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The price of gasoline in Milo’s state has increased sharply, and has caused him to purchase...

The price of gasoline in Milo’s state has increased sharply, and has caused him to purchase a new, more fuel-efficient car.

a. Draw a graph with Transportation by Car (in miles) on the horizontal axis and All Other Goods on the vertical axis. Show Milo’s optimal amount of car miles and All Other Goods before he buys the new car and label it A. How does his purchase affect the price of car miles? Show the impact on Milo’s optimal bundle on your graph, assuming that Transportation by Car is a normal good.

b. What happens to the amount of miles that Milo drives? Identify on the graph, and use in your explanation, the income and substitution effects.

c. What does your analysis indicate about estimates of the savings from more fuel efficient cars that are based on the increased mileage that the more efficient cars provide? Now suppose (as has actually been the case in the past) that more fuel-efficient cars are smaller and less comfortable, and overall less fun to drive. In words, how might this affect the overall price of car miles and thus your conclusion in part b?

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