Q1

1a>

As it is observed in the graph above, if the supplie is reduce, the supply curve moves to left, now
since the short run is inelastic, there are not many substitute for the oil in the market. Because the
supply curve is shifted to left we can see that the price has been changes for the demand. In this case
the demand curve remains same but the supplie sift made the price and quantity less.

As show in the graph, the previous Price was P1 and Quantity was Q1 for the Demand D and
Supply S1. After OPAC reduced the supply, the supply curve shifted to left as we know that if the supply
is decresed the supply curve shifts to left and if the supply is increased , it shifts to right. Here since the
supply curve is shifted to left, we got a new supply curve i.e. S2. S2 intersect at a point of the demand
(P2,Q2). Where P2 is the new price and Q2 is the quantity. Here the P2>P1 and Q2<Q1. As obserevd the
price is increased as the supply is decreased.

1b> So, In this question there are two condition that need to be explained.

1. What happens to labour curve when the labour start migrating from the country. So, if this
happens that means that the supply of the lobour becomes less. Please refer below graph for reference .
 E1

As we can see that the Qcurrent was the quantity and Wcurrent was the minimum wages with equilibrium
E which they had for the oil production for labour. As the labour supply decreased the Supply curve S
shifted to left and the new supply curve became S1 and we have a new equilibrium point E1. Now the
demand remained the same but the quantity decreased. Now with the same Minimum wages, the
Demand can not be supplied which is needed.

2. They increased the minimum wages.

As per the graph the new minimum wege required for for the supply for the firm is W1. Due to the
possibility of the war, to stop the supply curve from shifting further to left, the firm decided to increase
the current wage to the required wage W1. Since the demand remained same only the increase in wage
has the effect on supply not depliting any further.

Q2.

2a> Below are the two factors that prevented OPEC from sustaning the high prices in 1980s:

1. Reduced Demand :

OPEC had relied on the price inelasticity of demand of oil to maintain high
consumption, but underestimated the extent to which other sources of supply would become
profitable as prices increased.

Electricity generation from coal, nuclear power and natural gases, home heating from
natural gas and ethanol blended gasoline all reduced the demand for oil. Because of this reason
that they thought price is inelastic, OPEC fail to increase the price in 1980s as there are many
subsitutes discoved due to the high price. Now there are subsititutes for oil.
 2. Growth of Non-OPEC supply:

Due to rise of the non-OPEC oil supply grew, the demand from OPEC decreased as they
are less costly then the OPAC oil. During the 1980s, reliance on Middle East production almost
become null as commercial exploration developed majorly on non-OPEC oilfields in Siberia,
Alaska, the North Sea and the Gulf of Mexico and the Soviet Union became the world's largest
producer of oil. OPEC tried to reduce the supply more to increase the price but it failed
drastically because now there were other players in the market to compete against OPEC.

2b> Supply elasticity is the extent of change in the supply by a unit change in price.

Formula for Supply Elasticity is :

% change in quantity supplied

% change in price

For short run the elasticity is less than 1 but in the long run the elasticity is generally greater than 1.

If the the elasticity is less than 1, it is considered inelastic and if greater that 1 it is elasticity.

Example of Supply elasticity :

Example 1: Lets take as example of Lays potato chips

Currently Lays potato chips are of Rs.20, suddenly the supply is decreased to increase the price.
So, what will happen now. The elasticity of chips for the short run will be inelastic as people love lays more
than other companies’ chips.

Since for the chips we have many substitutes so eventually people will switch to other companies’
chips as they are cheaper then Lays potato chips. So now the elasticity will become more elastic as people
switch to other companies’ product.

Example 2: Lets take as example of Windows operating system

If microsoft decides to decrease the supply of windows OS to increase the price, for the short run
they will have increased revene as people will buy as they are not that much familiar with other OS. In the
long run if this continues, people will switch to either Mac Os or Linux OS which can be substituted for
windows .

So for the short run the supply elasticty was very low as but in the log run the elasticity will become
more as people start switching to other OS. So for the long run the product will become more elastice.
Q3.

OPEC has an oligopoly market structure that was behaving like a monopoly. They acted as a cartel to
increase the price of the oil by reducing the supply. So, we can say that OPEC is currently in Oligopoly
market structure.

Now suppose if OPEC added 23 new countries which are the other supplier of oil in the world, it will
become a monopoly because OPEC will have less competition and more share than other countries. For
OPEC the competition will become less and the market share will become more as they are now having
more countries with them to supply oil. So, major market share will be occupied by OPEC.

Q4

Industry
Price Individual
Total Profit Change Demand
Quantity per Total Marginal Marginal Demand
Revenue (TR- in (per
(barrels) barrel Cost Cost Revenue (per million
(Q*P) TC) Profit million
(in $) barrels)
barrels)

0 40 32.5 0 -32.5 - - - 3.4 2

1 38.5 40 38.5 -1.5 7.5 38.5 31 3.4 2

2 37 42.5 74 31.5 2.5 35.5 33 3.4 2

3 35.5 51 106.5 55.5 8.5 32.5 24 3.4 2

4 34 59.5 136 76.5 8.5 29.5 21 3.4 2.5

5 32.5 72 162.5 90.5 12.5 26.5 14 3.4 2.5

6 31 87.5 186 98.5 15.5 23.5 8 4 2.5

7 29.5 108 206.5 98.5 20.5 20.5 0 4 2.5

8 28 133 224 91 25 17.5 -7.5 4 2.5

9 26.5 162.5 238.5 76 29.5 14.5 -15 4 2.5

4a> Profit maximization happens when Marginal Cost = Marginal Price or Marginal Profit becomes 0.

As we can see in the table above, this condition is true when Quantity is 7, Price is 29.5 and Total Cost is
108.

The overall level of sales revenue is the total revenue at when Quantity is 7, Price is 29.5 and Total Cost
is 108 i.e., 206.5

4b> Please refer the below ploted graph for reference. Here the Red dot is the point of profit margin as
the line of Marginal Revenue and Marginal Cost intersect and its value is 20.5 :-

4c> As in the question given for industry demands rise when the price of per barrel is $32 or less. So,
according to the data the demand changes when quantity is 6 and the profit at that quantity is $98.5 per
barrel.

As for the individual demands, it rises when the price of the per barrel is $34 or less. So, according to the
data the demand changes when quantity is 4 and the profit at that quantity is $76.5 per barrel.

Q5

5a> When the price of the oils is increased, it will have a Cost Push type of inflation. Factor for such type
of inflation is known as Higher Price of Commodities because as the price increases the dependent good
on oil will also increase their prices. Let’s take as example, if the price of crude oil increases, the price of
fuel will also increase. As the price of fuel increases, the transportation price will also increase and so on.
So, if the oil prices are raised, it will have a Cost-Push inflation.

Other factors for Cost-Push Inflation are: -

1. Rising Nominal wages

2. Devaluation – rising important prices
3. Rising food and energy product
4. Higher Direct taxes (VAT)

Real – life examples:

1. One of best real-life example is OPEC oil prices increase in 1970s. During 1970s, there was a
huge increase in the oil prices set by OPEC and the demand was not decreased. So, because of
the oil prices increased, there was a huge inflation in many countries as oil is one of the most
need goods in the world and during that time the OPEC was the major contributor of the oil.

2. In 2012, Punjab and Sind provinces of Pakistan got hit by a severe flood which swept away the
crops, shutting down refineries, killing cattle and creating widespread disruption in supplies.
Increase in general level of prices was ensured. Increase in price due to drop in aggregate supply
is another example of Cost-Push Inflation.

5b> AD-AS is a Demand and supply graph which is similar to a simple market demand and supply model
but take a broader view of the economy. Here we can say that the AD-AS graph plotted against the
output also can be called as GDP and price level (can also be referred as interest rate)
 Diagram: AD-AS model

AD-AS Graph
Price Level

Aggregate Demand
Aggregate Supply
New Aggregated supply
Old Equilibrium
Changed Equilibrium

Output

From the case study, we observed that the OPEC acted as a monopoly and reduced the supply. Now
Reducing the supply mean there will be shortage of oil and price will go up. Now, oil is one of the main
sources of economy of any country because oil is used in many things. Now during 1970s, OPEC was a
major supplier for oil in the world. So now when is consider aggregated demand and aggregated supply
of a country, oils pay a major part. Now since the supply has been reduced the aggregated supply will
get impacted. And it will shift towards left. As we can see in above graph the aggregated demand
remained same (note there will be changes in demand too but it will be very less). Now as we see in
above diagram the Changed equilibrium shows that the output is reduced and the price level is
increased as the Aggregated supply has been shifted to left. Here, we can also say that the GDP will
decrease of a country.

It also caused recession and unemployment too as the GDP has been reduced.

Now here the type of unemployment happened is called as Cyclic unemployment. Since the supply of
the oil has been reduced, many of the industry dependent on oil to work will produce less as they are
not getting the supply for the same amount which they used to get. Since the production has been
reduced, there will be labor layoff as that many man power is not need now.
Q6

6a> Two methods or resources which RBI can adopt to help country recover from short run recession
phase are: -

1. Open Market Operation (OMO)

Open market operation is where RBI comes into open market to buy or sell Government
securities. OMO is usually caried out to keep the market in check by injecting money into the
system by buying government bonds. It keeps the target interest rate in line and these are
adjusted to meet inflation target. Another objective of OMO is to ensure the liquidity of the
banking system, so there is an element of short-term control of the money supply. Now buy
injecting money into the country economy, the money starts rolling and banks can use these
money to give loans. When OPO are carried with the intention of injecting money into the
economy to stimulate it out of a recession, this is called ‘quantitative easing’. Quantitative
Easing (QE) leads to a decrease in interest rate as bank will have more liquidity. The reduced
interest rate in turn boost GDP.

2. Cash Reserve Ratio (CRR)

There is a rule in RBI that the commercial banks are required to keep a certain percentage of
deposits as reserves with the RBI. If that percentage in increased, the banks will have less money
that in turn will lead to decrease in lending money and the circulation of the money will
decrease. In the percentage of deposit is decreased, banks will have more cash. If banks have
more cash, then they have more money to lend and this is how money can be injected into the
system to boost the economy and help with situation like recession and inflation. So, by
decreasing the percentage of deposed, we can control such type of situation.

6b> As the oil prices decreases, deficit spending will reduce. Since the oil prices are reduced, there will
be less spending on transportation. As the transport cost is low, there will be a shift of supply curve to
right. This means the Aggregate demand will be meet at a lower price. There will also be a relaxation for
government. There will be an economic prosperity.

In this condition government has to use contracting fiscal policy to control the flow of money in the
economy.

Two fiscal tools adopted by government are:

1. Increase in Taxation
2. Reducing government spending

1. Increase in Taxation:

By increasing the taxes, the government tries to control the flow of money in the otherwise the
industries will keep on buying the oil and there might come a situation of deflation. By increasing Taxes,
that money can be used by the government for other purposes so that there will a be control over the
industries otherwise they will keep making more money.
2. Reducing government spending:

Government uses this to reducing government spending or we can say cutting off the expenditure for
certain sector. So, here the spending money by government will be reduced for the industry which
highly rely on oil as they are not in need of such money. If the government spending is not reduced,
there will be excess money in the economy system which is also not good for any country. It will cause
deflation which is a threat to any country.

Surplus money can cause issue in the economy of any country. So, government tries to control it by not
spending the usual amount of money of the sectors which are having surplus money as in this case
where the oil prices are reduced.

6c>

Here the nominal GDP is calculated as:

(Price per Car*Number of Cars) + (Price per Bread Loaf * Quantity of breads) + (Price per
haircut*Number of haircuts)

For Real GDP, it is calculated as:

(Price per Car for the base year * Number of Cars) + (Price per Bread Loaf for the base year * Quantity of
breads) + (Price per haircut for the base year * Number of haircuts)

Below table will show the nominal and real GDPS of each year:

Price Price Real

Quantity Number
per Number Price/Bread per Nominal GDP
Year of of
Car of Cars Loaf ($) haircut GDP (Base
breads haircuts
($) ($) 2010)
2010 10000 200 2 500 25 700 2018500 2018500
2011 12000 200 3 600 25 800 2421800 2021200
2012 12000 350 3 650 22 900 4221750 3523800

Q7

Advantages:

1. It increases the competitive advantage for local suppliers. Their products are cheaper for
foreigners, this increases exports.
2. Higher tourism since country is cheaper for foreigners, they have higher incentive to have a
vacation which also increases exports.
Disadvantage:

1. Imports will become more expensive, causes inflation for imported products.
2. All the foreign denominated debt is much more expensive.
Let’s take an example of a company who bought x amount of foreign denominated debt, now
they have to pay for it more than how much they burdened.