Economics 121 B & C

Quiz 3 Answers

September 26, 1997

Prof. A. D. Becker

 

 

A proposal has been made to increase the sales tax on gasoline and use the revenues to encourage new and expanded ethanol (ethyl alcohol) production through a low-interest loan program. Up to 10% ethanol can be added to automotive gasoline; it replaces refined petroleum. Ethanol is usually made from corn.

  1. Analyze the short-run effects of tax/loan program on the markets for gasoline, ethanol, and corn. ("Analyze" means discuss what will happen to prices and quantities and explain why.) Support your answer with appropriate changes to the graphs below.

    2.  

    The tax on gasoline will raise the price of gasoline to consumers. Because gas and ethanol are substitutes (to an extent) this will increase the demand for ethanol. Because corn is an input in the production of ethanol, increased production of ethanol will be associated with increased demand for corn.

    Market

    Change

    Price

    Quantity

    Gasoline

    Tax

    Up for buyers,

    Down for sellers

    Down

    Ethanol

    Demand increases

    Up

    Up

    Corn

    Demand increases

    Up

    Up
  2. Identify some likely long-run (long-term) effects of the tax/loan proposal.

In the long run, the low-interest loan program will have the effect of increasing the supply of ethanol (shift right). This will lead to a lower price and higher quantity.

The lower price of ethanol will further reduce demand for gasoline. Higher ethanol production will lead to further increased demand (shift right) for corn.

The lower demand and taxes on gasoline may cause firms to get out of that business making supply decrease (shift left).

The higher price for corn may cause firms (farms) to enter that market causing its supply to increase (shift right).

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