Mexico is a producer and exporter of crude oil. Since Mexico is a relatively small crude-oil producing country, its actions do not affect world prices; as an exporter, Mexico faces a foreign demand curve that is perfectly elastic at a price of $15 per barrel. The equation for the demand curve is Q = 26 - P, where price (P) is measured in dollars per barrel and quantity demanded (Q) is measured in billions of barrels per year. The equation for the domestic supply curve is Q = 10 + P, where quantity (Q) is measured in billions of barrels per year.
A) Assuming free trade, show graphically how much crude oil will be produced, consumed, and exported by Mexico.
B) Graphically, show the gains from trade. Explain who wins and who loses, and show how much in terms of producer and consumer surplus. Does everyone in Mexico benefit from free trade? Explain why or why not? Is Mexico as a whole better off? Explain.
C) Suppose that Mexico government provides a $2 per-barrel subsidy for every barrel of Mexican crude oil bought by foreigners. Graphically, show the effects of the subsidy on domestic production; domestic consumption; exports; and welfare of producers, consumers, the government, and Mexico as a whole.