Empirical Analysis of OPEC Pricing Behavior Under Wealth Maximization and Rule of Thumb Models

Abstract

This paper presents, empirically tests and contrasts two models of OPEC oil price determination over the period 1974-1985. First, we test a structural model that assumes that in order to maximize wealth OPEC adjusts prices and production within each period, as a result of change in underlying demand and cost conditions. Subsequently, we present and test a rule of thumb model to explain OPEC's short run pricing behavior. A central consideration in such models relates to the determination of OPEC's target capacity utilization. Herein two formulations are proposed. First, OPEC is assumed to have an exogenously determined long run target for capacity. Second, it is assumed that OPEC sets the long run price of oil based on a revenue objective. The models were tested with quarterly data using ordinary least squares corrected for serial autocorrelation by means of the Cochrane-Orcutt technique. The rule of thumb model turns out to be comparable in terms of its explanatory power to a structural model of OPEC's pricing behavior. The results lend support to the notion that OPEC apparently