(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 347

322 PART 2 • Producers, Consumers, and Competitive Markets

EX A M P L E 9. 1 PRICE CONTROLS AND NATURAL
GAS SHORTAGES
In Example 2.10 (page 59), we discussed the price controls that were
imposed on natural gas markets during the 1970s, and we analyzed what
would happen if the government were once again to regulate the wholesale price of natural gas. Specifically, we saw that, in 2007, the free-market wholesale price of natural gas was about $6.40 per thousand cubic
feet (mcf), and we calculated the quantities that would be supplied and
demanded if the price were regulated to be no higher than $3.00 per
mcf. Now, equipped with the concepts of consumer surplus, producer
surplus, and deadweight loss, we can calculate the welfare impact of this
ceiling price.
Recall from Example 2.10 that we found that the supply and demand
curves for natural gas could be approximated as follows:
Supply: QS = 15.90 + 0.72PG + 0.05PO
Demand: QD = 0.02 - 1.8PG + 0.69PO
where QS and QD are the quantities supplied and demanded, each measured
in trillion cubic feet (Tcf), PG is the price of natural gas in dollars per thousand
cubic feet ($/mcf), and PO is the price of oil in dollars per barrel ($/b). As
you can verify by setting QS equal to QD and using a price of oil of $50 per
barrel, the equilibrium free market price and quantity are $6.40 per mcf and
23 Tcf, respectively. Under the hypothetical regulations, however, the maximum allowable price was $3.00 per mcf, which implies a supply of 20.6 Tcf
and a demand of 29.1 Tcf.
Figure 9.4 shows these supply and demand curves and compares the free
market and regulated prices. Rectangle A and triangles B and C measure the
changes in consumer and producer surplus resulting from price controls. By
calculating the areas of the rectangle and triangles, we can determine the
gains and losses from controls.
To do the calculations, first note that 1 Tcf is equal to 1 billion mcf.
(We must put the quantities and prices in common units.) Also, by substituting the quantity 20.6 Tcf into the equation for the demand curve,
we can determine that the vertical line at 20.6 Tcf intersects the demand

curve at a price of $7.73 per mcf. Then we can calculate the areas as
follows:
A = (20.6 billion mcf ) * ($3.40/mcf) = $70.04 billion
B = (1/2) * (2.4 billion mcf) * ($1.33/mcf ) = $1.60 billion
C = (1/2) * (2.4 billion mcf ) * ($3.40/mcf ) = $4.08 billion
(The area of a triangle is one-half the product of its altitude and its base.)
The annual change in consumer surplus that would result from these
hypothetical price controls would therefore be A - B = 70.04 - 1.60 =
$68.44 billion. The change in producer surplus would be -A - C =
-70.04 - 4.08 = -$74.12 billion. And finally, the annual deadweight loss