Question

A country imports 3 billion barrels of crude oil per year and domestically produces another 3 billion barrels of crude oil per year. The world price of crude oil is $90 per barrel. An imposition of a $30 per barrel import fee on crude oil that would involve annual administrative costs of $250 million. Assume that the world price will not change because of the country imposing the import fee, but that the domestic price will increase by $30 per barrel. After the imposition of the fee, the following changes will take place:

1. Domestic consumption will fall to 5.8 billion barrels per year,
2. Domestic production will rise to 3.25 billion barrels per year,
3. Imports will fall to 2.55 billion barrels per year.

Also assume that only producers, consumers, and taxpayers within the country have standing.

1. Estimate the annual social benefits of the import fee.
2. Assume that prior to the imposition of the import fee, the country annually consumed 900 million tons of coal, all domestically mined, at a price of $66 per ton. How would the CBA of the import fee change if, after the imposition of the import fee, annual consumption of coal rises by 40 million tons, but the price of coal remains unchanged.

Answer 1

a.

Change in domestic producer surplus:

Surplus from additional 0.25 billion barrels produced

Revenue = (.25 billion)($120) = $30 billion/year

Production costs (area under supply schedule) = (.5)($120-$90)(.25 billion) + ($90)(.25 billion) = $26.25 billion/year

Net change in surplus from new production = $30 billion/year-$26.25 billion/year = $3.75 billion/year

Surplus from higher prices on original production = ($120-$90)(3 billion) = $90 billion/year

Total change in producer surplus = $3.75 billion + $90 billion = $93.75 billion/year

Change in consumer surplus:

"Deadweight loss" from reduced consumption = (.5)($120-$90)(.2 billion) = $3 billion/year

Additional payments on quantity still consumed = ($120-$90)(5.8 billion) = $174 billion/year

Total change in consumer surplus = (-$3 billion) + (-$174 billion) = -$177 billion/year

Change in tax revenues:

Import fee applied to new import level: ($30)(2.55 billion) = $76.5 billion/year

Administrative costs -$.25 billion/year

Total change in tax revenues = $76.5 billion - $.25 billion = $76.25 billion/year.

Net Social benefits: -$7.00 billion/yr

The import fee would have negative net benefits of $7 billion/year and therefore does not pass the CBA test.

b.

As long as the secondary market for coal is undistorted and its price does not change, the increased consumption of coal is irrelevant to estimation of changes in social surplus in the primary (crude oil) market.