Greetings. In our last video we talked about the tasks that a cartel had to go about handling, if it was going to be able to get the price above the competitive level. So, to review that, where there were three of these tasks. And so look at this diagram on the left panel here, you can see we've got the market, and on the right panel, we've got an individual player in that market, okay? So, we were doing an example of OPEC. And this was the oil market. And so, we discussed the fact that for decades, from the end of World War II right up till the oil embargo in 1973, the price of oil had been pretty much rock solid right around $3 a barrel, okay? Just kind of [SOUND] straight line. And then, OPEC took that $3, I'm going to put this here and say, suppose this is the $3. That we would call it a competitive price. And OPEC said, you know what? We're going to change that. And so, we talked about the three things they had to do. The first thing they had to do, I'm going to put the tasks up here in red. The first task they had to do was to find the right output for the organization. That is, what's the optimum market output they'd like? Let's see, so well, we think we can reduce output from the competitive level to some level which we'll call Q stars of fix. So it used to be here, and we're just going to crunk down on our spigots of our oil wells and stop putting as much oil into the tankers that's going out into the open market for the world. The second thing they had to do, is they needed to come up with a quota rule. And we'll write that down by saying they needed to figure out how much each one of these firms would reduce their output. because the only way you can get market output down, which is what they had to do, they needed to shrink market output, to get price up, is that each one of the members had to take their fair share and cut down a little bit of their own. So, we'll talk about how it's hard for them to figure that out, but they eventually did. And what that meant was that the firm would would end up with some quota that was less than what it had been producing back in the competitive days. But, because of that, Price goes way up, this is the price in the fix, okay? And that price goes over here. And the individual firm, Realized that, at the current price in the market, which let's say is $12. At the current price of $12, my marginal cost is even less than what it used to be. I mean we used to be producing and giving for $3. That was the marginal revenue in the old days. I was giving this amount of output right here. But now, for less output and less marginal cost, I'm getting a lot of money. And so, what I'd like to do is push a few more barrels out, sort of what we call the incentive cheat. And, to stop that, the third task for firms to try to make their cartel work, is they needed to have a policing mechanism. They needed to set up some set of rules that would detect fellow cheaters in the cartel. Who is it that's shipping out midnight runs of oil and going above their quota? And then when they found those people they had to have credible deterrence. To say, if you do that, here's what we're going to do, the punishment is going to hurt, okay? Credible deterrence is something that's going to hurt, all right? That's kind of the way to think about this. Well, if this works, what we need to do is think about, what is the welfare analysis of the situation, okay? What's the welfare analysis? Remember what we talked about welfare? Welfare is really just an analysis of the efficiency of this. In other words, let's bring our friend, the benevolent dictator into the game, and see what the benevolent dictator would say about this particular outcome. And so to do that, we're going to draw a simple supply and demand picture. Put price on the vertical axis, market output on the horizontal axis, and we will draw a demand curve. That demand curve will just be like this. And we'll draw a supply curve to look like this. D0, S0. And we know that the competitive outcome was here. Again, I don't know exactly where that is. I just know that demand curve slopes down and supply curve slopes up. So,I have drawn the general shape of that. And that would give us an outcome where we would have, in the beginning, in the competitive case, we would experience consumer surplus, That looks like this. And we would experience producer surplus. That was this shaded area. So this would be producer surplus, and this would be consumer surplus. And, the benevolent dictator was quite happy. This output is exactly equal to the socially optimal output. But then when the cartel rolls around, look what happens. When the cartel rolls around, the cartel says, wait a minute, wait a minute, wait a minute. We're going to reduce output down to Q star sub fix, and that's going to drive price up to P star Sub fix. And in this world, the new consumer surplus is just, Let's see, new consumer surplus is just this triangle, okay? The price has gone up. Consumer surplus, if you recall, consumer surplus is the distance between what consumers would be willing to pay, oops, that little stick of mine kind of vanished, the distance between what consumers would be willing to pay minus what they actually have to pay for that barrel of oil. And we add all those up, and all we have now for consumer surplus is that small yellow triangle. What's happened to producer surplus? Well, producer surplus is the area below price, above marginal cost, which of course, the supply curve is just the sum of the marginal costs of the players in the industry. So producer surplus, becomes this. And what we see is that, in the eyes of the benevolent dictator, things are going bad. In the eyes of benevolent dictator, we now have this blue area, we call this the dead weight loss. The producers have made themselves more wealthy. Consumers are really taking a beating. And, on the whole, remember the benevolent dictator doesn't care consumers. Dollar to consumers dollars to producers, the benevolent dictator feels that distribution is irrelevant to it. All the benevolent dictator cares about is the size of the pie. And, clearly, the size of the pie has shrunk, because we're missing that entire blue triangle. It's gone now. It's just not there because the market only gets out to this Q star sub F. Thanks.
