1 When Iraq invaded Kuwait, the market price of crude petroleum jumped from $21.
ID: 1142502 • Letter: 1
Question
1 When Iraq invaded Kuwait, the market price of crude petroleum jumped from $21.54 per barrel to $30.50 per barrel—an increase of almost 42 percent. Your boss is puzzled, because the price increase actually occurred before there was a physical reduction in the current amount of oil available for sale.
a. Explain why the price of oil increased so rapidly.
b. One year after the invasion, the price of oil fell to $21.32 per barrel, its prewar level. Explain why.
2. You are an aide for the Senate Banking Committee chairman. He comes to you with a bill that proposes setting limits on what ATM owners can charge nonaccount holders, over and above what banks charge their own customers. Currently, large banks charge noncustomers an average fee of $1.35 per transaction in addition to the fees the customer's own bank imposes. The senator asks you to look at a proposal that would place a $0.50 cap on the fees ATM owners can charge noncustomers for accessing their money. If this legislation is enacted, what would be the likely Economic Welfare effects? (Hint: Look at effect on Consumer and Producer Surplus)
3. Discuss the Economic meaning of the Consumer Equilibrium condition.
Using the equilibrium condition explain why
demand curves are demand sloping,
the effects marketing and sales promotion on demand, and;
the effect of a change in tastes on demand.
4. Explain why the decision rule MR=MC is true for either the Long or Short run Profit Maximization.
5. Explain why the elasticity of demand for a firm’s product tends to be more elastic than the industry demand.
Explanation / Answer
(1)
(a) An invasion increased the political risk in Kuwait, which would disrupt oil supply. People and businesses feared that price of oil would rise after the invasion and war, therefore they increased the current consumption of oil at lower price, increasing the demand for oil. This shifted the oil demand curve rightward, increasing the price of oil. Therefore the price rise was a demand-side factor.
(b) A year after invasion, oil consumers got sufficient time to adjust their consumption bundle to substitute an alternative to oil, since choices rise in long-run compared to in short run. Therefore, demand for oil fell after a year, shifting the demand curve leftward, decreasing oil price. At the same time supply of oil started rising, shifting its supply curve rightward and decreasing oil price.
NOTE: As per Answering Policy, 1st question has been answered.
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