Question

The supply and demand schedules for gasoline in the country of Drivia are given in the table below. Initially, there are no taxes on gasoline. Assume that the externality damage from consuming gasoline in Drivia is 60 cents per gallon.

If Drivia instituted an optimal Pigovian tax on gasoline, what would the new equilibrium price and quantity be? Create a new graph illustrating the impacts of the tax.

Price per gallon Price per gallon Price per gallon
$3.00 60,000 90,000
$3.20 70,000 85,000
$3.40 80,000 80,000
$3.60 90,000 75,000
$3.80 100,000 70,000
$4.00 110,000 65,000
$4.20 120,000 60,000

Answer 1

The optimal Pigovian tax on gasoline in Drivia would be 60 cents per gallon. This tax would result in a new equilibrium price of $3.20 per gallon and a new equilibrium quantity of 70,000 gallons.

Step-by-step explanation:

In order to determine the new equilibrium price and quantity after the implementation of a Pigovian tax on gasoline, we need to consider the externality damage from consuming gasoline in Drivia. The tax acts as a way to internalize this externality by making the price of gasoline reflect its true social cost.

To calculate the optimal Pigovian tax, we need to find the difference between the quantity demanded and the quantity supplied at each price level and multiply it by the externality damage. The tax should be set at a level that reduces the quantity consumed to the socially optimal level.

Using the table provided, we see that the optimal Pigovian tax would be 60 cents per gallon, equal to the externality damage. This tax would shift the supply curve upward and result in a new equilibrium price of $3.20 per gallon and a new equilibrium quantity of 70,000 gallons.