Question

1. The challenge to the rule of Libyan leader Moammar Khadafi, and the ensuing conflict caused nearly all of Libya's 1.2 million barrels per day of oil exports to cease on February 20, 2011. As markets opened the next day, world oil prices jumped from 90 to 95 dollars per barrel.

a. Assuming perfectly inelastic short-run supply, and that total crude oil plus production was 82 million barrels per day before the loss of Libyan oil, what is the implied world short-run price elasticity of demand for crude oil? Explain how you derived your answer.

b. Oil futures markets anticipated that one year later, the price would fall to $92 per barrel, even if demand and OPEC production do not change since the loss of Libyan oil. Write one paragraph that explains some of the factors that explain why the demand and supply of oil are more elastic over a longer time horizon.

c. Suppose OPEC convened an emergency meeting to respond to the loss of Libyan oil. At the meeting, members proposed to adopt one of two choices: (1) leave all other countries' exports the same as before and enjoy the anticipated $92 price, or (2) allow each OPEC member (except Libya) to increase current production by 3 percent so as to bring world prices back to $90 per barrel. Venezuela could increase its output from its oil fields by spending $35 per barrel for each additional barrel produced. Saudi Arabia could increase its output from its oil fields by spending $15 per additional barrel. Iran could increase its output at a cost of $25 per each additional barrel. Which of the two options do you think each of the three countries would support? Explain why.

Answer 1