Elasticity: The Most Useful Number in Economics

You wake before dawn on October 16, 1973, in Kuwait City. Outside, the city hums with a tension that has been building for weeks. The Yom Kippur War is twelve days old. Arab nations are furious at American military support for Israel, and tonight, in a conference room at the Kuwait Sheraton, the finance ministers of the Organization of Arab Petroleum Exporting Countries are about to make a decision that will reverberate through the global economy for decades.

You represent one of the largest oil producers on earth. The question on the table is deceptively simple: cut oil production to punish Western nations that support Israel. But the real argument is about how much to cut.

Two camps have formed around the conference table.

The first camp argues for a modest cut: reduce output by roughly 5 percent per month until political demands are met. The logic is cautious but compelling. Oil is already the lifeblood of Western industrial economies. A small, sustained squeeze will cause real pain without triggering a desperate search for alternatives. Push too hard, and you might accelerate the very thing you fear most: a crash program of Western investment in nuclear power, North Sea drilling, and energy conservation that could permanently shrink demand for your oil.

The second camp wants something far more dramatic: an immediate cut of 25 percent or more, paired with a full embargo on shipments to the United States and the Netherlands. The logic here is equally compelling. Half-measures will be absorbed and forgotten. Western economies are so deeply dependent on cheap oil that even a severe shock will not cause them to reduce consumption meaningfully, at least not for years. If that is true, then a dramatic cut means dramatically higher prices, and higher prices on roughly the same volume of sales means an enormous windfall for every nation in this room.

Both arguments sound reasonable. Both cannot be right.

The entire outcome hinges on a single question that nobody around that table can answer with certainty: if oil prices spike sharply, by how much will consumers and industries actually cut their consumption? Will they scramble to find alternatives immediately, collapsing your revenue? Or will they grimace, pay the higher price, and keep the engines running?

You have to choose a side before sunrise.