Problem 12 In recent years, companies have ... [FREE SOLUTION]

Chapter 5: Problem 12

In recent years, companies have used fracking, or hydraulic fracturing, in drilling for oil and natural gas that previously could not be profitably recovered. According to an article in the New York Times, "horizontal drilling has enabled engineers to inject millions of gallons of high-pressure water directly into layers of shale to create the fractures that release the gas. Chemicals added to the water dissolve minerals, kill bacteria that might plug up the well, and insert sand to prop open the fractures." Experts are divided about whether fracking results in significant pollution, but some people worry that chemicals used in fracking might lead to pollution of underground supplies of water used by households and farms. a. First, assume that fracking causes no significant pollution. Use a demand and supply graph to show the effect of fracking on the market for natural gas. b. Now assume that fracking does result in pollution. On your graph from part (a), show the effect of fracking. Be sure to carefully label all curves and all equilibrium points. c. In your graph in part (b), what has happened to the efficient level of output and the efficient price in the market for natural gas compared with the situation before fracking? Can you be certain that the efficient level of output and the efficient price have risen or fallen as a result of fracking? Briefly explain.

Short Answer

Expert verified

Fracking, despite its pollution costs factored in, has likely resulted in an increased output and decreased price of natural gas. However, concrete declarations about the output and price cannot be confirmed without actual numerical values.

Step by step solution

Assume no significant pollution

Draw a supply and demand graph depicting the market for natural gas. Label the supply curve as \(S_1\) and the demand curve as \(D\). The intersection of \(S_1\) and \(D\) will give the first equilibrium, marked as \(E_1\), showing the price (\(P_1\)) and quantity (\(Q_1\)) without fracking. Fracking, by increasing supply, shifts the supply curve to right, say \(S_2\). The new equilibrium is \(E_2\) where \(S_2\) and \(D\) intersect, showing the price (\(P_2\)) and quantity (\(Q_2\)) with fracking but no significant pollution. \(P_2 < P_1\) and \(Q_2 > Q_1\).

Assume fracking causes pollution

Now, if fracking causes pollution, it is an external cost not included in the supply cost. To account for this external cost, we add it to the supply cost which shifts the supply curve from \(S_2\) to \(S_3\) (leftward shift). The new equilibrium, \(E_3\), is now at the intersection of \(S_3\) and \(D\) indicating new price (\(P_3\)) and quantity (\(Q_3\)). \(P_3\) is greater than \(P_2\) but less than \(P_1\) and \(Q_3\) is less than \(Q_2\) but more than \(Q_1\).

Compare pre and post-fracking conditions

Comparing the efficient level of output and price before fracking (\(Q_1, P_1\)) and after factoring the pollution cost (\(Q_3, P_3\)), we see that \(Q_3 > Q_1\) and \(P_3 < P_1\). This suggests that despite the pollution costs, fracking has increased the output and decreased the price of natural gas. However, whether the efficient level of output and price have increased or decreased isn't certain without concrete numerical values.