Greetings. We're thinking in these videos about modeling how a collusive arrangement might work. We've been using the example of OPEC to think about what happens when a group of people who are the dominant producers in a certain industry such as the OPEC, Organization of Petroleum Exporting Countries. We're talking about in the 1960s and 1970s in terms of who is producing the most oil. We were talking about how they might try to act like a cartel and produce a cartel. We came up with this idea of Cartel task number 1 and Cartel task number 1 said, "Hey, look." Given this situation where you've got price and quantity and you're not making very much because the demand curve is here. But the supply curve is so low and flat that in fact price is really, really low here, $3 a barrel, and this will put supply here. It didn't bend that way for a long, long time. Okay, so we're going to call this output Q_0 and Cartel task number 1 was to figure out, we put this up here, Cartel task number 1 was to determine to find Q star_fix which is less than Q_0, when you want to reduce output so you can drive price up. But how far do you do it? Where do you find that Q star_fix? So we said that it's a difficult problem. They might want to really reduce that are odd and make a lot of money. They might think that doing that might be too harmful to the world economy. So they want to take not too much at a time and just decrease it. These are hard problems and these guys, it was legal for them. It was above the law, there are no antitrust laws about sovereign nations. Our antitrust laws doesn't hold against sovereign nations having treaties with each other. That's what OPEC is, they get together. Those state run oil companies for these different countries, and they have come to agreement as to how to behave. That's nothing we can pursue with antitrust laws. So they can do it and they still had typically even though they could do it in the open. Imagine what it's like if you're thinking about US companies trying to have a collusive arrangement. The antitrust journals are full of these cases. You can read all about people who were sent to jail, monstrous finds when they found out people because they found a memo. I won't mention any names, but firms in industry X had gotten together at a annual product conference for their particular products that they sell in the industry and come to an agreement that they're all going to go home and raise their price by 25 percent. They wrote it all down on paper which they should have done. Because then what happens is that some morals pieces of papers falls in the hands of the FBI which is the enforcement arm of the Department of Justice, and the Department of Justice run a successful price fixing cases against them. Those people, they have to try and come up with these agreements in secret. Just imagine how hard it is for them to do that given the fact that OPEC found great difficulty even though they can just do it in public anytime they wanted. So now we have this Q star_fix. Then let's think about Task number 2. How do we implement this? How do we implement this market output reduction? Go back to the previous slide. They picked some level, and let's say that level is here. How do I know? I don't know I'm just saying suppose this is the level that they decide they're going to do it. This is the optimal output for the fix. Well, that will generate for them very nice prizes. We'll call this P star_fix. But how did they get there? How did they go from what is the current output level, the market output level is Q_0. How do we get that to pull back? So what we end up doing in these is we build, I don't want to do that in blue, we want to build a quota system. The end result of that quota system is that we are going to tell each member of the industry, each firm, which in OPEC's case, whether your country. Each firm is given a Q star_fix that they can produce, and that's it. So the idea is that if we work the quota system out, it will be that the total output in the market, Q star_fix, would be the sum over i equals 1 to N of the Q star_fix for each firm i. In other words, if we currently pushing out 50 million barrels of oil a day, we could take a rule where everybody cuts their production by half. Everybody cuts their production by half. If in fact everybody cut their own production by half, then total market would be cut by half. That would get us back to where we want to be. In this case, the quota would force each firm to produce less. Each firm is given a quota on [inaudible] reduce your output. Now this Task number 2 is super hard. It's hard because each firm says, "Not me." I tell you what, I'm currently making 400,000 barrels a day. It's not very much. I really can't reduce my output by as much as some of you undergraduates. So I'm going to ask your forgiveness and say, suppose I don't even be a member of the quota or tell me I can cut my barrels production by 10,000, I'll stay at 390,000 barrels a day. The other countries say "No, we all have to do this as a team." So what really happened in that case is the South East took the lead. The South East said, "We'll cut ours by half." So they cut from 15 million barrels a day to 7.5 million barrels a day. That's still a lot of oil, right? But the smaller countries said, "Well, that's good. I'm glad you did that. You can take my burden because you're so wealthy. I'm only getting daily production at 400,000. So please don't take any of mine, you're at 15 million. I'm glad to see you cut back but don't make me cut back because my country really needs more. We got this little war going on with our neighbors, and we need to be able to buy fighter jets and all these things." So this argument went over on and on and but they finally came to an agreement, and they'd solved Task number 2.
