Question

Senegal, a small country, buys propane (for cooking) on the world market, partly because there is no domesticproductionofpropane. Toencouragehouseholdstocookwithpropaneinsteadofwood(which is scarce and polluting), the country is considering subsidizing imports of propane. Use a demand and supply analysis to show the effect of such a subsidy on the price paid by consumers, and the quantity demanded and supplied.

Answer 1

In following graph, D0 and S0 are domestic demand and supply curves. Pre-trade equilibrium is at point A where D0 intersects S0 with price P0 and quantity Q0. When Senegal is a small importer, its relevant price is Pw (< P0), at which domestic demand is Q2 and domestic supply is Q1, with imports being (Q2 - Q1).

When a subsidy is imposed, domestic cost of production falls, increasing domestic supply. S0 shifts rightward to S1. Domestic demand remains unchanged since a change in domestic supply will not change world price, which stays at Pw and thus, price paid by consumers stays unchanged at Pw. But domestic supply increases to Q3, lowering imports which is now (Q2 - Q3).