ANSWERS TO QUESTIONS
- What is the substitution effect on your consumption of driving?
Because of the new technology, this individual needs to spend less money for the gas and the gas price will be less for him. Thus he can buy more gas with the same budget and then he might want to buy more gas to travel more miles. That is the substitution effect on the consumption of driving.
- What is the income effect of your newly increased fuel efficiency on your budget constraint?
The Budget for the individual is Income=Miles driven X Cost of Gas per mile + Quantity consumed from all the other goods other than Miles driven X Prices of these goods. After the new technology the budget constraint becomes Income=Miles driven X (Cost of Gas per mile)/2. I have used (Cost of Gas per mile)/2 because a person needs to spend half of the gas cost thanks to the new technology. Thus now a person can drive longer with the same amount of income. Because the cost of gas has gone down, one can afford more gas even though he consumes other goods at the same amount before the new technology. That means the real income (a person’s purchasing power) increases. When real income increases, a person faces alternatives. He can travel more or he can consume more from the other goods. Because the Miles driven is a normal good, I would use more gas with the extra purchasing power or real income.
- After considering both substitution and income effects, is it even possible that you may want to consume more gasoline now that your automobile is more fuel efficient than before?
Because I use the new technology and that provides me more purchasing power and I like driving, I would use more gas to travel. I would use the extra purchasing power to buy gas to travel more.
REFERENCES
Boyes, W. J. and Melvin, M. (2013). Microeconomics. South Western Publications, Mason, OH.
Stiglitz, J. E. and Walsh, C. E. (2007). Economics, W.W. Norton & Company, Inc., New York, International Student Edition, 4th edition, 2007.
Varian, H. R. (2010). Intermediate Microeconomics: A Modern Approach, W.W. Norton and Company/Affiliated East - West Press, 8th edition.
