Question

Use budget constraints and indifference curves to answer the following: Suppose that the average household consumes 500 gallons of gasoline per year. A 10-cent per gallon tax is introduced coupled with a $50 annual tax rebate per household. How will the consumption of gasoline be affected? Will the household be better or worse off after the new program is introduced?

*Please draw the curves*

Answer 1

Answer :

Based on given information, the yearly consumption of gasoline for per household is 500 gallons. Let in the above picture's diagram the initial budget line is BB and indifference curve is IC. Now after tax imposing by 10% per gallon the annual tax payment is (500 * 10%) = $50. As a result, the budget level decrease and the budget line shifts to leftward and becomes B1B1 where indifference curve is IC1. But every households get annual tax rebate of $50. As here tax payment = tax rebate = $50 hence the annual budget remains same as before. Hence after getting tax rebate the budget line shifts back and becomes BB where the indifference curve is IC. As after introduction of new program the budget line and indifference curve remains same as before hence the consumption of gasoline is not affected.

Higher indifference curve shows the higher utility and lower indifference curve shows the lower utility. Hence if the consumer reach at higher indifference curve then the consumer become better off. If the consumer reach at lower indifference curve then the consumer become worse off. As here the budget line and indifference curve remains same as before after introduction of new program hence households becomes neither better off nor worse off.