When you drive a car, you generate several negative externalities:
You cause some additional air pollution, you
increase the chances that other drivers will have an accident,
and you cause some additional congestion on roads,
causing other drivers to spend more time in traff ic. Ian
Parry of the International Monetary Fund and Kenneth
Small of the University of California, Irvine, have estimated
that these external costs amount to about $1.00 per
gallon of gasoline. Taxes on gasoline vary by state and
currently average about $0.50 per gallon.
a. Draw a graph showing the gasoline market. Indicate
the efficient equilibrium quantity and the market
equilibrium quantity.
b. Given the information in this problem, if the government
wanted to bring about the efficient level
of gasoline production, how large a tax should the
government impose on gasoline? Will the price consumers
pay for gasoline rise by the full amount of the
tax? Briefly explain using your graph from part (a).