Oct 30 2009

Calculating the price elasticity of supply of natural gas

Published by at 10:47 am under Elasticity

Previously I blogged about the decline in demand for natural gas and the resulting decrease in quantity supplied by gas producers:

Welker’s Wikinomics Blog  ‘Disequilibrium in the market for natural gas

Professor John Whitehead over at Environmental Economics Blog took the liberty of calculating the price elasticity of supply (PES: a measure of the responsiveness of producers to a change in a product’s price) of natural gas. In this case, since the price of natural gas went down, producers decreased the quantity of gas supplied. Professor Whitehead simply found the price of natural gas, and the rest was easy, given the date from the original article:

“Amid an abundance of natural-gas supplies and soft prices, gas producers are starting to pull the plug. Chesapeake Energy Corp. said it will cut 6% of its gas production in September in response to low natural-gas prices.”

And the professor’s calculation of PES:

PES = (change in Q/Q)/(change in P/P)And the percentage change in quantity is 6% (“Chesapeake Energy Corp. said it will cut 6% of its gas production …”).

…natural gas is about $5.75. During the period Feb-July ’07 price was pretty stable at about $7.50.

So, change in P/P = (7.5-5.75)/5.75 = .30 or 30%

Therefore: PES = 6/30 = .2

Update: While going over this blog post with my AP Econ students today, we noticed that the calculations from professor Whitehead’s blog are actually incorrect. The PES for natural gas is NOT 0.2, as Whitehead showed. Here’s why:

The original price of NG was $7.50, and when the price fell to $5.75 the quantity produced by Chesapeake Energy fell by 6%. Whitehead’s calculations of the percent change in price are wrong because he divides the change in price by the new price, when he should have divided it by the original price. The numerator in the PES formula should be (5.75-7.5)/7.5, which comes out to -2.33.

The PES is therefore -6%/-23.3%, or  0.26

While supply is still inelastic, it’s not QUITE as inelastic as professor Whitehead’s blog indicated.

Discussion Questions:

  1. With a price elasticity of supply of 0.26, how would you describe the responsiveness of gas producers to changes in price?
  2. Do you think the PES for natural gas would remain 0.26 over time if the prices were to remain low? Why or why not?
  3. What is the primary determinants of PES?

About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

32 responses so far

32 Responses to “Calculating the price elasticity of supply of natural gas”

  1. Sharon Lion 27 Sep 2007 at 12:43 am

    Since the PES is less than 1 at 0.2, then the gas producers are relatively unresponsive to the change in gas price. (6% change in production with a 30% changein price) However, supply becomes more elastic over a longer period of time. So the PES would not remain 0.2, but rather it will increase over time if the prices were to remain low because over time, the producers would have more time to adjust plant sizes accordingly.

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  3. Gabrielon 19 Nov 2008 at 1:44 am

    I have to agree with Sharon. Since the price elasticity of supply is 0.2, this means that the producers are relatively unresponsive, or inelastic, to a change in price. The PES would certainly not stay the same since the main determinant of supply is time. As time passes, producers become more elastic, since they have more time to adjust to changes in price. If the price of natural gas were to remain low, then producers would adjust by decreasing their supply. Producers would decrease supply because there is a direct relationship between price and quantity supplied. If prices went down, then the quantity supplied would also go down. In the short run, they might do this by decreasing the intensity of labour. In the long run they would shut down factories and decrease labour and capital.

  4. Noraon 31 Oct 2009 at 6:19 pm

    The price elasticity of supply is 0.26, which is less than one, hence relatively inelastic. This means that the gas producers are relatively unresponsive to a change in price. An inelastic supply curve shows that as price increases or decreases, the producers will not change their supply by much. The price decreased by 23.3% and the producer’s relative un-responsiveness caused a change in quantity supplied of only 6%.

    Over time, the PES would increase as the producers have more time to adjust their production according to the quantity demand. After a period of time, producers will become more responsive to a change in price, and the quantity supplied will change more.

    The primary determinant of PES is the time period considered. The longer the time period considered, the more elastic will be supply. In the market period, PES is very inelastic. In the short run, PES is more elastic, and in the long run the PES is much more elastic.

  5. Nicolo' Fanellion 02 Nov 2009 at 2:02 am

    The price elasticity of supply is, in this case, 0.26. Because it is smaller than one and bigger than zero, the PES for natural gas can be considered to be quite inelastic. This means that even if there is a large fall in prices, there will be a proportionally smaller fall in quantity supplied for gas.

    If prices were to remain low, over time PES will become more elastic and thus suppliers will supply a smaller amount of gas to its buyers. With more time, being the primary determinant of demand, producers will become more elastic. Thus, they will be able to employ less factors of productions in the gas industry, where such profits are not earned anymore and shift them to a more profitable one. Therefore, if the prices would remain this low, on the one hand it would be good for us, as we would not have to pay as much, but on the other, less and less of it will be supplied.

  6. Hannaon 03 Nov 2009 at 1:50 am

    Since 0.26 is less than one, it means that the price elasticity of supply is inelastic, meaning that producers are relatively unresponsive to a change in price. The price decreased by 23.3% but the producer’s change in quantity supplied was only 6%, which shows how the quantity supplied decreased by a much smaller number than the decrease in price, which, once again, shows that producers were relatively unresponsive.

    If the price of natural gas would remain low, then the PES would become more elastic over time, meaning that producers will decrease their quantity supplied so that it becomes closer to equilibrium. This is because over time, the producers are able to adjust to the decrease in price by decreasing their quantity supplied, so that they do not suffer from too much loss.

    The primary determinant of price elasticity of supply is time because over time the producers have time to adjust to the change in price. The more time that goes by, the more elastic the supply will become. In the market period, PES is very inelastic. In the short run, PES is more elastic, and in the long run the PES is much more elastic, so there is a constant increase in elasticity over time.

  7. Daniel Graberon 04 Nov 2009 at 6:05 am

    With a price elasticity of supply of 0.26, the producers will be quite unresponsive to a change in price. Therefore, the PES is highly inelastic. When the price of natural gas decreases, the quantity supplied will decrease proportionately less. If the prices were to remain low, the PES of natural gas would not remain the same. The producers cannot immediately change their factors of production. However, after a certain period of time, producers will be able to decrease their factors of production (they can reduce the number of employers or use less machinery). In this scenario, time is the primary determinant of PED. As more time passes, producers will be more responsive to a change in price. Therefore, producers will become more elastic. Consequently, after some time, the quantity supplied will decrease at a bigger rate than the price.

  8. Charlotte Spliidon 05 Nov 2009 at 4:29 am

    The producers are not very responsive to a change in price, or in other words, the PES is inelastic. So when there is a certain percent change in price, the percent change in quantity supplied is less.

    The PES would definitely not remain at 0.26. Take for example if the price was at 0, then the quantity supplied would most probably also be at 0, and so the PES is 0. The PES only measures at a specific point on the graph, not all the way through.

    A very important determinant of PES is time. If the price should suddenly rise, people won't really respond to it, but over time they would grow accustomed to it and may now purchase less or more of this good. Another determinant is how much the cost increases or decreases when supply changes. If the cost increases by a lot, then the producers maybe wouldn't want to increase the supply and this would make the good inelastic.

  9. kvoskuilon 05 Nov 2009 at 6:16 pm

    PES of Natural Gas

    1. The price elasticity of supply is 0.26, it is less that 1, and so it is inelastic. The calculations show that the producers are relatively unresponsive to a change in price. Since the percent change in quantity is -6% and the price change is -23.3% thus we can deduce that the producers are unresponsive to a price change.

    2. I believe that the PES of natural gas will not stay at 0.26 because producers will have had time to adjust to the change in price. The quantity demanded will increase due to a change in price so more or less will be produced.

    3. The primary determinate of supply is time. It is the time producers have to respond to a change in price. In due time, producers become more elastic because producers have had enough time to respond to a price change.

  10. Sophieon 06 Nov 2009 at 5:48 am

    The gas producers' response to this drop in price from 7. 50 to 5.75 is very low, at 6%. This means that the percentage change in quantity supplied is less than the percentage change in price of the product they have, revealing an answer less than one (0.26), and therefore proving it an inelastic product. However, if this would remain the price for a longer period of time, the company will be forced to cut back even more on production because otherwise their losses would affect them too hard. In a situation such as this one, the company either start responding to a decrease in price, or they will go bankrupt because their revenues have decreased due to the price decreases and soon enough they will have negative profits. Therefore, after time, the product will eventually become elastic.

    The primary determinant of PES is time. The reason for this is because if there has been a change of price of a product, then the company cannot immediately respond to this change. They need time in order to adapt, think and organize themselves to a new type of market output. Therefore, if there had been a change in price of a good, as time goes by the producer becomes more and more elastic, at the beginning being highly inelastic.

  11. MTon 13 Nov 2009 at 4:22 am

    This PES calculation is too simply. It uses a point elasticity calculation but the price change movement is too big for such a small delta point calculation. You should at least use an Arc-Elasticity formula since you do not know the same of the Supply curve. MT.

  12. Jonon 18 Nov 2009 at 4:27 am

    I agree — use the Arc Elasticity formula for the most correct calculation.

  13. Pilar Mulleron 03 Nov 2010 at 6:11 am

    1. A price elasticity of supply coefficient of 0.26 indicates that the supply is relatively inelastic, since it is below one. The responsiveness of gas producers in the short-run is a lot more inelastic than in the long-run. This is due to the problem of acquiring resources quickly enough. When demand for gas increases dramatically, the producers will not be able to respond to the demand and thus increase the quantity supplied in the market-period. However, in the long-run, the producers will have a lot more elastic supply thus being able to respond a lot better.

    2. The PES for natural gas will not remain 0.26 over time because as there is more time for the producers to adjust to demand changes, the PES coefficient will rise to be bigger than one, thus being elastic supply.

    3. The primary determinant of PES is the one of the time. In the short-run, supply will be always more inelastic than then long-run. In the market period, the period following a demand increase, the supply curve is nearly perfectly inelastic. In the short-run, it is relatively inelastic and in the long-run it becomes nearly perfectly elastic.

  14. Susanne Robertsonon 08 Nov 2010 at 3:05 am

    1. With a price elasticity of supply of 0.26, how would you describe the responsiveness of gas producers to changes in price?

    The responsiveness to gas is relatively inelastic as it is below 1. When the price elasticity of supply is below 1, this means that the producers will not be able to supply enough to meet the increase in demand.

    2. Do you think the PES for natural gas would remain 0.26 over time if the prices were to remain low? Why or why not?

    If the prices were to rise, the price elasticity of supply will eventually change as producers will have more time produce more. However in this case, the prices are low signifying less demand. As a result, there is no need for producers of natural gas to increase their supply at this point in time.

    3. What is the primary determinants of PES?

    The primary determinants of PES are the availability of inputs and time following the change in price.

  15. Emma Walwyn Brownon 08 Nov 2010 at 4:49 am

    1.With a price elasticity of supply of 0.26, how would you describe the responsiveness of gas producers to changes in price?

    The PES of 0.26 shows that that the responsiveness of gas producers to a change in price is low. Because the PES is below 1, it shows that gas is inelastic.

    2.Do you think the PES for natural gas would remain 0.26 over time if the prices were to remain low? Why or why not?

    The PES of gas will not remain at 0.26 over time because more time enables the gas producers to adust to the changes in quantity demanded due to the price change and therefore become more elastic.

    3.What is the primary determinants of PES?

    The primary determinant of PES is time. For example, in the short term, any crop product is very inelastic because it takes months to grow.

  16. Philippaon 09 Nov 2010 at 8:45 am

    1.With a price elasticity of supply of 0.26, how would you describe the responsiveness of gas producers to changes in price?

    The responsiveness of gas producers to changes in price is relatively inelastic; 0.26 < 1. This means that the amount being produced will not change greatly, however much the price changes due to demand shifts.

    2.Do you think the PES for natural gas would remain 0.26 over time if the prices were to remain low? Why or why not?

    Overtime, the producers would be able to obtain more raw materials and have time to produce more of natural gas, therefore PES would become more elastic and it would not stay at 0.26.

    3.What is the primary determinants of PES?

    The primary determinants of PES are the availability of inputs; the more readily available materials or goods themselves, the faster the producers can respond to changes in price either producing more or less. A second determinant would be the amount of time after a change in price when producers can adjust. With more time, the producers are able to adjust to the changes and therefore supply would become for elastic.

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