Given in description

Question

Suppose that, at the market clearing price of natural gas, the price elasticity of demand is -1.2 and the price elasticity of supply is 0.6. If, initially, the price was 10 percent below the market clearing price, then at this initial price there would be:

a.        A shortage equal to 1.8 percent of the market clearing quantity.

b.        A shortage equal to 0.6 percent of the market clearing quantity.

c.        A shortage equal to 18 percent of the market clearing quantity.

d.        A shortage equal to 6 percent of the market clearing quantity.

e.        (a) or (c) depending on the units of measurement being used.

Answer 1

Hello,

My answer is (C). A shortage of 18%. Keep in mind the formula to calculate elasticity is Percentual change in Quantiy divided by Percentual Change in Price. The formula is the same for Supply Elasticity and Demand Elasticity.

Given the problem is telling us we are going to be positioned at a level below market equilibrium, we know we are going to have an excess of demand. That much we know by simply basic supply demand curve analysis.

Percentual change in Demand = -1.2 x -10% = +12%

Percentual change in Supply = 0.6 x -10% = -6%

Because supply is being reduced by 6% and demand increased by 12%, shortage equals 18%. Therefore, the correct answer is (C).