Problem
Suppose a public referendum is being held on whether or not to levy a tax on gasoline. Currently, the supply of gasoline is given by Qs = -45 + 20P. You estimate the demand for gasoline to be Qd = 130 - 30P.
You are asked to evaluate the likely effects of a tax on gasoline equal to $1 per gallon of gasoline. Specifically, you are to file a report which predicts by how much this will reduce the amount of gasoline sold. You are also asked to estimate the proportion of the tax that will be paid by the suppliers of gasoline, and the proportion of the tax that will be paid by the consumers of gasoline.
You will first need to calculate the current price and quantity of gasoline sold.
1. What is the equilibrium price and quantity of gasoline?
Next you know from your economics class that you will need to know the price elasticity of demand and the price elasticity of supply of gasoline.
2. What is the price elasticity of demand for gasoline at the equilibrium price?
3. What is the price elasticity of supply of gasoline at the equilibrium price?
Using your answers to b) and c), you are now able to determine what proportion of the tax will be paid by buyers, and what proportion of the tax will be paid by sellers.
4. What proportion of the tax will be paid by sellers?
5. What price will buyers pay after the tax is imposed?
6. How many gallons of gasoline will be sold after the tax?
Finally, a new proposal suggests that the tax should be levied on the gasoline companies instead of the buyers.
7. From what you have learned in this class, how should you respond to this proposal?