Question

(For simplicity use hypothetical prices) Assume that the world price of oil is $15 per drum. At that price, Country A imports 400 million drums a day and consumes 600 million drums a day. The government then imposes a $50 per drum tax oil imports. For every $1 increase in oil prices, domestic consumption goes down 20 million drums a day while domestic production goes up 40 million drums a day.

a) What will the new oil price be? (assume the world supply is perfectly elastic at $15)

b) What will the new consumption, domestic production, and import levels be? How much will the government collect in taxes?

c) What will be the cost of inefficient production, the loss in consumer surplus, and deadweight loss? (use the triangle formula of 1/2 x Change in price x Change in quantity for both the loss of efficiency and the loss in consumer surplus)

d) Why, from an efficiency point of view, would a $5 tax on oil be better than the $5 on oil imports?

Answer 1