Sep 30 2010
Here’s a great example of a market in disequilibrium:
“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. The Oklahoma City-based company will also reduce its capital spending by 10% in 2008 and 2009. Other natural-gas producers are cutting back their output as well, analysts said.”
We learn in IB and AP Economics that markets are generally efficient thanks to the signals that prices send from consumers to producers to determine where scarce resources should be allocated. We’ve also learned how supply and demand interact in a market (such as that for natural gas) to determine equilibrium price and quantity. In the above example, there exists a disequilibrium, where either the quantity demanded exceeds the quantity supply (a shortage), or the quantity supplied exceeds the quantity demanded (a surplus).
Based on the excerpt above, discuss the causes and effects of the disequilibrium in the natural gas market. Are resources being under or over-allocated towards gas production right now? What about in a month or two? On a piece of scratch paper, sketch a supply/demand diagram and illustrate the above scenario. Describe the shifts you would draw in such a diagram.
- What is meant by “soft prices” in the natural gas market? Assuming output by gas producers remained constant, what must have changed to cause the soft prices?
- How have firms responded to soft prices? Does the reaction of the gas companies support the law of supply? Explain
- In the next month, what will happen to supply of natural gas?
- What may happen in the natural gas market if firms reduce capital spending in the next two years?
Once you’ve read this post, thought about the situation in the gas market, and commented below, read this for a clear, concise explanation of the situation from a college professor, or click here: Environmental Economics: A demand and supply example
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