Test #2 Flashcards
Total surplus
consumer surplus + producer surplus
consumer surplus
Suppose you are in the market for a new smartphone, and you value the latest model at $800, meaning that is the highest price you are willing to pay for it. If you find it on sale for $600, your consumer surplus is $200.
producer surplus
Imagine a farmer who grows strawberries. If the farmer is willing to sell strawberries at $2 per pound but the market price is $3 per pound, the difference of $1 per pound represents the farmer’s producer surplus for each pound sold.
Taxes
discourage bad behavior
Subsidies
encourage good behaviors
per unit taxes
The government collects revenue from the tax, in this example, $0.50 for each of the 950 packs sold per day, totaling $475 per day.
ad valorem taxes
If you buy a laptop for $1,000 and the sales tax rate is 7%, the ad valorem tax would be $70 (7% of $1,000), making the total cost of the laptop $1,070.
lump sum taxes
ex) license registration fees
dead weight loss
The decrease in total surplus
caused by market distortions
Deadweight loss occurs when the total surplus (sum of consumer and producer surplus) in a market is not maximized.
Statutory incidence
Statutory incidence of a tax refers to the legal obligation to pay the tax, as specified by law. It indicates who, according to the tax law or statute, is responsible for the remittance of the tax to the government. This is distinct from the economic incidence of a tax, which looks at who actually bears the burden of the tax through changes in market prices and quantities sold.
Tax Incidence
does not depend on the whether the government levies the tax on producers or consumers
What determines tax incidence?
relative price elasticities of demand and supply
Does inelastic or elastic bear more of the burden?
inelastic
Price increases where people are less responsive and therefore tax revenue is higher
Laffer Curve
The Laffer curve illustrates the relationship between rates of taxation and the resulting levels of the government’s tax revenue
If a government wants to raise revenue while minimizing deadweight loss, which good
would it tax?
Good with inelastic demand
A government wants to discourage the consumption of goods that impose costs on others, so it imposes a tax of $5 per unit. For which good will the tax reduce consumption
the most?
Good with relatively elastic demand
How can a government increase the effectiveness of taxes on “bad” behaviors?
Alternatives
Price Floor
min price that can be charged
Changing price and behavior
Impossible to change just one price
Impossible to change just one behavior!
If demand increases
at all prices there is a higher quantity demanded.
The opportunity cost of reading a single chapter from a textbook
has nothing to do with the price you paid for the book.
A regulation is designed to alter the behavior of individuals
by introducing a cost or benefit that encourages them change their behavior in the intended way.
Equilibrium price
no excess supply or demand
no pressure for quantity to change
Where there is currently a shortage in a market
one should expect the quantity demanded to fall.
Where there is currently a surplus in a market
one should expect the quantity supplied to fall.
In terms of being able to predict behavior, the value of a good is best thought of as
what one is willing to give up in order to acquire the good.
Opportunity cost
next best alternative
If we increase the price for winning a tournament,
we have also increased the reward associated with sabotaging others.
Every human cost
has a cost associated with it
Scarcity
not having enough of what is desirable
When there are more substitutes available
we expect demand to be less inelastic.
Imposing a binding price ceiling
results in a decrease in the quantity supplied to the market. A binding price ceiling is set below the equilibrium price, causing a shortage because it increases the quantity demanded while simultaneously decreasing the quantity suppliers are willing to provide at that lower price. This imbalance between higher demand and lower supply leads to shortages of the good or service in the market.
Removing a tax
Removing a per-unit tax on production would decrease the cost of production, which could be passed on to consumers in the form of lower prices.
Area under the demand curve and above the equilibrium price
consumer surplus
Fewer substitutes available means that
prices will change more
Imposing a binding price ceiling
results in a decrease in the quantity supplied to the market.
Lead pencils and ink pens are substitutes. When the government bans the use of lead
in pencils, which of the following would you expect to happen in the market for pens?
The equilibrium price of pens will go up.
If a price ceiling is imposed above the equilibrium price, is the outcome efficient?
Yes
If a $5 per-unit tax on the production of tires were removed, one would expect the
price of tires
to decrease by less than $5
As the product of one firm becomes increasingly different from those of other firms we
expect that
the demand curve facing the firm will be less elastic
