Question

1. What is unit inelasticity of demand?
2. OPEC (organization of petroleum exporting countries) is a group of countries that generates 45% of the world’s total crude oil production. Hence, OPEC has significant influence on the amount of oil produced each year. Countries in the OPEC sometimes do not agree with the prevailing price of oil in the global market. In such cases, they respond by cutting their production. (Example: Saudi Arabia stops pumping oil out of some wells.) What happens to the supply curve for oil in such situations? What happens to the price of oil?
3. Again, consider a simple economy with two producers and two goods. Is it possible for the TOT to be lower than the opportunity cost of one of the producers or higher than the opportunity cost for the other producer? Why or why not?

Answer 1

a) Unit inelasticity of demand, is defined as one where a change in price does not significantly impact demand. In other words, when the price goes up or down, consumers will not change their buying habits.

b) In cases, countries in the OPEC respond by cutting their production due to disagreement with the prevailing price of oil in the global market. This would lead to flatter supply curve for oil as the price of oil will increases due to the reduction in the supply of oil and demand being constant. This in particular indicate high elasticity.

c) Yes, it possible for the TOT to be lower than the opportunity cost of one of the producers or higher than the opportunity cost for the other producer. It is because to come into terms of trade both the nations on the basis of the price of the commodities produced by each has to strike an equilibrium. And it is not always possible to satisfy the opportunity cost. Hence, TOT can be lower than the opportunity cost of one of the producers or higher than the opportunity cost for the other producer.