Question

. Iran subsidizes gasoline, leading to a price to consumers that is below the market price....

. Iran subsidizes gasoline, leading to a price to consumers that is below the market price. Use a demand-supply framework to show the excess burden generated by this subsidy? Why is there an excess burden when consumers are clearly better off?

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Answer #1

Subsidy is provided to gasoline consumers so that they demand more gasoline. Hence demand shifts from DD to DD + subsidy. The price paid by buyers falls to 0D and the price received by seller is 0A. From the equlirbrium price of 0C, these prices are making both consumer and producer better off. Consumption also rises from Q1 to Q2

  • Consumer surplus is increased by area CDFE
  • Producer surplus is increased by area CABE

However, government bears a loss on the account of subsidy equal to ABFD. If we compare these benefits and cost we find that the there is a deadweight loss measured by region BEF and this deadweight loss is still not covered by the market after subsidy. This is the reason why there is an excess burden in the market due to subsidy (measured by BEF)

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