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Econ 200 AG

Article Response 3

NORWAY AND THE OPEC PRICE SHOCK


Alex Menendez
December 4th , 2014
Economic Topic(s): Producer Theory, Game Theory
?Taken from Norway Seeks To Temper Oil Addiction After OPEC Price Shock, Bloomberg News, 12/4/14

Description / Summary:

In recent news, OPEC, the conglomeration of the worlds leading crude oil exporters, has been summarily lowering
oil prices in order to damage rival countries whose infrastructures largely hinge upon their oil industries1 . In fact,
oil prices has fallen roughly 39% since June 2014. In general, what this triggers is a food of demand for oilpriced
considerably lowerand less of a general need for jobs in the energy sector. Naturally, then, the Norwegian government
has eliminated roughly 7,000 oil jobsa massive hindrance to Norwegian gross domestic product. At the same time,
however, economists warn that the very act of protecting these jobs is what solidifies a countrys (specially Norways)
utter dependence upon its commodities sector and oil usage. Thus, in the current situation, Norway is forced to
decide between two difficult consequences:
Weaken GDP
Possibly reduce chances for energy independence
What has been decided, however, is that falling oil prices will be exploited to boost Norways relative competitiveness.
The primary route through which this will be done, according to Prime Minister Erna Solberg, is to lower production
costs in among emerging energy producers, thus investing less money into a slowly weakening sector.

Analysis:

In general, Norway faces a situation in whichdue to losses in oil jobsit must put several investment projects on
hold, thus lowering its expectations for spending on oil production. At a glance, it may seem that it works out
that Norway has to be responsible for less workers (i.e., less contributions to variable cost), yet a closer look reveals
otherwise. Consider the general equation that expresses profit:
= (p ct ) q
Where ct is the average total cost. If less workers (capital) are to be paid and factored into the cost of production,
it would seem that overall, should become larger. However, the quantity produced (and subsequently sold) would
also decreases due to a decrease in the number of employees. Thus, profit would not increase, and the situation
boils down to one in which the Norwegian government is spending money on a sector that is consistently producing
less. Of course, the mathematics would have it that they spend less, but at the cost of having total revenue and the
number of barrels exported being smaller as well. Thus, in response to lower oil prices (driven by OPEC), Norway
is deciding to lower its production costs on oil. We can translate this into the corresponding payoff matrix where
the entries represent the utilities of Norway and OPEC(N , O ). The columns correspond to decisions made by
OPEC, while the rows correspond to decisions made by the Norwegian government. A one corresponds to a win,
while a zero corresponds to a loss.
Low Spending on Oil
High Spending on Oil

Charge a Low Price


(1 , 1)
(0 , 1)

Charge a High Price


(1 , 0)
(0 , 0)

In the above table, the optimal solution (where both Norway and OPEC receive optimal utility) is to respond to
low prices (enforced by OPEC) by lowering the cost of production in order to stay competitive and possibly increase
competitiveness. Also note that the above payoff matrix is slightly non-traditional in that it doesnt have both
players taking the exact same actions; rather, OPECs actions revolve around price-setting, while Norways actions
revolve around spending.

1 This

has been referred to as a deathmatch.

Econ 200 AG

Article Response 3

P
Soil

peq
pnew

Doil
qeq

qnew

Depicted in the above graph is a shift away from equilibrium within the oil market to a new set of coordinates,
(qnew , pnew ), under which a shortage occurs due to a low supply of oil, yet an ever-increasing demand.