3. In Example 9.1, we know that the supply and demand curves for natural gas in

Question

3. In Example 9.1, we know that the supply and demand curves for natural gas in the 1970s can be approximated as follows: Qs= 14 + 2PG + 0.25P, and where Po is the price of gas and Po is the price of oil. We calculated the gains and losses from price controls on natural gas and found that there was a deadweight loss of $1.4 billion. This calculation was based on a price of oil of $8 per barrel. If the price of oil were $12 per barrel, what would the free market price of gas be? How large a deadweight loss would result if the maximum allowable price of natural gas were $1.00 per thousand cubic feet?

Explanation / Answer

According to the above question ,the supply and demand curves for natural gas in th 1970s can be approximated as follows

Qs=14+2PG+0.25PO and   QD= -5PG+3.75PO'

PG- Price of the gas

PO- Price of the oil

Take price of the oil at $12 per barrel, So take the value of Po =12 and put in the above equation of QS and QD

Now the above equation become

QS= 17+2PG    and QD=45-5PG

Now equating the equation of quantity demanded with quantity supplied

Now, QS = QD

17+2PG = 45-5PG'

So, PG=$ 4

At, PG=4, the equilibrium quantity or QS becomes 25 thousand cubic feet(Tcf)

If a ceiling of $1 is imposed,

Producers supply 19 Tcf and Comsumers demand 40 Tcf.

The area below the demand curve and above the supply curve is consider as the Deadweight loss and here it is between the quantities of 19 Tcf and 25 Tcf.

Deadweight loss can now be calculate as

0.5(5.2-4)(25-19)+0.5(4-1)(25-19)= $ 12.6 billion

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