How Fracking works and its effects in economics.

Fracking is a really good way to understand how supply and demand work in a real market. First of all, fracking stands for hydraulic fracturing and it's basically a way that companies will drill a well into the ground and then they will spray water and sand other items into shale rock, so there'll be the shale rock formation and they break up the shale rock and they're gonna be able to extract oil and natural gas. So this natural gas is important because natural gas can be used to heat people's homes or to power air conditioning and so forth. So we're gonna have some really interesting economic effects from this increase in the supply of natural gas.

Understanding the Market after Fracking

So basically because we have this new technology if we think about the market for the natural gas we're actually going to have a shift in our supply curve. So I've got our S1 supply curve and then we've got our downward sloping demand curve which is D and because we have a new technology that allows for more production of natural gas our supply curve is going to shift and we're going to have its shift to the right. So I'm just gonna put S2 to our new supply curve.

Now previously our equilibrium was at the red point and our old price and our old quantity of natural gas are shown in the graph. So this was the equilibrium amount but now the equilibrium is shifted. Now the equilibrium is shifted to the right. Where supply curve 2 intersects with the demand curve. So now we have this new equilibrium so if we were to extrapolate this out now we see that here we have our new price and our new price is lower than our old price. So the price of natural gas is going to go down and then if we extrapolate this new equilibrium quantity, there's going to be a higher quantity of natural gas that's being produced in the market and consumed.

Effects in the Market of Coal after Fracking

So our price has gone down in the quantity has gone up of natural gas. Now think about this, practically coal is a substitute for natural gas. Because coal can also be used to heat homes, let's just focus on heating homes in the United States because this is where fracking's had a really big impact in the United States. When we think about the market for natural gas and coal we could use either one to heat people's homes but if we have a situation where all of a sudden this new technology is decreasing the price for natural gas what is going to happen to the market for coal? If coal is a substitute or we can think of natural gas as a substitute for coal the idea is that there's a substitute that has become cheaper. So a substitute for coal has become cheaper, people can use natural gas instead of coal. The price of natural gas drops what's that going to do to the demand for coal?

So for the natural gas we had a shift in the supply curve but now with coal, we're actually going to be having a different kind of shift, we're gonna have the D1 demand curve and our demand curve is now going to shift left. So see if we've got here we're getting our new demand curve D2. Now we also have a new equilibrium, so our new equilibrium is gonna be where the new demand curve intersects the supply curve. So now we'll get our new price of coal and just correspond to this equilibrium we've got our new quantity of coal.

You see that the new quantity is lower than the old quantity and the new price is lower than the old price. So the price of coal has gone down and then also the quantity has gone down. So what has happened here, we've seen that technology has made it easier to basically produce a lot more natural gas. Because we've got this new technology where we can get natural gas out of shale rock and because natural gas can be used to heat homes it's displacing some of the coal. We got this big supply of natural gas, it's displacing some of the coals that used to be able used to heat homes. So now the price of coal has gone down and this has all happened since the beginning of the 21st century. I mean this is the devious timeframe in the U.S. Now the price of coal is plummeting and the quantity is plummeting, so what has been happening? Well, we've been having bankruptcies of coal firms.

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