Given:

Current national average price of gas $3.322/gallon

Current gasoline demand: 395.26 million gallons/day

Elasticity of demand estimate: -0.02

Negative externalities of gasoline: $0.85 dollars per gallon

1a) The first thing we need to do is plot out our market supply and demand curves. We already have the equilibrium point. We can use our elasticities to extend the supply and demand curves back (toward the y-axis) from the current equilibrium point. From the equilibrium point, calculate a new point along each curve by assuming that quantity decreases by 15% from the equilibrium quantity. Then, what is the corresponding price along each curve, associated with a 15% decrease in quantity? Use the elasticity equation, but not the mid-point formula (i.e., the current price and quantity are your base values). Show your calculations. Assume both curves are linear, and use your results to draw an accurate (e.g., with axes to scale using graph paper) supply-and-demand graph of the gasoline market. Note that once you have two points on each curve, you can draw a straight line extending through both points. Be sure to label your axes, and include numbers for the new price and quantity points along each curve. Hand-drawn graphs are fine, but please scale your axes accurately in order to get a reasonably correct answer in the next part. You can also use Excel, PowerPoint, or another program

b. Now, add your externality costs to your graph with a new, parallel supply curve, and estimate the new equilibrium price and quantity of gasoline with the Pigovian tax. While you can calculate the exact new equilibrium values by determining the mathematical equation for each line and a bit of algebra, a reasonably accurate visual estimate based on your graph is totally sufficient. Indicate the new equilibrium price and quantity on your graph based on your approximation.

c. Finally, based on your answer above calculate the net social gain (in dollars) if the United States instituted your correct Pigovian tax. Be careful about the units (e.g., whether the values are in millions or billions of dollars per day). Identify this area on your graph. Note that you dont need to calculate consumer and producer surplus, just the welfare gain from the tax. Also, how much would the U.S. collect in taxes from your Pigouvian tax (per day)? Show your calculations on the answer sheet. You dont need to show the tax area on your graph.