Answer to Question #138841 in Macroeconomics for Jet

Question

A tax on crude oil would raise the cost of the primary resource used in the production of gasoline. A proponent of such a tax has claimed that it will not raise the price of gasoline using the following argument. While the price of gasoline may rise initially, that price increase will cause the demand for gasoline to decrease, which will push the price back down. Is this reasoning correct? Explain.

Answer 1

The price increase will really cause the demand for gasoline to decrease, but as the demand for gasoline is inelastic, then the decrease in price will be insufficient to be pushed back down as it was before the tax was imposed.