Question

Question 5 1 pts 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. What will result from a price ceiling that is 10 percent below the market clearing price? O A shortage equal to 6 percent of the market clearing quantity More information is needed. O A shortage equal to 1.8 percent of the market clearing quantity O A shortage equal to 0.6 percent of the market clearing quantity O A shortage equal to 18 percent of the market clearing quantity

Answer 1

Solution:

With the price ceiling, the price has fallen by 10%. Price elasticity formula is: %age change in quantity/%age change in price

So, %age change in quantity = elasticity*%age change in price

Thus, at this new price level:

Quantity demanded changes by: %age change in quantity demanded = -1.2*(-10) = +12%

Quantity supplied changes by: %age change in quantity supplied = 0.6*(-10) = -6%

So, quantity demanded increases by 12% while the quantity supplied decreases by 6%. So, if the initial market clearing quantity was x, the new demand = x*(1 + 0.12) = 1.12*x

The new supply = x*(1 - 0.06) = 0.94*x

The shortage is the amount by which demand exceed supply. So, shortage = 1.12x - 0.94x = 0.18x or 18% of x

Thus, along the given options, (E) is the correct option.