Predicting the new equilibrium price of oil after OPEC's production increase
What is the predicted equilibrium price of oil after OPEC increases its production by 4 million barrels per day?
To predict the new equilibrium price of oil after OPEC's production increase, we can use the concept of elasticity and the given information. The price elasticity of demand for oil is -0.2, indicating an inelastic demand. This means that a change in quantity demanded will result in a proportionally smaller change in price. Given that the supply of oil is perfectly inelastic, meaning it does not respond to price changes, the entire burden of the production increase falls on the demand side. To calculate the new equilibrium price, we need to determine the change in quantity demanded resulting from OPEC's production increase. OPEC increases production by 4 million barrels per day, which we will subtract from the original equilibrium quantity of 90 million barrels per day to get the new quantity demanded. New quantity demanded = 90 million barrels per day - 4 million barrels per day = 86 million barrels per day Using the price elasticity of demand formula: % Change in quantity demanded = Price elasticity of demand * % Change in price Since the supply is perfectly inelastic, the % change in price equals the % change in quantity demanded. % Change in price = % Change in quantity demanded = (86 - 90) / 90 = -4/90 = -0.044 Now, we can calculate the new equilibrium price: New equilibrium price = Old equilibrium price * (1 + % Change in price) New equilibrium price = $88 * (1 - 0.044) New equilibrium price = $88 * 0.956 New equilibrium price ≈ $84.128 Therefore, after OPEC's production increase, the predicted equilibrium price of oil is approximately $84.128 per barrel.