Gasoline and bicycles are substitutes in consumption. Suppose we increase the federal gasoline tax to $1 per gallon. Initially, the gasoline price rises due to the tax, and the demand curve for bicycles shifts rightward because these goods are substitutes. Then, the bicycle price rises, and the demand curve for gasoline shifts rightward. Assuming the general equilibrium is achieved in both markets after these two steps, which of the following statements is NOT true?
A) Partial equilibrium analysis only focuses in the first-round changes in the gasoline market (ignoring the secondary effects that arise from changes in the bicycle market).
B) Partial equilibrium analysis would predict a larger shift in the price and quantity demanded for gasoline than a general equilibrium analysis.
C) The price increase in gasoline is larger under the general equilibrium approach, but the change in the quantity of gasoline demanded is smaller than under partial equilibrium analysis.
D) All of these statements are true.

Question

Quizplus · Accepted Answer

In general equilibrium analysis, we take into account the secondary effects that arise in both markets. Thus, the shift in the demand curve for bicycles and the subsequent increase in the bicycle price lead to a smaller shift in the demand curve for gasoline in the general equilibrium approach compared to partial equilibrium analysis. Therefore, partial equilibrium analysis would predict a larger shift in the price and quantity demanded for gasoline than a general equilibrium analysis.

Gasoline and Bicycles Are Substitutes in Consumption