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Homework answers / question archive / Question One A

Question One A

Economics

Question One A. Something strange is happening on the world market for natural gas. News reporters have identified some factors causing the unexpected behavior of producers. First, it has been realized that the high prices for crude oil have stimulated production of crude oil, and this has increased the supply of natural gas as natural gas is usually found in the same well as crude oil. Second, natural gas wells also include sizable quantities of a valued chemical used to make plastics called ethane, and ethane prices are increasing. Third, energy suppliers recently started deploying a new, extremely productive technology for exploring and drilling for crude oil and natural gas known as hydraulic fracturing, or “fracking.”     With the aid diagram(s) carefully explain why the supply of natural gas keep increasing when natural gas prices are falling? (8 marks) B. Suppose that the general demand function for good X is   Qd =    60 - 2Px    +    0.01M + 7PR   where Qd = quantity of X demanded   Px = price of X M =    (average) consumer income   PR = price of a related good R   i. ii. iii. Is good X normal or inferior? Explain. (1 mark) Are goods X and R substitutes or complements? Explain. (1 mark) Suppose that M = ¢40,000 and PR = ¢20.   What is the demand function for good X?   (2 marks)   Suppose the supply function is   Qs = -600 + 10Px   iv. v. vi. vii. What are the equilibrium price and quantity?    (3 marks) What happens to equilibrium price and quantity if other things remain the same as in part (iv) but income increases to ¢52,000?    (3 marks) What happens to equilibrium price and quantity if other things remain the same as in part (iv) but the price of good R decreases to ¢14? (3 marks) What happens to equilibrium price and quantity if other things remain the same, income and the price of the related goods are at their original levels, and supply shifts to Qs = -360 + 10Px? (4 marks)

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A.

The observations regarding the natural gas market or crude oil market are as follows:

1. High prices of crude oil stimulated the production of crude oil and has increased the supply of natural gas.

2. Ethane prices are increasing as natural gas is used for its production.

3. New productive technology deployed by the suppliers for exploring and drilling of crude oil known as hydraulic fracturing or fracking.

The prices of natural gas or any other crude oil are determined by the market forces - demand and supply. And the prices set because of these determinants in turn decides the quantity that will be supplied in the market and the demand of crude oil.

Crude oil is a natural resource and hence is available in limited quantity. The supply of the raw material from natural resources determine the supply. When the supply is less in the market, the prices tend to rise and as a result the demand falls.

Now, in the following case it is given to us that the supply of natural gas is increasing even though the prices are falling. The reason for this might be the increase in demand due to lower prices in the market. When the prices are low, people demand more quantity od natural gas. As a result, the the suppliers see an opportunity to make a larger market share in the economy and hence earning more profits. This attracts more suppliers and motivates the suppliers to produce more.

The following diagram shows this situation:

 

The prices of natural gas fall to P1 from P and hence the quantity demanded inreases to Q1 from Q. Hence to compete with the market demand of the natural gas, the supply increase resulting in the supply curve to shift rightwards. Now, the new equilibrium condition is at E1. So, the supply increases as a result of increase in demand.

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