Now the gasoline tax is assessed at a rate of 22 per gallon, generating over $624 million in revenue for the state. Suppose someone concerned about pollution and climate change and would like to know whether increasing the tax will meaningfully reduce gasoline consumption. He need also worried on the finance committee and concerned about the state budget, so he needs an estimate of how the tax will affect revenue.

Use microeconomic analysis to determine how much a typical person will respond to various increases in the gasoline tax rate. You may assume that a representative household has an annual income of $65,866. Consumers choose between gasoline and a collection of all other goods. The marginal rate of substitution of gasoline for other goods is given by the function 4290/g. The current price of a gallon of gasoline is $3.25 with the current tax included. Assume the unit price of all other goods is $1.

1. Start by finding the status quo household gasoline consumption and drawing a graph to represent it. Under this arrangement, how much gasoline do we expect the whole state to consume if there are 2.15 million households? How much revenue does the gasoline tax generate? Label everything and use a straightedge to draw clean lines. Round all figures to the nearest whole number.

2. Now calculate how much gasoline consumption would change if the tax were raised by an additional 50 per gallon. Draw the new budget line and put a dot at the new optimal consumption bundle. Compare consumption and revenue figures to those under the status quo.

3. Repeat for a tax hike of 75 per gallon over the original level.

4. Connect the three dots in your graph to create the price-consumption curve. In a new plot below, use the price-consumption curve to create an individual demand curve. On the axes, below the individual demand numbers, also write down the numbers for total demand.

5. Briefly summarize your findings. Would the proposed tax hikes succeed in reducing gasoline consumption? By how much? Are consumers better or worse off? How do the proposed hikes affect state revenue? What is your recommendation based on the economic analysis just performed? Are you satisfied with this recommendation, or are there other factors you would want to consider before concluding?