Reference no: EM132604886

1. Among the tax proposals considered by congress in the 1990's was a tax on gasoline. The price elasticity of the supply of gasoline is estimated to be 0.4 and the price elasticity of demand for gasoline is estimated to be -0.5. The average price of a gallon of gas in the 1990's was $1 and100 units are traded each year where a unit represents one billion gallons.

a) What are the slopes( dQ /dp ) of supply and demand curves? Illustrate the market clearing price and quantity in a supply and demand curve diagram.

b) In your diagram for part (a) illustrate the effect of the imposition of $t per unit tax on a gallon of gas. In your diagram clearly label P D(price that consumers pay), P S(price that producers receive) and the quantity traded after the tax (note that you do not need to calculate these numbers for this diagram). Be sure to indicate the following areas in your diagram:

i. Consumers Burden of the tax

ii. Producers Burden of the tax

iii. Total tax revenue

iv. Deadweight loss of the tax

c) What is deadweight loss? Why does a per-unit tax cause deadweight loss? If the government wants to minimize deadweight loss then what markets should it target for taxation?

d) If the per unit tax is $0.54 per gallon then what will be the price that consumers pay for a gallon of gas (i.e. what is PD)? How much will producers receive? What will be the quantity traded in this market? What will be the deadweight loss?

e) If the per unit tax is $0.54 per gallon what is the total tax revenue? Among the total tax revenue, how much do consumers take the burden? How much do producers take the burden?

f) If supply had been perfectly inelastic then what would have been the effect of the tax on PD, PS and the quantity traded? Who would have paid the tax? Illustrate your answer in a new diagram.