Question

“The outlook for the market in the second half of the year is starting to look more encouraging as the global economy recovers, said Mohammad Barkindo, secretary-general of the Organization of Petroleum Exporting Countries. The cartel and its allies are rapidly implementing their production cuts, he said.” (Blooberg News: “OPEC Chief Optimistic That the Worst of Oil Crisis is Over” by Vonnie Quinn, Annmarie Hordern, and Grant Smith, May 15, 2020)

Applying the model of supply and demand, explain briefly how the change(s) mentioned in the news affect the market of oil and how the equilibrium price and quantity of oil will change.

Answer 1

Due to recovery of the economy, the aggregate demand of the economy will increase, which result in the shift of demand curve from D1 to D2 in the graph. Due to production cut by OPEC, the supply of the oil will fall, which will result in shifting of supply curve from S1 to S2.

The final equilibrium point due to these two situations is E2, where price level is higher. The output will fall but how much? depends on the extent of shift in demand and supply. It is possible that output falls more than the initial output (output < at point E). It is possible that output lies between E and E1.