ABSTRACT
This chapter uses dynamic game theory and rational expectations to analyze the nature and effects of supply shocks in oil markets. Research in applying rational expectations methodology in dynamic macroeconomics has emphasized the importance of going beyond postulating demand and supply curves to analyzing the agents' optimization problems (see, for example, Sargent, 1982). Traditional macroeconomics has often proceeded by drawing demand and supply curves for various sectors of the macroeconomy with dynamic elements introduced by including lagged variables. Dynamic elements have been viewed as arising from adjustment costs, lags in decision making, and most importantly from expectations of agents regarding future values of variables. Agents are assumed to form their expectation by using various schemes based on past observations. Analysts applied these models empirically by regarding the parameters of these dynamic demand and supply curves as "structural" (in the sense of being invariant to alternative policy rules of government or, in the present context, OPEC) and using the estimated parameter values for analyzing the effects of different policies. Implicit in this
vis-à-vis the oil exporting countries, which may conveniently be viewed as a monopoly with or without a fringe of competitive producers.
