16. According to data from the U.S. Department of Energy, the average retail price of regular gasoline rose from $0.93 in 1985 to $1.81 in 2005, a 95% increase.

a. Other things equal, describe the effect of this price increase on the quantity of gasoline demanded. In your explanation, make use of the optimal consumption rule and describe income and substitution effects.

In fact, however, other things were not equal. Over the same time period, the prices of other goods and services rose as well. According to data from the Bureau of Labor Statistics, the overall price of a bundle of goods and services consumed by an average consumer rose by 82%.

b. Taking into account the rise in the price of gasoline and in overall prices, other things equal, describe the effect on the quantity of gasoline demanded.

However, this is not the end of the story. Between 1985 and 2005, the typical consumer’s nominal income increased, too:

the U.S. Census Bureau reports that U.S. median household nominal income rose from $23,618 in 1985 to $46,326 in 2005, an increase of 96%.

c. Taking into account the rise in the price of gasoline, in overall prices, and in consumers’ incomes, describe the effect on the quantity of gasoline demanded.