Question

Each student (using his / her own language) explains and interprets these two pages on Customs taxes on US oil imports.

You are required to explain the idea from the presented paper to someone who does not know anything about economics, that is, you have to simplify the idea while explaining it

Supply and Demand Analysis: An
Oil Import Fee
The basic logic of supply and demand is a powerful tool of analysis. As an extended example of
the power of this logic, we will consider a recent proposal to impose a tax on imported oil. The
idea of taxing imported oil is hotly debated, and the tools we have learned thus far will show us
the effects of such a tax. .
Consider the facts. Between 1985 and 1989, the United States increased its dependence on oil
imports dramatically. In 1989, total U.S. demand for crude oil was 13.6 million barrels per day. Of
that amount, only 7.7 million barrels per day (57 percent) were supplied by U.S. producers, with
the remaining 5.9 million barrels per day (43 percent) imported. The price of oil on world mar-
kets that year averaged about $18. This heavy dependence on foreign oil left the United States vul-
nerable to the price shock that followed the Iraqi invasion of Kuwait in August 1990. In the
months following the invasion, the price of crude oil on world markets shot up to $40 per barrel.
Even before the invasion, many economists and some politicians had recommended a stiff
oil import foc (or tax) that would, it was argued, reduce the U.S. dependence on foreign oil by
(1) reducing overall consumption and (2) providing an incentive for increased domestic produc-
tion. An added bonus would be improved air quality from the reduction in driving.
Supply and demand analysis makes the arguments of the import fee proponents easier to
understand. Figure 4.5(a) shows the U.S. market for oil. The world price of oil is assumed to be
$18, and the United States is assumed to be able to buy all the oil that it wants at this price.This means that domestic producers cannot get away with charging any more than $18 per barrel. The
curve labeled Supplyus shows the amount that domestic suppliers will produce at each price level.
At a price of $18, domestic production is 7.7 million barrels. Stated somewhat differently, U.S.
producers will produce at point A on the supply curve. The total quantity of oil demanded in the
United States in 1989 was 13.6 million barrels per day. At a price of $18, the quantity demanded
in the United States is point B on the demand curve.
The difference between the total quantity demanded (13.6 million barrels per day) and
domestic production (7.7 million barrels per day) is total imports (5.9 million barrels per day).
Now suppose that the government levies a tax of 33 1/3 percent on imported oil. Because the
import price is $18, a tax of $6 (or .3333 X $18) per barrel means that importers of oil in the
United States will pay a total of $24 per barrel ($18+ $6). This new, higher price means that U.S.
producers can also charge up to $24 for a barrel of crude. Note, however, that the tax is paid only
on imported oil. Thus, the entire $24 paid for domestic crude goes to domestic producers.
Figure 4.5(b) shows the result of the tax. First, because of a higher price, the quantity
demanded drops to 12.2 million barrels per day. This is a movement along the demand curve
from point B to point D. At the same time, the quantity supplied by domestic producers increased
to 9.0 million barrels per day. This is a movement along the supply curve from point A to point C.
With an increase in domestic quantity supplied and a decrease in domestic quantity demanded,
imports decrease to 3.2 million barrels per day (12.2 - 9.0).'
The tax also generates revenues for the federal government. The total tax revenue collected is
equal to the tax per barrel ($6) times the number of imported barrels. When the quantity
imported is 3.2 million barrels per day, total revenue is $6 X 3.2 million, or $19.2 million per day
(about $7 billion per year).
What does all of this mean? In the final analysis, an oil import fee would (1) increase domes-
tic production and (2) reduce overall consumption. To the extent that one believes that
Americans are consuming too much oil and polluting the environment, the reduced consump-
tion may be a good thing.

Answer 1

Between the years 1985 and 1989, US imported a lot of oil from other countries abroad, as the price of such oil was lower, the payment on oil purchased from overseas wasn't drastic.

However when the price of oil increased, US had to spend a lot on such imports. As the prices earlier were lower, the domestic oil producers did not have any incentive to increase production because they knew the revenue which they would earn would be lower.

When the government imposed an import tariff, which is basically a tax imposed on oil bought from overseas. The price of such imported oil increased, and domestic producers were able to charge a higher price because the price of imported oil itself increased, earlier the domestic producers were not able to charge such a high price because imported oil was cheap.

As the price of oil in the domestic market increased, domestic producers were provided an incentive to increase production, because they realized that they will earn more and thus the domestic supply increased. As the price increased, people demanded less oil because they had to spend a larger part of their income on oil. As domestic suppliers increased output, quantity of imported oil fell.

The revenue which was collected by imposing the tax also increased the tax base of the federal government. In the end the reduced demand also led to less environmental pollution levels.