Suppose that the current price of oil is $60 a barrel and the interest rate is 3%.Further,suppose that the interest rate remains unchanged and no new discoveries of oil are made.If two years from now the economist for the National Petroleum company believes that the rate of oil extraction is exactly right,believes that the rate of oil extraction has been too slow,what would be the likely price for a barrel of oil at that time?

Question

Quizplus · Accepted Answer

If the rate of oil extraction has been too slow, then there will be a decrease in the supply of oil in the market. This will cause the demand-supply gap to widen, and the price of oil will increase. However, the increase in the price will be lower than what it would have been if the interest rate was not a factor. Using the formula for future value with compound interest, the price of the barrel of oil would be:

FV = PV x (1 + r)^n

Where PV = $60, r = 3%, and n = 2

FV = $60 x (1 + 0.03)^2 = $66.51

Therefore, if the rate of oil extraction has been too slow, the likely price for a barrel of oil two years from now would be below $66.51, which is the price without considering the slowdown in extraction. Hence, the most appropriate choice is C: Below $63.60 a barrel.

Suppose That the Current Price of Oil Is $60 a Barrel