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MSA 202

Case Study 3.4: Oil Production PAGE 140

1. OPEC currently produces about 38 per cent of the world output of oil.

Assuming the short-term price elasticity of demand is -0:28, estimate the

effect of the output cut on the current price, stating any assumptions in

your calculations.

Since the price elasticity of demand of oil is less than 1 in its

absolute value, it is said to be inelastic demand. If inelastic demand,

people buy about the same amount whether the price drops or rises.

And oil is one of those things people must have. From 3.5m barrels a

day to cut of 900,000 barrels per day, the current price of the oil may

increase sharply mainly because if oil production decreases (assuming

its inelastic demand, the price goes up.

2. Describe the factors currently driving the world demand for oil; why has

the price not fallen below the $20 level as many expected?

If the price has fallen into $20 per barrel, it means that the

production of oil increases. The factors currently driving the world

demand for oil for the price had not yet fallen $20 are that first, to be

safe, $20 is the most competitive price the OPEC could offer to have

break-even for the costs they incurred during production. And, Higher

prices will incentivize shale oil and gas production in the US and

elsewhere, eroding their market share.

3. Explain the effect of other non-OPEC producers on the cartel’s output


OPEC is a cartel that aims to manage the supply of oil in an effort,

to set the price of oil on the world market, to avoid fluctuations that might

affect the economies of both producing and purchasing countries. The

decisions of non-OPEC producers regarding on production of oil or shale

oil will affect the cartel’s output decisions in the sense that it sets the

price of oil on the world market. If they may have produced more, the

price goes down and inversely.