Question 3

a. Consider the market for gasoline. If gasoline causes pollution, is the free-market equilibrium optimal? (Explain briefly and illustrate with a diagram.)

b. i. Show how a tax on gasoline can reduce the consumption of gasoline? Use a diagram of demand and supply to illustrate your answer.ii. How does the responsiveness of demand influence the effectiveness of the government's policy? iii. What is the key characteristic of gasoline that makes its demand elastic or inelastic?

c. Suggest an alternative policy to the tax on gasoline. (Explain briefly and show the effect of this policy using your diagram of the supply and demand for gasoline.)