The government of Iraq wants to increase revenues from selling its oil
production into the international market. The nation's olil reserves are
contained in five separate fields. Each field is capable of producing the
following amount at the following constant marginal costs:
| Field | Production capacity (million barrels per day) | Marginal cost ($/barrel) |
| Heavyweight | 10 | 70 |
| Marqi al Sadr | 2 | 50 |
| Saddam Yankee |
1 | 40 |
| Baath Bonanza |
3 | 20 |
| Fediyah | 2 | 30 |
If there is no production at all in Iraq, the world price of oil is $100/barrel.
Iraq contains so much oil, however, that the amount of production in this
country affects the world price. For every million barrels produced in Iraq,
the world price drops by $2 per barrel. After the US invations, the Coalition
Provisional Authority had contracted with many different private companies
to operate in each oil field, selling in a competitive world export market.
1. How much oil would competitive operators be producing from each field?
What will be the resulting world price? How much profit will be earned from
each field? (Hint: make a table of production and revenue and create the
supply curve by ranking fields from least marginal cost to the highest marginal
cost. Plot the demand curve and marginal cost curves. Where do they intersect?)
2. government of Iraq decides to increase control over its oil resources
and turns operation of oil fields over to a state oil company. Now that the
government oil company can set production levels for each field, how much
oil will its managers decide to produce from each field in order to maximize
profits? What will be the resulting world price? How much profit will be
earned from each field? (Hint: what is the revenue obtained from selling
one additional barrel -- marginal revenue -- at each level of production?)
3. After several years of high prices, more oil reserves in other countries
are brought into production, and energy conservation measures reduce world
demand. If no oil is produced in Iraq, the price is now only $75/per barrel.
The price still declines by $2 dollar for each million barrels Iraq produces.
If the government oil company keeps production unchanged from before, what
is the new world price? Should the government oil company change production
from some fields? If so, which ones, and by how much? What will be the
effect of this action on the world price?