South-Western College Publishing - Economics  
Iran, a World Leader in Production of Oil, Considers Rationing Gasoline
Topic Elasticity ; Supply and Demand
Key Words Iran, oil, gasoline, subsidy, price control, rationing.
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Reference ID: A160878716

News Story Iran subsidizes its citizens' gasoline consumption, such that the price paid by consumers is only 1/5th the actual market price. But now it's considering not only removing the subsidy, but also rationing gasoline consumption. Why? Because while Iran has lots of oil, it's missing that middle step between crude oil and gasoline - refining capacity.

Iran has only enough capacity to meet about 60% of the country's demand for oil. As a result, it must import gasoline at world prices to meet the demand. It's costing the Iranian government dearly, and as a result of the subsidy, a significant amount of gasoline smuggling is going on. The government is considering solving the problem by lifting the subsidy, and rationing gasoline consumption. The government has also considering "smart cards," which will ration gasoline by price. That is, individuals can purchase a rationed amount of gasoline at the subsidized price, but then can purchase additional gasoline at the world import price.

Iran is in the process of boosting refining capacity, but that supply increase is still a few years away. It's been estimated that slowly phasing out the subsidy will reduce consumption by 20%, but consumers are more concerned about the price increase. Poor consumers look at the gas subsidy as a way of redistributing the wealth from oil revenues across the country. It appears that, regardless of country, no consumer likes having a subsidy taken away.

Discussion Questions:
1. Illustrate the problem in Iran with a graph of supply and demand in the market for gasoline. Be sure to identify the effect of the subsidy and the resulting shortage.
2. What is the rationale behind quantity rationing with the "smart cards?"
3. Why would smuggling occur in the presence of the subsidy?
Multiple Choice/True False Questions:
1. A subsidy has the effect of
  1. Keeping the price above the market equilibrium price
  2. Keeping the price below the market equilibrium price
  3. Keeping market quantity below the market equilibrium quantity
  4. A and C
2. In the market for gasoline in Iran, there is currently

  1. An excess of supply over demand
  2. An excess of demand over supply
  3. An equilibrium between supply and demand
  4. None of the above
3. The purpose of a subsidy is to
  1. Increase consumption by reducing price
  2. Decrease consumption by increasing price
  3. Increase consumption by increasing price
  4. Decrease consumption by decreasing price
Source "All Hands to the Pump." The Economist. March 22, 2007.
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