In this question, we investigate the impact of a capital-gains-tax-induced increase in the rental price of capital on firms within an industry. Suppose you are running a gas station in a competitive market where all firms are identical. You employ weekly labor and capital k using a homothetic decreasing returns to scale production function, and you incur a weekly fixed cost of F.

(a) Begin with your firm's long run weekly average cost curve and relate it to the weekly demand curve for gasoline in your city as well as the short run weekly aggregate supply curve assuming the industry is in long run equilibrium. Indicate by x how much weekly gasoline you sell, by p the price at which you sell it, and by X the total number of gallons of gasoline sold in the city per week.

(b) Now suppose that an increase in the capital gains tax raises the rental rate on capital k (which is fixed for each gas station in the short run). Does anything change in the short run?

(c)What happens to x, p and X in the long run? Explain how this emerges From your graph.

(d) Is it possible for you to tell whether you will hire more or fewer workers as a result of the capital gains tax-induced increase in the rental rate? To the extent that it is not possible, what information could help clarify this?

(e) Can you tell whether employment of labor in gasoline stations increases or decreases? What about employment of capital?