Question

Suppose initially an oil market faces the demand curve Qᵈ=100−Pᵈ

, and the supply curve Qˢ=Pˢ /3.
However, the government considers that the price of oil is too high, and decided to give producers a subsidy of 4 dollars per barrel. a) With the subsidy, please find the new equilibrium quantity, the price buyers pay, and the price producers receive. b) We see in this case that the incidence of subsidy is shared by both consumers and producers. Under what conditions should the subsidy lower the price consumer pay by 4 dollars per barrel? (hint: elasticity)

Answer 1

The government subsidy shifts the supply curve, affecting the equilibrium price and quantity. The extent to which consumers benefit from the subsidy depends on demand elasticity. Historical events like the OPEC embargo show the real-world implications of demand elasticity on oil prices.

Step-by-step explanation:

When the government provides a subsidy of 4 dollars per barrel to producers, the new supply curve becomes Qs = (Ps + 4) / 3. To find the new equilibrium, set the supply equal to the demand: (Ps + 4)/3 = 100 - Pd. Solving for the equilibrium price and quantity involves substituting Ps = Pd and then manipulating the equation to isolate P on one side. For the incidence of the subsidy to lower the price consumers pay by exactly 4 dollars, the demand curve must be perfectly inelastic, meaning consumers would buy the same amount regardless of the price. If the demand is inelastic, then producers benefit more but consumers still see some price decrease.

However, if the demand is perfectly inelastic, the entire subsidy would be passed to the consumers. The new equilibrium post-OPEC embargo showed much higher prices due to inelastic demand, whereas a more elastic demand would result in a smaller increase in price and a larger decrease in quantity, such as in the long run when conservation efforts took effect.