply game theory to construct a payoff matrix and to subsequently identify the Nash Equilibrium that best explains OPEC's inability to act as a monopoly, which partly explains Venezuela's current crisis.

Expected Student Learning Outcomes

Students will identify the price formation in oligopolistic markets.
Students will set up a 2x2 game and solve for the Nash Equilibrium.
Students will solve the Prisoner's dilemma and connect its Nash Equilibrium to oligopolies.

Information Given to Students

After listening to the podcast, you have learned about Venezuela's current crisis, oil dependency, and desire for high oil prices. In this activity, you will apply knowledge on price formation in oligopolistic markets to OPEC's example. For simplicity, assume that other OPEC countries, different than Venezuela, act as one. Suppose Venezuela and other OPEC countries have two production strategies: i) collude and limit oil supply to a level that was agreed upon during OPEC meetings or ii) compete and increase oil supply. Construct a game using payoff rankings from 1 (worst) to 4 (best) and identify the Nash Equilibrium that best explains OPEC's inability to act as a monopoly.

After all teams are finished, a gallery walk will be used to report answers simultaneously.

Venezuela and OPEC Activity (Microsoft Word 2007 (.docx) 15kB Aug16 18)

Teaching Notes and Tips

Prefatory Remarks:
One of the most well-known examples of an oligopoly is the Organization of Petroleum Exporting Countries (OPEC), whose mission is to: "coordinate and unify the petroleum policies of its Member Countries and ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry" (http://www.opec.org/opec_web/en/about_us/23.htm).

Venezuela is one of OPEC's members. While Venezuela has oil, the country has been experiencing a profound economic, political, and social crisis that stems from its dependency on oil. In the NPR Planet Money podcast about Venezuela, Alejandro Velasco, an NYU historian, said: "as long as the price of oil was high, there weren't, actually, a lot of serious problems." Moreover, he says that Venezuelans wish for a time in which oil prices are high again.

During the AE:

Teams should simultaneously reveal their choice through a gallery walk. As a recommendation, within each team, a team member can be randomly chosen to explain the way the Nash Equilibrium is found in the chosen payoff matrix.


Discussion questions:
  • Why are the payoffs different for each player under each strategy (e.g. collude vs. compete)? How do the payoffs relate to pricing in oligopolistic markets?
  • How are price and quantity related in an oligopolistic market? What happens to the price as supply decreases?
  • Why does Venezuela want a higher price of oil? How is this desire connected to the elasticity of demand for oil? (Optional question for courses that have covered the way elasticity of demand affects changes total revenue as price changes)
  • Why is Venezuela unable to convince other OPEC countries to limit their supply of oil and act as a monopoly?
  • What policy recommendation would you give Venezuela to get out of its current crisis?
  • Suppose that the price of oil increases due to a political/military crisis in the middle east, what would you recommend Venezuela to do with the increase in oil revenue?
  • What happens if the Prisoner's Dilemma is play multiple times in a repeated game as opposed to a one-shot game?
  • Why, even in the repeated game, collusion is difficult in this case?
Closing Remarks:
While Venezuela's crisis is complex and stems from various mistakes, its dependency on oil and its revenue is a major reason why the country is in its current economic, political, and humanitarian crisis. While Venezuela wishes it could return to its high oil price days, achieving cooperation within oligopolists is challenging. If the price oil increases for other reasons, Venezuela should learn from its past mistakes and invest its oil revenue to decrease its dependency on it.

Assessment

The learning outcomes can be assessed through a 2x2 game theory question based on any oligopoly on a homework or exam question. For example, an exam could include a 2x2 matrix. The student can be asked to solve for the Nash Equilibrium. This question can be focused on other oligopoly examples, different than OPEC, and can have a subsequent question asking for the connection between the Prisoner's Dilemma and oligopoly price formation.

References and Resources

Prior to class listen to:
  • https://www.npr.org/sections/money/2016/10/21/498867764/episode-731-how-venezuela-imploded. In this NPR Planet Money episode, an in-depth analysis about Venezuela's current crisis is provided. This analysis provides an important example of the risks of depending on high oil prices, which serve as a motivation for studying OPEC's inability to act as a monopoly.