Many of the most disruptive events for the world’s economics
over the past several decades have originated in the world market for oil. In
the 1970s members of the Organization of Petroleum Exporting Countries (OPEC)
decided to raise the world price of oil to increase their income. These
countries accomplished this goal by jointly reducing the amount of oil they
supplied. From 1973 to 1974, the price of oil (adjusted for overall inflation)
rose more than 50 percent. Then, a few years later,OPEC did the same thing
again. From 1979 to 1981, the price of oil approximately doubled. Measured in
2004 dollars, the price of crude oil reached $91 per barrel, and the price of
gasoline was $3 per gallon.
Yet OPEC found it difficult to maintain a high price. From
1982 to 1985, the price of oil steadied declined about 10 percent per year.
Dissatisfaction and disarray soon prevailed among the OPEC countries. In 1986,
cooperation among OPEC members completely broke down and the price of oil
plunged 45 percent. In 1990, the price of oil (adjusted for overall inflation)
was back to where it began in 1970, and it stayed at that low level throughout
most of the 1990s. in the early 2000s the price of oil rose again driven in
part by increased demand from large and rapidly growing Chinese economy, but
it did not approach the levels reached
in 1981.
This OPEC episode of the 1970s and 1980s shows how supply and demand can behave differently in the short run and in the long run. In the
short run both the supply and demand for oil are relatively inelastic. Supply
is inelastic because the quantity of known oil reserves and the capacity for
oil extraction cannot be changed quickly. Demand id inelastic because buying
habits do not respond immediately to changes in price. Thus as the short-run
supply and demand curves are steep. When the supply of oil shifts from the
price increase from is large.
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