Currently, the state taxes motorists at the pump $0.59 (59 cents) per gallon of unleaded fuel. These taxes are in addition to the federal gasoline tax, also levied at the pump, of $0.18/gallon. As per the models below, assume the price of gasoline is $3/gallon before taxes.
Assume that the market supply and demand schedules for motor gasoline in Pennsylvania is given by:
Demand:
P = 5,400 – 2QD
Supply:
P = 3
where: QD represents the quantity demanded of millions of gallons of motor gasoline. P = price in $/gallon.
Assume that the market supply and demand schedules for vehicle miles traveled (VMT) in Pennsylvania are given by:
Demand:
P = 0.85 – 0.0001QD
Supply:
P = 0.1
where: QD represents quantity demanded of millions of VMT. P = price in $/VMT.
a)  Using these supply and demand schedules, please derive the equilibrium price and quantity pair {Q*, P*} that would occur without any taxation, in both VMT and gasoline markets.
b) Now derive the equilibrium {Q*t, P*t} with both the federal tax and the existing Pennsylvania state gasoline tax. Tabulate state tax revenue produced.
c)  What VMT tax rate would replace the gasoline tax revenue completely?
d)  Now evaluate the benefits in terms of reduced carbon dioxide emissions associated with each of the tax policies. Assume that 20 pounds of CO2 are emitted per gallon of fuel consumed. ($51/ton CO2).
e)  What are the costs of each tax policy?

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