03 Jun Question As the newly elected governor of Iowa, you h
Question
As the newly elected governor of Iowa, you have taken “the pledge” to promote biofuels. Currently the marginal cost of conventional diesel is $3 per gallon and the marginal cost of biodiesel is $3.25/gallon. Assume for this question that from a consumer perspective biodiesel and diesel are perfect substitutes and consumers will just buy whichever is cheaper. In addition, assume that each gallon of diesel does $1 of damage to the climate and that each gallon of biodiesel does only 50¢ of damage. You feel like should instead impose a tax on both fuels that reflect their damages.
Your Stanford educated advisor suggests that you subsidize biofuels by the difference in damages between the two fuels, 50¢/gallon. That way the relative prices of the two fuels would correctly reflect the relative damage they impose. She says that the cost advantage of biodiesel is the same either way, but taxes are harder to sell politically.
You still argue for the tax. Why?
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