Q. 27 During a discussion several year... [FREE SOLUTION]

Chapter 4: Q. 27 (page 105)

During a discussion several years ago on building a pipeline to Alaska to carry natural gas, the U.S. Senate passed a bill stipulating that there should be a guaranteed minimum price for the natural gas that would flow through the pipeline. The thinking behind the bill was that if private firms had a guaranteed price for their natural gas, they would be more willing to drill for gas and to pay to build the pipeline.
a. Using the demand and supply framework, predict the effects of this price floor on the price, quantity demanded, and quantity supplied.
b. With the enactment of this price floor for natural gas, what are some of the likely unintended consequences in the market?
c. Suggest some policies other than the price floor that the government can pursue if it wishes to encourage drilling for natural gas and for a new pipeline in Alaska.

Short Answer

Expert verified

It requires huge investment by the firm and therefore firm needs to be incentivized through a higher price that signals future profits.

Step by step solution

Step 1. Definition

The price floor is a market regulation when the government adjusts the price above equilibrium. The government imposes a price floor to protect sellers. Minimum wage law is an example.

Step 2. Explanation

The imposition of a price floor in the natural gas market will raise the minimum price for natural gas suppliers. Since the minimum price is higher than the equilibrium price, the quantity demanded will decrease while the quantity supplied will increase. As a result, this will lead to excess natural gas in the economy, which is an unintended consequence of the price floor in the economy.

Step 3. Conclusion

The government may also impose subsidies to encourage drilling for natural gas in Alaska. The reason is that the imposition of subsidies will reduce the production cost of suppliers, so they will be motivated to supply more natural gas.