Cartelization
(Abnormal Profits)
Diagram(1.1)
The above diagram is an example of cartel, OPEC, where many firms colluding together have a very low (average total cost). In 1970 OPEC ‘S prices even crossed $100, the box above (PabC) shows the abnormal profits being earned by OPEC, after acting as a cartel, excess price reduced the rate of increase in demand for oil, because the countries cannot avoid the use if oil in the short run, so they started making much more efficient use of the oil they used to buy, hence reducing the growth of demand.
UNSTABLE PRICES & FALLING DEMAND (1970 Scenario)
NON- OPEC MEMBERS- The countries which were not involved with OPEC started producing as much as possible and meeting the consumers demand at a lower rate than OPEC’S. This gave the opportunity to the regional and non-OPEC members to produce to the optimum limit, hence making huge amount of profits.
The countries which were within the boundaries of OPEC also started producing according to their limits and thus this gradually increased the supply of oil in the market and hence it was very hard to manage the prices of oil by OPEC because of the above conditions.
Diagram(2.1)
The above diagram shows that due to the production of extra oil from the OPEC members, in order to achieve more profit , has lead to an increase in supply from S1-S2, and decreasing the price level from P1-P2, Thus, the quantity supplied has increased and caused decrease in the price of oil.
Increase In demand and gaining the Equilibrium price -:
Diagram (3.1)
The above diagram shows the setting back of the equilibrium, where the demand curve for the oil, shifts from D1-D2 and there is a new equilibrium price set at Eq2 and the quantity demanded increases to Q2.
The increase in demand should also cause an increase in the supply of oil in the world market, because all the countries and firms not associated with OPEC, should have started production to get some hold of profit from increasing demand, but all the sources of supply and production of oil by the other countries and organizations have finished and now the countries will have to use expensive technology to extract oil which will cause them( the non-OPEC members and firms) a huge increase in average costs.
OPEC has got huge oil reserves and production possibilities, but OPEC will not squeeze all of it, in the market, OPEC will keep the oil reserves intact and take long time to build upon new oil fields and keep the supply in control, to charge between a profitable range of $60 & $80.
Conclusion
The government will demand highest efficiency from the usage of oil and spend money on increasing the efficiency.