Some observers have argued that importing oil makes the United States hostage to the policies of Saudi Arabia and other countries in the Middle East. This complicates US foreign policy.

a. Explain why an externality is present in this situation.

b. Propose a Pigouvian tax to deal with the externality.

c. Some economists want to curb domestic gasoline consumption but are wary of giving the government substantially more revenues than it already has. As an alternative, Feldstein [ 2006b, p. A10] suggested a system of tradable gasoline rights ( TGR): “

In a system of tradable gasoline rights, the government would give each adult a TGR debit card. The gasoline pumps at service stations that now read credit cards and debit cards would be modified to read these new TGR debit cards as well. Buying a gallon of gasoline would require using up one tradable gasoline right as well as paying money. The government would decide how many gallons of gasoline should be consumed per year and would give out that total number of TGRs. In 2006, Americans will buy about 110 billion gallons of gasoline. . . . To reduce total consumption by 5%, [government] would cut the number of TGRs to 104.5 billion.” Draw a diagram to illustrate how the price of the tradable gasoline rights would be determined. Suppose that the market price per voucher were 75 cents. How would this change the opportunity cost of buying a gallon of gasoline?