Gus spends his income on gas for his car and food. — The government raises tax thereby raising price But also lowers increasing Gus's

SOLUTION

Gus will buy less gas. As shown in the accompanying diagram, the increase in the price of gas makes his budget line steeper (the relative price of gas is now higher). The increase in income shifts his budget line outward so that it is just tangent to the indifference curve that he was on before the gas price rose. That is, Gus goes from bundle A on his original budget line BL1 to bundle B on his new budget line BL2. In effect, what this policy does is to isolate just the substitution effect of the price change: the income effect is fully compensated for by the increase in Gus's income, so only the substitution effect remains.