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.

The subsidy increases demand, and lowers equilibrium price. The shortage occurs at the new equilibrium price, since supply cannot meet that level of quantity demanded.

2. What is the rationale behind quantity rationing with the "smart cards?"

Effectively, smart cards separate consumers according to elasticity. Those with inelastic demand will pay for their gasoline at the higher world import price. Those with elastic demand will reduce their consumption, therefore reducing overall consumption.

3. Why would smuggling occur in the presence of the subsidy?

If the subsidy reduces price in Iran, but the price of gasoline remains high in, say Iraq, then there is an incentive to buy gasoline in Iran at the low price, smuggle it across the border into Iraq, and sell it for a profit.

Multiple Choice/True False Questions