Question

A carbon tax is a tax on carbon based energy sources like natural gas. Let’s say that you have $100 to spend on utilities for your aparment, you can only purchase electricity from a natural gas power plant, and that electricity costs $0.10 per unit. You see electricity and all other non-carbon based utilities (e.g. internet) as imperfect substitutes.

1 Graph your current utility maximing bundle assuming that you split expenditures between electricity and other household utilities, meaning right now you spend $50 on electricity and $50 on other household utilities.

2 Assume that Massachusetts adds a $0.10 per unit tax on electricity. Graph your new utility maximizing bundle assuming you continue to split your total budget.

3 Graph the income and substitution effects of the tax.

Answer 1