ECON 2302: CH. 5 Study Guide
Apply the correct label to each of the four colored regions in the graph, which shows the results of a tax increase. Blue triangle Green rectangle Yellow triangle Red triangle
Blue triangle: ~ consumer surplus The consumer surplus has been reduced by the tax. Green rectangle: ~ tax revenue The tax revenue has come partly out of the consumers' pockets and partly out of the producers'. Yellow triangle: ~ deadweight loss This is the monetary value of the decline in economic activity due to the tax increase. Red triangle: ~ producer surplus The producer surplus has been reduced by the tax.
It is likely that consumer surplus will _____ and producer surplus will _____.
decrease, decrease Producers will usually share the tax burden on products with substantial price elasticity of demand.
Calculate the producer surplus for a landscaper who is hired to work for $50/hour, but is willing to work for $40/hour.
$10 The landscaper is able to sell his product for $10/hour more than his minimum price.
Calculate the deadweight loss for refrigerators if a $2 excise tax is imposed on refrigerators, and quantity demanded falls from 500 to 300. Use the figure for reference as needed.
$200 The deadweight loss is (1/2) x (decrease in demand) x (increase in tax) (1/2) x (200) x ($2) =$200 The government can expect to collect $600 in tax revenue from the excise tax on refrigerators: $2 per refrigerator, for 300 refrigerators.
Pedro wants to buy a new car. The most he is willing to pay is $21,000. If he finds a car for $18,000, what will his consumer surplus be?
$3,000 Pedro found a car that was less expensive than his reservation price, so he will be better off buying the car.
How much tax revenue was collected if the government levied a $2 excise tax on air conditioners and 490 units were sold after the tax? Before the tax, 500 air conditioners were sold.
$980 It is likely that this tax was designed to generate revenue, not modify behavior, since $2 is a small tax and people continue to purchase air conditioners after the tax was levied. The number of air conditioners sold before the tax does not factor into this calculation.
Suppose that the government wants to discourage spray paint sales in an effort to eliminate graffiti. Which graph illustrates the type of tax that would be the most effective at reducing spray paint sales?
Click the graph with: ~ P5 on the Y-Axis ~ Q5 and Q1 on the X-Axis ~ Giant yellow D.W.L. labelled triangle against the Y-Axis ~ Has no tax revenue This graph illustrates an extreme tax. The government is not going to collect any significant tax revenue from the tax on spray paint, but the deadweight loss is huge and very few people are buying spray paint. Even though the government does not collect much tax revenue for a large tax or an extreme tax, many people will modify their behavior, and it is likely that spray paint purchases will decrease greatly.
Raising tax rates will always raise tax revenue.
False There may, however, be other reasons to raise taxes, such as discouraging certain behaviors.
If the government places a $2 tax per bag of potato chips on the producers, what would the consumers of potato chips observe?
The price of potato chips would rise by some amount, but by less than $2. Excise taxes are often levied on producers, who then pass part of the tax off onto consumers.
The government might levy an excise tax on a product if it wants to collect _____ from the purchase of that particular good or service. The government would prefer to tax goods with a _____ demand. The government might also tax a product to incentivize consumers to _____. If taxes are too high on a certain good or service, many consumers will _____ that good.
tax revenue, highly inelastic, modify their behavior, cease buying The government could use a high tax on cigarettes to discourage smoking.
Joe wants to buy a baseball bat and is willing to pay up to $30 for one. The sporting goods store in town sells bats for $50. Fill in the blanks to explain what can we assume about Joe's decision to buy a bat. It is _____ that Joe will buy the bat because the price is _____ than Joe's willingness to pay. If Joe bought the bat, it would be an example of _____.
unlikely, higher, voluntary consumer loss Joe will likely not buy the bat because it is above his maximum purchase price. Joe may end up looking elsewhere for a bat that is more in his price range.
In which of the following scenarios would an excise tax placed on producers result in the smallest deadweight loss?
when demand is perfectly inelastic When demand is perfectly inelastic, the quantity sold is the same before and after the tax. This makes the deadweight loss of the tax zero, because consumers did not change their behavior.
Initially, Alice's willingness to pay for pumpkin pie is $7.00 per slice, point A; and Betty's is $5.00, point B. Drag new labels to the graph to show what it would look like if Alice's willingness to pay for pumpkin pie was instead $6.00 per slice, point A'; and Betty's willingness to pay was $4.00, point B'. The price of a slice of pie stays the same at $4.00 a slice.
2nd box on the top left in the the "Consumer surplus" area: ~ A' The very middle box on top of the point E where both the Demand and Supply line intersect: ~ B' Betty will not have any consumer surplus, but she would also not have any loss. With millions of slices being sold, to perhaps a million or more customers, the change in Alice's and Betty's willingness to pay does not move the demand curves and does not affect the equilibrium point. But their individual situations now correspond to different points on the curve than before.
Nick wants to buy a box of crackers for $1.75. Cracker producers want to sell their product for $1.25. When Nick gets to the store, he finds that the crackers he wants to buy are marked $1.68. What is the total surplus generated from this transaction?
50 cents This transaction benefits society, because both the consumer and producer ended up with a surplus. The consumer surplus is 7 cents, and the producer surplus is 43 cents.
What might be true if the government levied a 40% excise tax on gasoline? Select all that could apply.
Applies: ~ Gasoline has a highly inelastic demand. The government may realize that people will continue to drive regardless of how much their gasoline is taxed. The government may be trying to generate a large amount of tax revenue. ~ The government wants people to drive less. A 40% tax is very high. It might encourage people to modify their behavior and drive less. Does not Apply: ~ Gasoline has a perfectly elastic demand. If gasoline has a perfectly elastic demand, the 40% tax will cause people to switch to a different product. Gasoline has few substitutes, so it is likely this is not the case. ~ The government is trying to increase legal gasoline sales in order to combat the production and sale of illegal "bootleg" gasoline. Taxing gasoline effects the legal market, so a 40% tax would actually make bootleg gasoline more attractive. Taxes have two functions: increasing revenue for the government and forcing people to modify their behavior.
A market that reaches efficient equilibrium for price and quantity will result in a total surplus that is as large as possible. This large total surplus allows the consumers and producers to share the total surplus in a fair and equitable way.
False The split of total surplus between consumers and producers often depends on the relative elasticity of each side of the market. The split may or may not be equitable.
Steve sells his home to Srivani and ends up with a producer surplus of $100,000. Srivani has a consumer surplus of $1,000 from the sale. What is true about the surplus from the sale?
Both parties experience surplus, but there is inequity because Steve has a much larger producer surplus. Both parties benefited from the sale, but Steve benefitted much more than Srivani because his producer surplus is much higher than Srivani's consumer surplus.
The table below shows the value that three students place on their economics textbooks. Not every label will be used. Willingness to Pay for a New Economics Textbook Buyer | Willingness to pay Ron | $200 Leslie | 150 Donna | 100 Label the consumer surplus that each consumer experiences under the three different prices depicted in the graph. Box on the top-left graph labeled "(a) $175 per Textbook" Top box on the graph in the top right labeled "(b) $125 per Textbook" Bottom box on the graph in the top right labeled "(b) $125 per Textbook" Top box on the bottom graph labeled "(c) $50 per Textbook" Middle box on the graph in the top right labeled "(b) $125 per Textbook" Top box on the bottom graph labeled "(c) $50 per Textbook" Bottom box on the graph in the top right labeled "(b) $125 per Textbook" Top box on the bottom graph labeled "(c) $50 per Textbook"
Box on the top-left graph labeled "(a) $175 per Textbook" ~ Ron's consumer surplus ($25) Top box on the graph in the top right labeled "(b) $125 per Textbook": ~ Ron's consumer surplus ($75) Bottom box on the graph in the top right labeled "(b) $125 per Textbook": ~ Leslie's consumer surplus ($25) Top box on the bottom graph labeled "(c) $50 per Textbook": ~ Ron's consumer surplus ($150) Middle box on the graph in the top right labeled "(b) $125 per Textbook" Top box on the bottom graph labeled "(c) $50 per Textbook": ~ Leslie's consumer surplus ($100) Bottom box on the graph in the top right labeled "(b) $125 per Textbook" Top box on the bottom graph labeled "(c) $50 per Textbook": ~ Donna's consumer surplus ($50)
The current market price of a car wash is $20. Jeff is willing to supply a car wash for $10, whereas the lowest amount Steve will accept to supply a car wash is $15. Drag the labels to the correct part of the graph to indicate each producer's surplus. Boxes on the left Box on the right
Boxes on the left: ~ Jeff's producer surplus ($10) Jeff will end up with a large producer surplus. Box on the right: ~ Steve's producer surplus ($5) Steve will have a producer surplus, but it will not be as large as Jeff's because the lowest price at which Steve is willing to sell is higher than Jeff's. Both producers are willing to sell and will have a surplus, but the size of the surplus depends on the lowest price they were willing to sell their service for.
Suppose the government imposes a tax on car producers. Which graph would most likely illustrate the result?
Click on the graph with 2 Supply lines (one orange red and one light orange) Car producers are willing to supply fewer cars at any price, because they are paying a portion of that price as the tax. This shifts the supply curve and leads to a new market equilibrium, E2, with fewer cars being sold. Though the government may choose to tax the producer instead of the consumer, the producer passes along a portion of the tax to the consumer in the form of a higher price.
Emily works in the stockroom at a retail store for $10/hour on Saturdays. The store is within near walking distance of her home. She can make $15/hour by babysitting on Saturday, but she must spend $2 on gas to drive to her babysitting job. What costs must Emily consider when determining the minimum price at which she is willing to sell her labor? Select all that apply.
Cost to Consider: ~ the $4 in direct costs she would spend to drive to and from her babysitting job Emily must pay for gas to drive to and from the babysitting job. She must figure out if spending $4 to work will be worth it. ~ the opportunity costs of not working at the store on a Saturday when she babysits Emily will need to consider not only the money she can earn by babysitting but also the income she would give up by not working at the store. Not a Cost to Consider: ~ the cost of personal items (e.g., phone and clothes) Emily uses during babysitting Since Emily will carry her phone and wear similar clothes at either job, these costs can be ignored. Every producer will have a different willingness to sell, because each producer faces different direct and opportunity costs.
If a price is low enough to attract buyers, it will always encourage producers to sell.
False There is an equilibrium price that is high enough that producers will want to sell and low enough that buyers will want to buy.
What might happen if the government raised the excise tax on televisions from $5 to $15?
Deadweight loss for televisions would increase because producers would sell fewer units at a higher price. A slight increase in taxes would probably cause demand for televisions to fall a little, which would increase deadweight loss.
Eric enjoys making pizza. When he makes pizza for his friends, sometimes Eric cares about how the pieces are distributed, and sometimes he doesn't. Which of Eric's actions are associated with equity, and which of his actions are associated with efficiency?
Equity: ~ He cuts the pie into many slices so that everyone gets a piece. Equity is concerned with how the pie gets distributed. ~ He cuts the pie into eight equal slices. Equity is concerned with fairly distributing the pie. Efficiency: ~ He lets one person eat the whole pie. Efficiency is concerned with someone eating the pie once it is made. ~ He makes sure that the whole pie is eaten. Efficiency is concerned with making sure that none of the pie is wasted. In the real world, there is a debate between efficiency and equity.
Which of the following are examples of excise taxes? Select all that apply.
Excise Tax: ~ a $0.50 tax on pizza Pizza is a good that could be taxed. ~ a $1.00 tax on stamps Stamps are a good that could be taxed. ~ an 8% tax on a plane ticket Plane tickets are goods that can be taxed. Not an Excise Tax: ~ a 1% capital gains tax A capital gains tax is not levied on a particular good or service. ~ a 15% tax on income Income is not a good or service. ~ a 25% tax on payroll Payroll is not a good or service. Excise taxes are levied on products or services you can buy. Many goods have excise taxes, but the amount of tax varies from state to state.
Suppose a scathing medical study is released that describes the detrimental effects of drinking soda. Because of this, consumers switch their preferences toward healthier drinks and buy less soda. What will happen to the consumer and producer surplus? Drag each label to the appropriate graph.
Graph on the left blue area: ~ initial consumer surplus Graph on the left orange area: ~ initial producer surplus Producer surplus is the difference between a supplier's willingness to sell and the price the supplier actually receives in the market. Graph on the right blue area: ~ new consumer surplus Consumer surplus is the difference between a buyer's willingness to pay and the price the buyer must pay in the market. Graph on the left orange area: ~ new producer surplus Producer surplus is the difference between a supplier's willingness to sell and the price the supplier actually receives in the market. Consumer surplus and producer surplus both decrease when there is a decrease in demand.
Identify the two situations with the highest total surplus.
Highest Total Surplus: ~ Jay buys a house for $40,000 less than he was willing to pay. He bought his home from sellers who received $2,000 more than they were willing to sell for. In this case, both the seller and the producer had a surplus from the transaction. The total surplus would be $42,000. ~ Kevin wanted to spend $50 on a dishwasher and bought one at $45 from a producer who was hoping to receive $40. Kevin was happy to save $5 on his dishwasher and the seller ended up with a $5 producer surplus. The total surplus generated was $10. Not the Highest Total Surplus: ~ Bonnie buys flowers for $2.25 less than she was willing to pay. She bought them from a seller who would have been willing to accept $3 less that what Bonnie paid. The flower producer had a willingness to sell that was $3 lower than the price Bonnie paid. Bonnie was happy to find that the flowers were less expensive than she was willing to pay. The total surplus was $5.25. ~ Don wanted to buy a scooter for no more than $5, but was only able to find a producer who would sell for $15. It is likely that this transaction would not take place, because Don cannot find a scooter for a price he is willing to pay. If Don purchased this particular scooter, he would have a voluntary consumer loss of -$10. Since the producer surplus cannot logically be more than the selling price of $15, the total surplus would have been at most $5.
Order the products, from least to greatest, by how much of the tax incidence would fall on the consumer if an excise tax were to be levied.
I. Luxury yacht Luxury yachts have highly elastic demand. Producers would bear the burden of the tax on a product with many substitutes. II. frozen vegetables Fresh vegetables have a moderately elastic demand because although there are substitutes, some people will choose to continue buying frozen vegetables over canned. Producers will share the tax burden with the consumer. III. car insurance Drivers need car insurance in order to drive. If an excise tax were levied on car insurance, consumers would have no choice but to pay it. In this example it is likely that consumers would continue buying frozen vegetables and car insurance, but would drastically reduce the number of luxury yachts they purchase.
Jennifer, Tony, and Becky are students in a history class. All three plan on selling their textbooks back at the end of the year. The bookstore will buy each textbook back for $95. Jennifer is willing to sell her textbook back for $87, Tony is willing to sell his textbook back for $45, and Becky is willing to sell her textbook back for $105. Based on each student's producer surplus for this situation, order them from highest surplus to lowest surplus.
I. Tony, Tony had a very low willingness to sell and will have $50 in producer surplus if he sells his book to the bookstore. II. Jennifer Jennifer's willingness to sell is a bit higher than Tony's, but she will still end up with $8 in producer surplus. III. Becky Becky will not be able to make a producer surplus from the bookstore at all, because she will not sell her textbook. The price the bookstore is offering is below her willingness to sell. Becky may decide it is not worth it to sell her textbook to the bookstore and may look for an alternative buyer who could satisfy her minimum selling price.
Determine whether each of the following actions is based on equity or efficiency. Match the correct term with each action. I. A doughnut shop offers a discount on all doughnuts purchased after 5 p.m. to reduce the number of doughnuts the shop must discard at the end of the day. II. A children's baseball league makes a rule that all team members must receive some amount of playing time in every game. III. A university adopts a policy to make sure that there are no unused classrooms during the school day.
I. efficiency People concerned with efficiency care about preventing the waste of goods and services. II. equity People concerned with equity care about distributing resources fairly. III. efficiency People concerned with efficiency care about making sure all resources are used.
Suppose the government imposes a tax on three products with differing demand elasticities. Match the product to the group that will most likely bear the incidence of the tax. I. consumers and producers II. consumers III. the government IV. producers
I. somewhat elastic With somewhat elastic demand, the tax incidence is shared by producers and consumers. II. highly inelastic With highly inelastic demand, if the government were to raise taxes, people would have little choice but to pay. III. LEAVE EMPTY IV. highly elastic With highly elastic demand, if the government impose a tax, many people would just switch to a substitute. Thus the producers would bear most of the burden of the tax. Goods with highly inelastic demand are more likely to be taxed because taxes do not lower their demand.
Assume that the government places a tax on the buyers of televisions, and the demand curve decreases. What is the price without the tax, and what prices do the consumers pay and producers receive after the tax is imposed? Drag the labels to the corresponding dotted gray lines on the graph. Top box Mid box Bottom box
Top box: price buyer pays Consumers must pay more when the tax is imposed. Mid box: price without tax The price without the tax is the initial equilibrium price. Bottom box: price seller receives Producers receive less when the tax is imposed. When a tax is imposed on buyers, the price consumers must pay increases and the price the seller receives decreases. The difference between these two prices represents the per unit tax amount that the government receives.
The table below shows the value that three students place on their economics textbooks. Willingness to Pay for a New Economics Textbook Buyer | Willingness to pay Ron | $200 Leslie | 150 Donna | 100 Top circle Middle circle Bottom circle
Top circle: Ron's Ron's willingness to pay appears on this "stair-step" demand curve as a horizontal line at his willingness to pay $200. Middle circle: Leslie's Leslie's willingness to pay appears on this "stair-step" demand curve as a horizontal line at her willingness to pay $200. Bottom circle: Donna's For a demand curve with only a few consumers who each will buy only one item, the willingness to pay appears as a horizontal stair step at the same price as each consumer's willingness to pay.
Drag the product to the graph that would represent its supply and demand after a tax has been added. Top left graph Right graph Bottom left graph
Top left graph: ~ prescription medication Prescription medication is nearly perfectly inelastic, thus consumers would bear the burden of any tax on medication. Right graph: ~ television sets Some people would cease buying television sets, but others would pay the tax. Producers and consumers would share the tax burden. ~ cable television subscription Producers and consumers would share the tax burden for cable television subscriptions, since its demand is somewhat elastic. Some consumers will switch to a different product, which will lower demand, but many consumers will pay the increased price. Bottom left graph: ~ a "store brand" of bottled water Producers will bear the burden of the tax because consumers could easily switch to a different brand of water. Whether producers bear the burden of the tax by themselves or share the tax burden with consumers, deadweight loss will occur.
When an allocation of resources maximizes total surplus, the result is said to be efficient.
True In order for a market to be efficient, the allocation of resources must maximize total surplus.
Taxes do not always cause deadweight loss.
True Products with almost perfectly inelastic demand will not experience deadweight loss, because people need to keep purchasing them regardless of price.
Judy purchased a speedboat for $120,000. She was willing to pay $150,000. After a few years, she wanted to sell the boat for $85,000 and ended up selling it to Gary for $90,000. What is true about the surplus generated by the speedboat? Select all that apply.
True: ~ Judy's consumer surplus is $30,000. Judy was able to buy the boat for a lower price than the highest price she was willing to pay, so she has consumer surplus. ~ Judy's producer surplus is $5,000. Judy was able to sell the boat for more than her minimum selling price, so she has producer surplus. Not True: ~ Gary's consumer surplus is $5,000. There is no way to calculate Gary's consumer surplus since we do not know how much he was willing to pay for the boat. ~ Judy's producer surplus is $270,000. Calculate Judy's producer surplus by finding the difference between the price she wanted to sell the speedboat for and the price she was able to sell it for. Judy will be happy with both her speedboat purchase and the eventual sale because she was able to buy the boat for a lower price than she anticipated and she sold it for more than her minimum selling price.
Airbnb, a vacation rental company that is considered a normal good, had record sales prior to the public health crisis of 2020. With the country thrown into a recession, many people had to put their vacations on hold. This drop in consumer income caused the _____ curve for Airbnb to shift to the _____, which led to a _____ in producer surplus.
demand, left, decrease
A television set currently costs $100. A new excise tax law is passed and will impose a $5 tax on the sale of each television set. How much should a consumer expect to pay for the television set once the tax is in place?
between $100 and $105: Both the consumer and producer will pay part of the tax. The consumer will bear part of the tax burden and pay somewhat more than the original price of $100. The producer will bear the rest of the tax burden and receive somewhat less than $100.
The graphs below show the impact of a $6 excise tax on each good. Based on the elasticity of demand for each good, how much tax revenue and deadweight loss will result from the tax? The good in graph A has _____ demand, which yields tax revenue of _____ and a deadweight loss of _____. The good in graph B has _____ demand, which creates tax revenue of _____ and _____ of deadweight loss. If the government places an equal tax on two goods, there will be _____ tax revenue and _____ deadweight loss generated by the good that has the more inelastic demand.
elastic, $900, $150, perfectly inelastic, $1200, $0, more, less The government tends to places excise taxes on goods that have more inelastic demand because it generates more tax revenue and leads to a smaller decline in economic activity.
When the price of a good or service is _____ enough, it will encourage consumers to buy. However, the price also has to be _____ enough to encourage producers to sell. In this way, both parties benefit from the sale. In order to calculate producer surplus, sellers must understand their direct costs and their _____ costs, whereas consumers must consider their _____ price based on the value they place on a particular good or service.
low, high, opportunity, reservation Understanding consumer and producer surplus is important to understand how the allocation of resources affects economic well-being.
