Suppose the current price of oil is $120 per barrel. At its next meeting, OPEC d

Question

Suppose the current price of oil is $120 per barrel. At its next meeting, OPEC decides to increase crude oil production by 10%. Assume that OPEC accounts for 40% of the world's supply of crude oil and no other nation changes its oil production during the time frame being considered. The price elasticity of demand for oil is estimated at 0.1. What will be the price of oil after the OPEC's action? (In your calculations use the conventional formula for percentage changes, rather than the midpoint formula.) Suppose the current price of oil is $120 per barrel. At its next meeting, OPEC decides to increase crude oil production by 10%. Assume that OPEC accounts for 40% of the world's supply of crude oil and no other nation changes its oil production during the time frame being considered. The price elasticity of demand for oil is estimated at 0.1. What will be the price of oil after the OPEC's action? (In your calculations use the conventional formula for percentage changes, rather than the midpoint formula.)

Explanation / Answer

ASSUMPTION : OIL IS A NORMAL GOOD AND THUS HAS A NEGATIVE PRICE ELASTICITY.

In the above question if OPEC increases the quantity of oil produced by 10 percent this leads to an overall increase in oil production by 10 percent as no other producer in the world is changing its output of oil.Given price elasticity of oil=0.1 , from the formula ed=percent change in quantity/percent change in price we get percent change in price as 100 percent. Thus the new oil price would be 120-120=0.(price elasticity assumed to be negative).However in case of positive price elsticity for oil our new price would be=120+120=240.

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