Recall exercise 2 from Chapter 4 in which an increase in the toll on a highway from $.40 to $.50 would reduce use of the highway by 10,000 cars per week.
a. Because of the reduced use of the highway, demand in the secondary market for subway rides increases. Assuming that the price of subway rides is set equal to the marginal cost of operating the subway and marginal costs are constant (i.e., the supply schedule is horizontal), and no externalities result from the reduced use of the highway and the increased use of the subway, are there additional costs or benefits due to the increased demand for subway rides? Why or why not?
b. Because of the reduced use of the highway, demand in the secondary market for gasoline falls – indeed, by 30,000 gallons per year. As we realize, there is a stiff tax on gasoline, one that existed prior to the new toll. Assuming that the marginal cost of producing gasoline is $1 per gallon, that these marginal costs are constant (i.e., the supply schedule is horizontal), that no externalities result from the consumption of gasoline, and that the gasoline tax adds 30 percent to the supply price, are there any additional costs or benefits due to this shift? If so, how large are they?