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Question:

Suppose the market demand function for oil in an industrialised oil-producing country is P = 120 - q. The marginal cost of producing it is MC = 1q, where P is the domestic oil price and q is the quantity demanded and/or supplied.

a)What are the equilibrium prices and quantities in a competitive market? Compute the consumer surplus and producer surplus. Show your answers using a demand-supply diagram.

b)Compute the equilibrium prices, quantities, and the consumer and producer surpluses, assuming a monopoly. (Hint: The marginal revenue curve has twice the slope of the demand curve). Show that when this market is a monopoly, the sum of the two surpluses is smaller than a competitive industry. Again, in a diagram, show your answers, especially the deadweight loss associated with the monopoly.

c)Assume that the government imposes a price control at the world oil price P = $40. Find the consumer and producer surplus associated with the resulting allocation assuming no import. Compare this price control allocation to the monopoly allocation in part (b).

d)The lower world oil price creates shortages in the domestic market (assume competitive market). One way to solve this problem is to allow oil imports. However, it is sometimes argued against importing oil to achieve self-sufficiency and thereby energy security. What is your opinion in this regard? Should this country allow imports of oil? Explain.

e)Now, consider the competitive domestic oil market again, where the market determines the price. Suppose to restrict the carbon emission associated with oil production, the government imposes a $40 per unit of output tax on producers. Explain, using a diagram, why the competitive price and quantity you computed in (a) are inefficient after the tax is imposed.

f)It is often argued that electric cars may help reduce dependency on oil and thereby remove associated negative environmental externality. For Australia, would you recommend promoting electric vehicles from an environmental point of view? Explain [You may need to review some literature on energy sources in Australia].