1. The government of a small country is concerned about the harmful pollution generated from consumption of gasoline. Studies indicate that the price elasticity of demand for gasoline, EP, is -0.4. Currently, a gallon of gasoline is priced at $3.00, which is also its cost of purchase by retailers and 30 million gallons of gasoline are sold per day in a perfectly competitive retail market.
2. With P as notation for Price ($/gallon) and Q as notation for Quantity (millions of gallons), state an equation relating price elasticity, 'EP', to the slope, 's', of a demand curve. Then use the data provided above to verify that s = - 0.25, and determine the equation of this straight line demand curve.
3. In order to discourage the consumption of gasoline, the government is proposing to raise its price through a gasoline tax. To what level must gasoline price be raised if the government wants to reduce consumption of gasoline by 15 million gallons?
4. An advisor to the government recommends that instead of levying a tax, the objective in part (b) could be achieved by allowing a monopolist to take over the gasoline retail market. Determine if this policy will work.
5. Compute the values of consumer surplus, producer surplus, and government revenue under each of the two policies in parts (b) and (c). Based on your calculations, which policy option would be preferred from a social welfare perspective? Would consumers be impacted differently? How about the government? Explain.