Assume henceforth the parameters assumed above, and that the population includes two kinds of people: 100 million people who own cars, and have an income of $24,000, and the remainder of the population, which owns no cars at all.
What is the aggregate demand for gasoline (G), measured in billions of gallons, as a function of price? Assume henceforth that aggregate gasoline demand (measured in billions of gallons) is given by G = 120=p. Further suppose that in an e ort to reduce U.S. reliance on oil from the Middle East, the government imposes a gasoline tax of two dollars per gallon; the net price faced by consumers increases by $1.00. Finally, assume that the supply of gasoline is a linear function of its price.
a) How much revenue does the government realize from the tax increase?
b) Using the assumption that the supply of gasoline is a linear function of price along with other information from above, solve for the supply schedule.
c) How much pro ts are lost by the oil industry from U.S. sales as a consequence of the tax increase?
d) If there was no gasoline tax, what would the equilibrium price of gasoline be?
e) How much would the government need to rebate to gas consumers if it were to exactly compensate them for the increase in tax (i.e., what's the compensating variation)?
f) The sum of the compensating variation and pro ts lost provide one measure of the welfare loss associated with the gasoline tax. Compare this total loss to the revenue produced by the tax.