Quiz4micro - Demonstrate this on a graph(c Show how Tom’s response can be decomposed into the income and substitution effects Fearing that the

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Quiz #4 In an effort to promote the usage of public transportation, suppose the government levies a proportional gasoline tax of t per dollar of gasoline purchased by consumers. Tom spends his income ( I ) on gasoline ( G ) (which he uses to fuel his car) and a basket of other goods ( C ). Denote the prices of gasoline and the “other good” as P G and P C , respectively. Tom is a rational individual, and he considers G and C to be normal goods. (a) Describe how Tom arrived at his decision regarding the amount of gasoline and the other good consumed before the enactment of the policy. Be sure to include the budget constraint and the optimal conditions that he satisfied. (b) What is the effect of the policy on Tom’s consumption of gasoline?
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Unformatted text preview: Demonstrate this on a graph. (c) Show how Tom’s response can be decomposed into the income and substitution effects. Fearing that the policy has contributed to the lingering recession, the government also chooses give an income tax credit of T dollars. For Tom, the tax credit T exactly equals the taxed portion of his final expenditure on gasoline. (d) Will Tom be just as well off as before the enactment of the policies? Will he end up on the same indifference curve? Demonstrate. (Hint: Compare the pre-policy budget constraint at the optimal quantities to the post-policy budget constraint at the optimal quantities.)...
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This note was uploaded on 04/26/2010 for the course ECO 420K taught by Professor D during the Spring '10 term at University of Texas at Austin.

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