South-Western College Publishing - Economics  
China Gasses Up
Subject Market Disequilibrium, Shortages and Surpluses
Topic Supply and Demand; Production and Costs
Key Words Supply, Production, Demand, Prices, China
News Story

China intends to increase natural-gas production eightfold over the next 17 years, so that it contributes 8 percent of the nation's energy supply, up from the current 1.6 percent. The reasons are that energy demand is rising five percent a year, coal produces too many environmental problems, and oil production has slowed.

Changing the energy mix is not easy. Natural gas pipelines are running at a fraction of capacity because the rate at which homes are being hooked up to use gas is slow -- a consequence of China's historical preference to supply the bulk of its natural gas to fertilizer production in order to ensure an adequate food supply. There is also concern that natural gas may not be as bountiful as hoped. China sets the price of gas low, at $75 per 1300 cubic yards, compared to the international market price of $100, which deters international private companies from exploration. Imports from Siberia may be necessary. (Updated October 15, 1998)
Questions

1. Draw a diagram of the market for natural gas in China. Put the price on the vertical axis and the quantity traded on the horizontal axis. Add a supply curve and a demand curve and mark the equilibrium price at $75 per 1300 cubic yards.
a) Show what has happened as the supply of natural gas to domestic customers has increased (without a concomitant change in the demand for gas). Assume that the Chinese government has not changed the price of gas.
b) Is there a surplus or a shortage? Explain.
c) What is the government doing to restore equilibrium? Refer to the news story. Illustrate the implications of this for the disequilibrium position on your diagram.

2. Draw another diagram of the Chinese market for natural gas. Again, show the equilibrium price as $75.
a) In the future, it is predicted that demand will outstrip supply. Show an increase in demand, with supply constant, and price unchanged.
b) Is there a surplus or a shortage? Explain.
c) According to the news story, what might be done to remedy the problem? Illustrate the effect of this on the disequilibrium on your diagram.

3. How might the price mechanism help deal with these disequilibrium situations if the Chinese government were to relinquish its control over the price of natural gas? Would China realize its objective of increasing gas usage if it changed the price of gas in the situation in Question 1? Or in Question 2? Would it matter if it did not?
Source Ian Johnson, "For Chinese, Natural Gas Is Growing in Importance," The Wall Street Journal, August 26, 1998

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