You work for the United States Congressional Budget Office, the federal agency tasked with providing economic information
Question:
You work for the United States Congressional Budget Office, the federal agency tasked with providing economic information and analysis to Congress. Some members of Congress are interested in updating the federal excise tax on gasoline, which has not been changed since 1993. They would like you to describe the potential economic cost of setting the tax (or subsidy) incorrectly and determine what tax (or subsidy) level would be optimal for the United States.
Before you begin your analysis, you should do some background research on the topic. Read the research paper “The Economic Cost of Global Fuel Subsidies” by Lucas Davis, which is available on Moodle.1 The basic premise of the paper is that a fuel subsidy creates deadweight loss due to over-consumption. Similarly, a fuel tax creates deadweight loss due to under-consumption. The total amount of deadweight loss generated by a fuel tax or subsidy depends on the level of the tax or subsidy, the elasticity of fuel demand, and the elasticity of fuel supply.
For parts of this analysis, you will need to use data on gasoline prices and consumption in the United States. The staff of the United States Energy Information Administration has compiled a dataset of monthly gasoline prices and consumption for the years 2010–2019. You may download the dataset project_data.xlsx from Moodle. The dataset has three variables:
Variable
Month: Month of sample Price: Average gasoline price for the month (in $ per gallon) Quantity: Quantity of gasoline purchased in the month (in million barrels)
Month | Price($/gallon) | Quantity(million gallons) |
Jan-2010 | 2.769 | 7191.534 |
Feb-2010 | 2.699 | 6609.498 |
Mar-2010 | 2.824 | 7372.302 |
Apr-2010 | 2.9 | 7530.054 |
May-2010 | 2.89 | 7878.276 |
Jun-2010 | 2.785 | 7758.072 |
Jul-2010 | 2.782 | 8023.05 |
Aug-2010 | 2.783 | 8007.678 |
Sep-2010 | 2.757 | 7641.816 |
Oct-2010 | 2.853 | 7787.262 |
Nov-2010 | 2.913 | 7283.556 |
Dec-2010 | 3.048 | 7621.698 |
Jan-2011 | 3.148 | 7098.966 |
Feb-2011 | 3.264 | 6593.916 |
Mar-2011 | 3.615 | 7490.028 |
Apr-2011 | 3.852 | 7231.182 |
May-2011 | 3.96 | 7544.67 |
Jun-2011 | 3.735 | 7538.244 |
Jul-2011 | 3.705 | 7805.07 |
Aug-2011 | 3.696 | 7719.894 |
Sep-2011 | 3.667 | 7260.834 |
Oct-2011 | 3.506 | 7390.866 |
Nov-2011 | 3.443 | 7125.426 |
Dec-2011 | 3.326 | 7465.248 |
Jan-2012 | 3.44 | 7041.552 |
Feb-2012 | 3.64 | 6942.432 |
Mar-2012 | 3.907 | 7449.708 |
Apr-2012 | 3.958 | 7252.644 |
May-2012 | 3.791 | 7784.574 |
Jun-2012 | 3.596 | 7522.368 |
Jul-2012 | 3.498 | 7674.87 |
Aug-2012 | 3.78 | 7980.756 |
Sep-2012 | 3.91 | 7113.75 |
Oct-2012 | 3.812 | 7587.384 |
Nov-2012 | 3.521 | 7308 |
Dec-2012 | 3.381 | 7322.406 |
Jan-2013 | 3.391 | 7347.06 |
Feb-2013 | 3.736 | 6713.238 |
Mar-2013 | 3.779 | 7609.056 |
Apr-2013 | 3.638 | 7497.42 |
May-2013 | 3.675 | 7851.648 |
Jun-2013 | 3.689 | 7633.332 |
Jul-2013 | 3.661 | 8001.84 |
Aug-2013 | 3.645 | 7911.75 |
Sep-2013 | 3.604 | 7594.944 |
Oct-2013 | 3.42 | 7881.258 |
Nov-2013 | 3.322 | 7669.83 |
Dec-2013 | 3.357 | 7773.36 |
Jan-2014 | 3.392 | 7373.184 |
Feb-2014 | 3.434 | 6937.98 |
Mar-2014 | 3.606 | 7673.358 |
Apr-2014 | 3.735 | 7577.472 |
May-2014 | 3.75 | 7803.768 |
Jun-2014 | 3.766 | 7537.068 |
Jul-2014 | 3.688 | 8076.222 |
Aug-2014 | 3.565 | 8025.654 |
Sep-2014 | 3.484 | 7571.508 |
Oct-2014 | 3.255 | 8071.098 |
Nov-2014 | 2.997 | 7595.7 |
Dec-2014 | 2.632 | 7909.902 |
Jan-2015 | 2.208 | 7708.47 |
Feb-2015 | 2.301 | 6995.268 |
Mar-2015 | 2.546 | 8071.602 |
Apr-2015 | 2.555 | 7813.218 |
May-2015 | 2.802 | 8064.924 |
Jun-2015 | 2.885 | 7910.574 |
Jul-2015 | 2.88 | 8246.154 |
Aug-2015 | 2.726 | 8260.602 |
Sep-2015 | 2.462 | 7997.22 |
Oct-2015 | 2.387 | 8249.094 |
Nov-2015 | 2.26 | 7850.388 |
Dec-2015 | 2.144 | 8170.302 |
Jan-2016 | 2.057 | 7682.01 |
Feb-2016 | 1.872 | 7607.208 |
Mar-2016 | 2.071 | 8337.084 |
Apr-2016 | 2.216 | 7678.734 |
May-2016 | 2.371 | 8088.066 |
Jun-2016 | 2.467 | 8061.186 |
Jul-2016 | 2.345 | 8325.156 |
Aug-2016 | 2.284 | 8362.704 |
Sep-2016 | 2.327 | 7987.77 |
Oct-2016 | 2.359 | 7947.66 |
Nov-2016 | 2.295 | 7809.816 |
Dec-2016 | 2.366 | 8207.598 |
Jan-2017 | 2.458 | 7465.71 |
Feb-2017 | 2.416 | 7188.72 |
Mar-2017 | 2.437 | 8231.916 |
Apr-2017 | 2.528 | 7779.828 |
May-2017 | 2.503 | 8162.994 |
Jun-2017 | 2.46 | 8078.112 |
Jul-2017 | 2.414 | 8224.062 |
Aug-2017 | 2.494 | 8396.304 |
Sep-2017 | 2.761 | 8069.166 |
Oct-2017 | 2.621 | 8251.278 |
Nov-2017 | 2.678 | 7617.162 |
Dec-2017 | 2.594 | 8144.178 |
Jan-2018 | 2.671 | 7740.348 |
Feb-2018 | 2.705 | 6825.756 |
Mar-2018 | 2.709 | 8257.536 |
Apr-2018 | 2.873 | 7628.922 |
May-2018 | 2.987 | 8222.256 |
Jun-2018 | 2.97 | 8161.146 |
Jul-2018 | 2.928 | 8267.532 |
Aug-2018 | 2.914 | 8361.36 |
Sep-2018 | 2.915 | 7792.554 |
Oct-2018 | 2.943 | 8108.016 |
Nov-2018 | 2.736 | 8044.974 |
Dec-2018 | 2.457 | 8050.98 |
Jan-2019 | 2.338 | 7755.93 |
Feb-2019 | 2.393 | 7265.454 |
Mar-2019 | 2.594 | 8206.632 |
Apr-2019 | 2.881 | 7944.846 |
May-2019 | 2.946 | 8425.662 |
Jun-2019 | 2.804 | 8064.63 |
Jul-2019 | 2.823 | 8236.494 |
Aug-2019 | 2.707 | 8592.066 |
Sep-2019 | 2.681 | 7808.724 |
Oct-2019 | 2.724 | 8259.174 |
Nov-2019 | 2.693 | 7989.996 |
Dec-2019 | 2.645 | 7965.132 |
The members of Congress have asked for a memo of approximately 2 pages on this topic. Address all of the questions on the following pages to ensure you provide them with the information they need to understand this important topic.
As a Managerial Economics major, you know the full social cost of consuming gasoline is not just the private cost of producing the gasoline. Consuming gasoline creates pollution, which imposes an externality on the rest of the economy. Recent research suggests the externality from consuming gasoline in the US is $1.60 per gallon.3 This externality plays an important role in setting the optimal gasoline tax, so you should discuss it in your report.
(a) What was the total social cost of consuming a gallon of gasoline in the US in 2019?
(b) Calculate the deadweight loss that arises from the current US gasoline tax, as compared to pricing at the total social cost, using 2019 data and your estimated own-price elasticity. (It may help to sketch a version of Davis’s Figure A2 comparing the taxed price with the opportunity cost.)
(c) What level of gasoline tax (or subsidy) would minimize deadweight loss when considering the full opportunity cost of gasoline? What is the deadweight loss at this optimal tax (or subsidy) level? You can achieve this answer using math, a graph, or your economic intuition; any method is fine as long as you explain it fully.
Finally, the members of Congress are interested in understanding how the supply side of the gasoline market could affect the optimal tax (or subsidy).
(a) Davis assumes the supply of gasoline is perfectly elastic, which simplifies the calculations. In reality, however, the supply curve is likely upward-sloping—higher prices induce more production. Describe how an upward-sloping supply curve would change the optimal tax (or subsidy). (It may help to sketch a version of Davis’s Figure A2 with an upward-sloping supply curve.) You can achieve this answer using math, a graph, or your economic intuition; any method is fine as long as you explain it fully.
(b) Energy markets are typically not perfectly competitive, meaning an individual firm has the ability to manipulate the market-clearing price and quantity. Describe how imperfect compe- tition would affect the optimal tax (or subsidy). (Think about the way in which firms want to manipulate the market-clearing price and quantity.) You can achieve this answer using math, a graph, or your economic intuition; any method is fine as long as you explain it fully.