question 3

xanaduAn excerpt from the mid-term “problem set” in ENR-302

3. The country of Xanadu is dependent of the use of domestically produced methanol for 100% of its energy needs. The price of methanol is set by a competitive market and the fuel is priced at $2.50 per gallon. Two large companies supply 80% of the market and each has costs of $1.50 per gallon. The opposition party and most of the national labor unions argue that these two companies are making obscene profits. They demand that the President place a mandatory price cap of $2.00 on the price of methanol to prevent “this abuse of market power.”

Assume that the elasticity of demand is 0.4 and the elasticity of supply is 0.8. Discuss in 250 words or less, the impact on supply and demand, if the President gives in and caps the price of methanol at $2.00 per gallon. Explain your answer.