Why Did OPEC Fail to Keep the Price op On High

Many of the most disruptive events for the world's economies 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 incomes. 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 tluin 50 percent. Then, a few years later, OPEC did the same thing again. From 1979 to 1981, the price of oil approximately doubled.

Yet OPEC "found il difficult lo maintain a high price. From 1982 to 1985, the price of oil steadily declined about 10 percent per year. Dissatisfaction and disarray soon prevailed among the OPEC o.nintries. 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 19711, and it stayed at that low level throughout most of the 19^05- (Tn the first decade of the 21st century, the price of oil rose again, but the main driving force was not OPEC supply restrictions but, rather, increased world demand, in part from a large and rapidly growing Chinese economy.)

This OPEC episode of the 1970s and Nflils 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 is inelastic because buying habits do not respond immediately to changes in price. Thus, as panel (a) of Figure 8 shows, the short-run supply and demand curves are steep. When the supply of oil shifts from St to the price increase from P, to P, is large.

The situation is very- different in the long run. Over long periods of time, producers of oil outside OPEC respond to high prices by increasing oil exploration and by building new extraction capacity. Consumers respond with greater conservation. for instance by replacing old inefficient cars with newer efficient ones. Thus, as panel <b) of Figure 8 shows, the long-run supply and demand curves are more elastic. In the long run, the shift in the supply curve from s, to s, causes a much smaller increase in the price.

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  • ausonia
    Why did OPEC fail to keep the price of oil high?
    8 years ago

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