Gas prices fluctuate often and in both directions. respond to the following: How
ID: 1198410 • Letter: G
Question
Gas prices fluctuate often and in both directions. respond to the following:
How responsive do you think consumers will be to the price change when these fluctuations occur due to changes in supply? Why? Use the various determinants of elasticity to explain your answer.
How does the price elasticity of demand for gasoline impact the effectiveness of taxes on gasoline aimed at correcting a negative externality?
Consider incorporating the supply-and-demand model to demonstrate the elasticity of demand for gas and to show the effects of tax on the market for gas.
Explanation / Answer
(a) When change in supply causes gas price fluctuations, I believe consumers will be less responsive to price change. This is because, gas being a necessity good, fluctuating price level will not impact consumption of gas below a threshold limit.
Price responsiveness will depend on the following factors:
- How much gas is perceived as a necessity than luxury
- What percent of total income is spent on purchase of gas (the higher this percentage, the higher the price-responsiveness)
- Availability of substitutes. If substitutes of gas were available, price-responsiveness would have been much higher.
(b)
A negative externality tax will increase the price of gasoline. However, since elasticity of demand is low, the price increase will not affect gasoline consumption by a large amount. Therefore, the tax maynot be as effective as intended to be.
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