Question

B. Consider a consumer choosing between two goods, food and gasoline. Suppose her monthly income is $1200 and average price of food per unit is $30. Price of gasoline per liter is $4. Suppose that the government levies a per unit consumption tax on gasoline. The tax rate is set to 20 percent.

(a) Illustrate this change on a new graph with gas on the horizontal axis and explain if the consumer is better/worse off (indicate slope and intercepts)

(b) In this after tax scenario (compared to the before tax scenario), how much the consumer has to give up in terms of expenditures on food, if she wants to consume 100 liters of gasoline? Illustrate on a graph. (5.5 marks) (Hint: expenditures = price × quantity)

(c) In this after tax scenario (compared to the before tax scenario), how much the consumer has to give up in terms of expenditures on food, if she wants to consume 200 liters of gasoline? Illustrate on a graph.

(d) In this after tax scenario (compared to the before tax scenario), what is the maximum amount of expenditures on food that she has to give up, if she wants to consume gasoline? Illustrate on a graph.

(e) What does the lost value that you calculated in part (d) represent. (Hint: Compare with the lost expenditures on gasoline.)

Answer 1