Let's use our model of supply and demand to model the market for oil. You should draw separate diagrams for each question that asks you to draw a diagram.

a$.$ Is the demand for oil relatively elastic or inelastic? Why do you think this is the case?

b$.$ Suppose there is a decline in the supply of oil. Draw a supply and demand diagram and use it to illustrate the impact on the market.

c$.$ Explain how the impact of the shock in part b depends on the elasticity of demand. Use a diagram $($or diagrams$)$ to support your answer.

d$.$ Suppose the government is concerned about the effect of high fuel prices on consumers. As a result, the government offers consumers a subsidy for purchases of home heating oil. Model the impact of this subsidy using a supply and demand diagram.

HINT: A subsidy means that for each unit purchased, the government provides some money. This is like the opposite of a tax. We can model the impact of a subsidy using the same method that we used to model taxes, but we shift the curve in the opposite direction. That is$,$ you can model a subsidy by shifting the demand curve up by the amount of the subsidy. $($Alternatively$,$ you could shift the supply curve down.$)$ As with a tax, there will be two prices: the price $(P_c)$ that the consumer actually pays and the price $(P_s)$ that the firm actually receives $($after accounting for the subsidy$).$ Note that in the case of a subsidy, $P_S>P_c,$ which is the opposite of what happens with a tax.

e$.$ How does the subsidy affect this market? Discuss the effect on prices and quantity.

f$.$ Discuss both the benefits and the costs of this policy. As part of your answer, be sure to discuss whether there are additional costs to society associated with the market for oil that are not captured in the diagrams you drew above.