Business

3. Congress and the president decide that the United States should reduce air pollution by reducing its use of gasoline. They impose a $0.50 tax for each gallon of gasoline sold.

a. Should they impose this tax on producers or consumers? Explain carefully using a supply-and-demand diagram.

b. If the demand for gasoline were more elastic, would this tax be more effective or less effective in reducing the quantity of gasoline consumed? Explain with both words and a diagram.

c. Are consumers of gasoline helped or hurt by this tax? Why?

d. Are workers in the petroleum industry helped or hurt by this tax? Why?

a. In theory, it does not matter whether the tax is imposed on producers or consumers(the effect is predicted to be the same. If the tax is imposed on producers (sellers), then we represent this case by shifting the supply curve up by the amount of the tax ($0.50)—from S1 to S2 in the diagram below. If the tax is imposed on consumers (buyers), then we represent this case by shifting the demand cure down by the amount of the tax ($0.50)—from D1 to D2 in the diagram below. In either case, the quantity bought and sold is predicted to decrease by the same amount, from Q1 to Q2, the price paid by consumers is predicted to increase by the same amount, from P1 to P2, and the price received by producers is predicted to decrease by the same amount, from P1 to P2 – 50¢. This equivalence comes from the fact that a tax on sellers also hurts buyers because sellers sell less and charge higher prices, and a tax on buyers also hurts sellers because buyers buy less.

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b. A large price elasticity of demand (in absolute value) represents the case when consumers are very responsive to price changes, including price changes caused by taxes. Thus, when taxes increase the price paid by consumers and consumers are very responsive to this price change, they will decrease they amount of gasoline that they want to buy by a large...