Question

Gas prices fluctuate often and in both directions. In your initial post, 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?

Answer 1

Elasticity is determined by various factors such as availability of substitutes(greater the availability of substitutes the more elastic the good will be), nature of the good(if the good is a necessity the demand will be inelastic or less elastic),time(with passage of time demand tends to be elastic) and habit(goods consumed as part of habitual practices tend to be less elastic or inelastic).Gasoline has an inelastic demand due to fewer availability of substitutes and over the years with increase in the number of automobiles used gasoline can be categorized under the head of necessities.Hence the consumer demand will remain more or less the same even if the gas prices fluctuate.

Negative externalities refers to cost suffered by a third party for an economic transaction.It is the negative effect that a third party bear for an economic transaction.Imposition of taxes on gasoline will not be much successful in reducing the demand for gasoline as demand for gasoline is less elastic.But at the same time the government can make use of the revenue earned by imposing taxes on gasoline policies aimed at correcting negative externalities. Imposition of taxes on gasoline may prove to less effective to reduce the negative externalities created by the production and consumption of gasoline.

However the demand for gasoline is not perfectly inelastic.A drastic price rise may force consumers to cut down their consumption by following carpool or cancel their long drive plans etc.