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The U.S. government is considering reducing the amount of carbon dioxide that firms are allowed to produce by issuing a limited number of tradable allowances for carbon dioxide (CO2) emissions. In an April 25, 2007, report, the U.S. Congressional Budget Office (CBO) argues that "most of the cost of meeting a cap on CO2 emissions would be borne by consumers, who would face persistently higher prices for products such as electricity and gasoline ... poorer households would bear a larger burden relative to their income than wealthier households would." What assumption about one of the elasticities you learned about in this chapter has to be true for poorer households to be disproportionately affected?

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Explanation:

Four ptooireor households to be disproportionately affected by an rise in energy prices, it is essential that those households devote a greater part of their salary on energy goods than richer households. In other words, as income increases, the amount of energy products demanded has to increase less than proportionately. So the CBO must think that the income elasticity of demand for energy products, although positive, is less than 1: energy products are income-inelastic. In fact, this is just what the CBO report says: "lower-income households tend to spend a larger fraction of their income than wealthier households do and energy products account for a bigger share of their spending."

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