Consider a city that gets its natural gas from two pipelines, with each pipeline supplying half the city’s natural gas. Suppose the price elasticity of supply is 0.70 and the price elasticity of demand is 0.55. If one pipeline breaks, by how much will the price of natural gas increase? (Related to Application 6)

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Application 6 A BROKEN PIPELINE AND THE PRICE OF GASOLINE APPLYING THE CONCEPTS #6: How does a decrease in supply affect the equilibrium price? 1110 In the chapter opener, a pipeline break decreased the supply of gasoline to the city of Phoenix by 30 percent and increased the equilibrium price by only 40 percent. Given a short-run price elasticity of demand for gasoline of 0.20, a price increase of 150 percent would be required to decrease the quantity demanded by 30 percent. Why did the price increase by only 40 percent? To predict a change in the equilibrium price, we must look at both sides of the market, demand and supply. When the Texas pipeline broke, gasoline sellers in Phoenix switched to the West Coast pipeline. The increase in the Phoenix retail price allowed Phoenix sellers to outbid sellers in other cities for gaso- line produced by West Coast refineries. This is the law of supply in action: the increase in the Phoenix price diverted gasoline from other cities, reducing the impact of the pipeline break. As a result, the equilibrium price increased by only 40 percent, not the 150 percent that would have occurred in the absence of the supply boost from West Coast refineries. We can use the price-change formula to illustrate this case. Suppose the price elasticity of supply is 0.55 and the price elas- ticity of demand is 0.20. In this case, a 30 percent decrease in supply generates a 40 percent increase in the equilibrium price: percentage change in equilibrium price -30% 0.55 +0.20 40% Related to Exercises 6.5 and 6.9. 30% 0.75 SOURCE: Based on Federal Trade Commission, Gasoline Price Changes: The Dynamic of Supply, Demand, and Competition (Washington, D.C.: 2005).