OPEC Is Trapped In a Prisoner's Dilemma

OPEC Is Trapped In a Prisoner’s Dilemma

The examples we have previously given about Prisoner’s Dilemma is only about two companies or two people, however, mathematicians have been able to develop more advanced versions of Prisoner’s Dilemma that can be used to analyze the behavior of a greater number of participants. These models are invaluable to understanding the oligopolist industries with several companies and the incentives these companies confront in such industries when they are trying to form a cartel. The basic conclusion of these models with man companies is that generally the dominating strategy is to cheat on the agreements of the cartel.

This result contributes a lot to explaining why the cartel of the OPEC has difficulties when trying to reach their objective of increasing the prices of petroleum by reducing production. Simply, cheating on the agreements of the OPEC is a dominating strategy for the member countries.

In order to see how this works, first you have to understand that the OPEC has meetings where it decides how much petroleum should be produced and what part of that total production corresponds to each country. In the meetings, each country is assigned a certain amount or a quota, which is in other words the maximum amount they should produce. For example it is possible that Saudi Arabia might be assigned 12 million barrels while another country might be assigned 2 million barrels.

The problems generally start to show up after the meetings have taken place; after all of the petroleum ministers have gone back to their own countries. All of the countries realize that overproducing is their best strategy no matter what the other countries do. Let’s say for example that Nigeria decides to produce more then their 5 million barrel quota. This means that Nigeria would benefit from producing more no matter what the other countries do, for example:

If the other countries go along with their quotas, Nigeria would benefit in this case by selling above its quota because they will be able to sell great amounts of petroleum at a high price – obviously the high price would be in the case the other countries are going along with their quota.

If the rest of the countries do not go along with their quotas and they overproduce petroleum, the price of the petroleum would then be low, in other words Nigeria would also have to over produce. There would be no reason to go along with the quota if the prices are low because everybody else is cheating.

Since each country faces the same temptation of producing above their quota, generally the OPEC cartel does not work very well. In general overproduction is a dominating strategy and given the retributions, it’s too tempting.

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