Collaborative Research: Market power and resource allocation

University Of California-Los Angeles, Los Angeles CA

Investigators

Abstract

Most discussion of the social cost of market power focuses on the harm to consumers, with little focus on the extent to which production can be distorted. However, market power and especially cartelization can be a significant source of production misallocation. This project aims at measuring this effect in an important setting -- the global market for crude oil, in which the OPEC cartel, the largest cartel currently in existence, is active. Over the course of history, OPEC has allocated production to members via a quota system. One effect of this quota system is to shift output from low cost producers to high cost producers. By exploiting a comprehensive data of global oil producing assets, this project will produce precise estimates of the global costs of this production distortion. Therefore, this research will enrich public understanding of the global costs of the current structure of the global oil market, and better inform microeconomic policies on the relative costs of market power. This project aims to investigate the extent to which market power can be an important source of production misallocation. This research will engage with existing literatures in the fields of Macroeconomics and Industrial Organization that seek to understand the sources of differential performance across countries and industries. The setting is the global oil market. Using a comprehensive global data set of oil producing assets, the investigators will first measure covariances between observed production costs and market shares, because variation in these measures can be shown to reflect variation in misallocation over time. The investigators will then adopt a more structural econometric approach to estimate asset-specific cost functions and further aggregate them to form an industry supply function. This will allow current allocations to be compared to the allocations that would occur in a perfectly competitive model, hence providing a static quantification of misallocation on a year-by-year basis. This static measure will then be adjusted to account for the dynamic extraction problem embodied in the oil production process, which will be addressed by adapting existing computational oligopoly methods from Industrial Organization.