To explain the operation of OPEC in term of demand and supply model.
Explanation of Solution
The following figure shows the effects on
In the case of the oil market, when supply decreases, the response depends on the time horizon. The operation of OPEC varies in the short-run and in the long run.
Fig A. shows that when the demand and supply is inelastic, then the shift in supply curve (S1 to S2) leads to a greater increase in price.
However, in the long run, when supply and demand is elastic, then shift in supply curve (S1 to S2) in fig b. leads to a small increase in price (P1 to P2). Thus, in the shortrun, the price increases to at a greater degree as compared to the long run.
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