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Chapter 6: Problem 15

The U.S. government is considering reducing the amount of carbon dioxide that firms are allowed to produce by issuing a limited number of tradable allowances for carbon dioxide \(\left(\mathrm{CO}_{2}\right)\) emissions. In an April 25 , 2007, report, the U.S. Congressional Budget Office (CBO) argues that "most of the cost of meeting a cap on \(\mathrm{CO}_{2}\) emissions would be borne by consumers, who would face persistently higher prices for products such as electricity and gasoline \(\ldots\) poorer households would bear a larger burden relative to their income than wealthier households would." What assumption about one of the elasticities you learned about in this chapter has to be true for poorer households to be disproportionately affected?

Short Answer

Expert verified
Answer: A reduction in tradable CO2 emission allowances disproportionately affects poorer households because they spend a higher percentage of their income on necessities like electricity and gasoline, which have inelastic demand. This means that when production costs rise due to the emissions cap, suppliers pass on the cost to consumers in the form of higher prices, forcing poorer households to bear a larger burden relative to their income compared to wealthier households.

Step by step solution

01

Identifying the Elasticity

To explain how poorer households bear a larger burden due to cap on CO2 emissions, we need to consider the concept of price elasticity of demand. Price elasticity of demand measures the responsiveness of the quantity demanded for a good to a change in its price. If the demand for a product like electricity and gasoline is inelastic, it means that a change in price will not have a significant impact on the quantity demanded. In this situation, consumers are more likely to bear the burden of the higher price as they cannot reduce their consumption significantly.
02

Inelastic Demand for Necessities

Products like electricity and gasoline are considered necessities for most households, meaning that their consumption cannot be significantly reduced, even when the prices increase. Necessities usually have a low price elasticity of demand. Hence, when production costs rise due to the enforcement of CO2 emissions cap, suppliers pass on the cost to consumers in the form of higher prices, since they know that demand is less sensitive to price changes.
03

Impact on Poorer Households

Typically, poorer households spend a higher percentage of their income on necessities like electricity and gasoline compared to wealthier households. Because their demand for necessities is inelastic, they still need to purchase these products despite the higher prices. Therefore, when prices increase due to CO2 emissions cap, poorer households end up bearing a larger burden relative to their income than wealthier households.
04

Conclusion

In this context, the crucial elasticity involved is price elasticity of demand. For poorer households to be disproportionately affected by the reduction in tradable CO2 emission allowances, it is assumed that the demand for the products influenced by these allowances, such as electricity and gasoline, has a low price elasticity of demand (inelastic demand). This assumption implies that the quantity demanded does not change significantly with an increase in price, making consumers bear the burden of those higher prices and thus disproportionately affecting poorer households who spend a higher percentage of their income on these necessities.

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Most popular questions from this chapter

A recent report by the U.S. Centers for Disease Control and Prevention (CDC), published in the CDC's Morbidity and Mortality Weekly Report, studied the effect of an increase in the price of beer on the incidence of new cases of sexually transmitted disease in young adults. In particular, the researchers analyzed the responsiveness of gonorrhea cases to a tax-induced increase in the price of beer. The report concluded that "the.... analysis suggested that a beer tax increase of \(\$ 0.20\) per six-pack could reduce overall gonorrhea rates by \(8.9 \% . "\) Assume that a sixpack costs \(\$ 5.90\) before the price increase. Use the midpoint method to determine the percent increase in the price of a six-pack, and then calculate the cross-price elasticity of demand between beer and incidence of gonorrhea. According to your estimate of this cross-price elasticity of demand, are beer and gonorrhea complements or substitutes?

Use an elasticity concept to explain each of the following observations. a. During economic booms, the number of new personal care businesses, such as gyms and tanning salons, is proportionately greater than the number of other new businesses, such as grocery stores. b. Cement is the primary building material in Mexico. After new technology makes cement cheaper to produce, the supply curve for the Mexican cement industry becomes relatively flatter. c. Some goods that were once considered luxuries, like a telephone, are now considered virtual necessities. As a result, the demand curve for telephone services has become steeper over time. d. Consumers in a less developed country like Guatemala spend proportionately more of their income on equipment for producing things at home, like sewing machines, than consumers in a more developed country like Canada.

According to data from the U.S. Department of Energy, sales of the fuel- efficient Toyota Prius hybrid fell from 158,574 vehicles sold in 2008 to 139,682 in \(2009 .\) Over the same period, according to data from the U.S. Energy Information Administration, the average price of regular gasoline fell from \(\$ 3.27\) to \(\$ 2.35\) per gallon. Using the midpoint method, calculate the cross-price elasticity of demand between Toyota Prii (the official plural of "Prius" is "Prii") and regular gasoline. According to your estimate of the cross-price elasticity, are the two goods complements or substitutes? Does your answer make sense?

The accompanying table shows the price and yearly quantity sold of souvenir T-shirts in the town of Crystal Lake according to the average income of the tourists visiting. $$ \begin{array}{c|c|c} & \begin{array}{c} \text { Quantity of T-shirts } \\\ \text { demanded when } \\\ \text { average tourist } \end{array} & \begin{array}{c} \text { Quantity of T-shirts } \\\ \text { demanded when } \end{array} \\\ \text { Price of } & \text { average tourist } \\\ \text { T-shirt } & \text { income is } \$ 20,000 & \text { income is } \$ 30,000 \\ \hline \$ 4 & 3,000 & 5,000 \\\ 5 & 2,400 & 4,200 \\\ 6 & 1,600 & 3,000 \\\ 7 & 800 & 1,800 \end{array} $$ a. Using the midpoint method, calculate the price elasticity of demand when the price of a T-shirt rises from \(\$ 5\) to \(\$ 6\) and the average tourist income is \(\$ 20,000 .\) Also calculate it when the average tourist income is \(\$ 30,000\). b. Using the midpoint method, calculate the income elasticity of demand when the price of a T-shirt is \(\$ 4\) and the average tourist income increases from \(\$ 20,000\) to \(\$ 30,000 .\) Also calculate it when the price is \(\$ 7\)

A recent study determined the following elasticities for Volkswagen Beetles: Price elasticity of demand \(=2\) Income elasticity of demand \(=1.5\) The supply of Beetles is elastic. Based on this information, are the following statements true or false? Explain your reasoning. a. A \(10 \%\) increase in the price of a Beetle will reduce the quantity demanded by \(20 \%\). b. An increase in consumer income will increase the price and quantity of Beetles sold.
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