Question 4 - 50 marks (include diagrams)

Assume that supply curve for litres of petrol in the weekly retail market for petrol in Australia in 2022 is perfectly elastic and that demand is downward sloping.

a. Explain why in the retail petrol market in the absence of any taxes there is likely to be a negative consumption externality.

(5 marks)

b. Suppose that the consumption externality is $0.44 cents per litre sold. Explain and show by drawing a carefully labelled diagram, that without any government intervention the amount of petrol traded is higher than what is socially efficient and results in a dead-weight loss to Australia.

(10 marks)

c. Explain and show by drawing a carefully labelled diagram how a Pigouvian tax on petrol consumers could reduce the amount of petrol bought and sold to the socially efficient level. {Recall a tax on demand, lowers the demand curve and where it intersects with supply gives the pre-tax price.WS06-Qu8 demonstrates a tax on demand and Lecture05-Topic 4 Addendum page 11, shows a demand subsidy}

(10 marks)

d. Explain and show by drawing a carefully labelled diagram how an excise tax of $0.44 per litre levied on petrol sellers could achieve the same result in b and also reduce the amount of petrol bought and sold to the socially efficient level.

(10 marks)

e. Why does the government collect excise tax from the sellers of petrol (petrol stations) rather than motorists who consume and burn the petrol in their cars?

(5 marks)

f. At the 2022 March Budget, the federal government reduced the petrol excise tax by half to $0.22 cents per litre to ease the pressure on the cost of living. Explain why most economists said it would ease the cost of living and reduce the price of petrol by $0.22, but thought it was bad microeconomic policy? Why might income handouts increase the cost of living, but from a microeconomic policy perspective not be so bad?

{You do not have to draw a diagram for this question}.

(10 marks)