Output adjusting cartels facing dynamic, convex demand under uncertainty: The case of OPEC

This paper analyzes the optimal strategy of a monopoly facing stochastic and dynamic demand and choosing a Cournot-type strategy, more precisely, adjusting its output. This investigation is motivated by the decisions of OPEC to adjust its output and by the again high and volatile oil prices. The oil market characteristics – uncertainty, dynamic and convex demand, and a quantity adjusting cartel – provide in turn an explanation for two different kinds of volatility for oil prices, small and large. Moreover, it makes a difference in such a setting whether OPEC plays in prices (as it did up to 1985) or in quantities (its current policy) and the model implications are compatible with the observed pattern. The numerical example, even accounting for all necessary caveats, suggests that OPEC may not be a perfect cartel but even assuming that OPEC behaves like a duopoly would lead to much larger supplies.