Econ Exam

Factors Affecting Elasticity

- Availability of Substitutes - If there are a few substitutes for a good, then even when its price rises greatly, you might still buy it. - If the lack of substitutes can make demand inelastic, a wide choice of substitute goods can make demand elastic. Relative Importance A second factor in determining a good's elasticity of demand is how much of your budget you spend on a good. Necessities v. Luxuries Whether a person considers a good to be a necessity or a luxury has a great impact on a person's elasticity of demand for that good. Change Over Time Consumers do not always react quickly to a price increase, because it takes time to find substitutes. Because they cannot respond quickly to price changes, their demand is inelastic in the short term. Demand sometimes becomes more elastic over time as people eventually find substitutes.

Total Revenue

- elasticity helps us measure how consumers respond to price changes for different products. The elasticity of demand determines how a change in price will affect a firm's total revenue or income

Where do firms produce

A key factor in where a firm will locate is transportation. When inputs such as raw materials are expensive to transport, a firm will locate close to the inputs. When outputs (the final product) are more costly to transport, firms will locate close to the consumer.

Medicare/Medicaid

About 42 million people receive Medicare benefits. It pays for hospital care and for the costs of physicians and medical services. Medicare costs have been rising as a result of expensive technology and people living longer. It faces the same problem as Social Security. Medicaid benefits help low-income families pay for their medical expenses The federal government shares the cost of Medicaid with state governments.

Advertising

Advertising is a factor that shifts the demand curve because it plays an important role in many trends. Companies spend money on advertising because they hope that it will increase the demand for the goods they sell.

Labor and Output

All business owners must decide how many workers they will hire. The addition of new workers will increase production until it reaches its peak, at which point, production actually decreases.

Input Costs

Any changes in the cost of an input used to make a good will affect supply. A rise in the cost of raw materials, for example, will result in a decrease in supply because the good has become more expensive to produce The high input costs that dairy farmers pay for feed, labor, and fuel result in higher prices for milk and other dairy products

demand curves

Ashley's demand curve shows the number of slice she is willing and able to buy at each price, while the market demand curve shows demand for pizza in an entire market.

Law of demand in action

Changes in price are an incentive; price changes always affect quantity demanded because people buy less of a good when its price goes up.

Non-Price Influences

Changes in the global economy Since many goods and services are imported, changes in other countries can affect the supply of those goods. An increase in wages in one country or the increased supply of a good in another will cause the overall supply curve to shift. Restrictions on imports also affect supply.

Population

Changes in the size of the population will also affect the demand for most products. Population trends can have a particularly strong effect on certain goods.

Discretionary Spending

Defense spending accounts for about half of the government's discretionary spending. The Department of Defense uses this money to pay salaries of enlisted men and women as well as its civilian employees. This money also buys weapons, missiles, ships, tanks, airplanes, and equipment. The remaining discretionary funds goes to pay for the following: Education and training Scientific research Student loans Law enforcement Environmental cleanup Disaster relief

demand

Demand is the desire to own something and the ability to pay for it. The law of demand states that when a good's price is lower, consumers will buy more of it. When the price is higher, consumers will buy less of it. The law of demand is the result of the substitution effect and the income effect --two ways that a consumer can change his or her spending patterns. Together, they explain why an increase in price decreases the amount consumers purchase.

Tax Bases

Different taxes have different tax bases. The individuals income tax is based on a person's earnings. The corporate income tax is based on a company's profits. The property tax is based on real estate and other property. The sales tax is based on goods and services that are sold.

Progressive Taxes

Economists describe taxes based on their structure and according to the tax base. A progressive tax is a tax for which the percentage of income paid in taxes increases as income increases.

factors that affect elasticity of demand

Economists have developed a way to calculate how strongly consumers will react to a change in price. Original price and how much you want a particular good are both factors that will determine your demand for a particular product.

Determining Fairness

Economists have proposed two different ideas about how to measure the fairness of a tax. The benefits-received principle holds that a person should pay taxes based on the level of benefits he or she expects to receive from the government. The gasoline tax is an example of the benefits-received principle. The ability-to-pay principle holds that people should pay taxes according to their ability to pay. Good taxes generate enough, but not too much, revenue. Citizens needs are met, but not to such an extensive degree that the tax discourages production.

State taxes spent on...

Education Every state spends taxpayer money to support at least one public state university. They also provide financial help to local governments for public elementary and secondary schools. Public Safety State police enforce traffic laws and help motorists in an emergency. State governments build and run corrections systems. Public Welfare State funds support hospitals and clinics and unemployment benefits. Highway and Transportation State crews resurface roads and repair bridges. States pay some of the cost of facilities like waterways and airports. Arts and Recreation States fund parks, nature reserves, museums, and art and music programs. Administration State governments spend money to keep the government running. Revenues pay for state workers' salaries.

Elasticity and Revenue

Elasticity of demand determines the effect of a price change on total revenues.

Consumer Response

Elasticity of demand is the way that consumers respond to price changes; it measures how drastically buyers will cut back or increase their demand for a good when the price rises or falls. - Your demand for a good that you will keep buying despite a price change is inelastic. - If you buy much less of a good after a small price increase, your demand for that good is elastic

Social Security and Medicare

Employees also withhold money to help fund Social Security, Medicare, and unemployment insurance under the Federal Insurance Coalition Act (FICA). Most of the FICA taxes you pay go to Social Security benefits for retired people, surviving members of wage earners, and disabled people. The Medicare tax helps pay for health insurance for people over 65.

Withholding and Tax Returns

Employers help collect taxes by withholding money from your paycheck based on an estimate of how much you will owe in federal income tax for that year. After the calendar year ends, employers give their employees a report of how much income tax has already been paid. Employees then fill out a tax return to send to the federal government. - On your tax return, you figure out how much of your income is taxable. Taxable income is a person's total income minus exemptions and deductions. Tax returns are due to the Internal Revenue Service by April 15

Types of Taxes

Excise taxes—a general revenue tax on the sale or manufacture of a good or service such as gasoline, cigarettes, and other items Estate taxes—a tax on the total value of the money and property of a person who has died Gift taxes—a tax on the money or property that one living person gives to another The goal of the gift tax is to stop people from avoiding the estate tax by giving away property before they died. Import taxes—Tariffs, or import taxes, are taxes place on imported goods.

Shifts in the Supply Curve

Factors that reduce supply shift the supply curve to the left, while factors that increase supply move the supply curve to the right.

How federal gov spends income

Federal spending is divided up into mandatory and discretionary spending. Mandatory spending pays for Social Security, Medicare, Medicaid, and other entitlements. Discretionary spending pays for everything else, including defense, education, law enforcement, environmental cleanup, and disaster aid.

Federal Aid

Federal taxes are sometimes used to help state and local governments. State and federal governments share the cost of Medicaid, unemployment insurance, education, lower-income housing, highway construction, and dozens of other programs. States also rely on federal aid for disaster relief.

State Budgets

Governments plan their spending by creating a budget. The federal government has one budget while state governments have two budgets. An operating budget is a budget for day-to-day spending needs. A capital budget is spending on major investments. Unlike the federal government, 49 states require balanced budgets—budgets in which revenues are equal to spending.

Higher Production

If a firm is earning a profit from the sale of a good or service, then an increase in the price will, in turn, increase the firm's profits. In general, the search for profit drives the choices made by the producer.

Option 2: Shut Down the Factory

If a firm shuts the factory down it still has to pay all of its fixed costs so it would have money going out but nothing coming in. The firm would lose an amount equal to its fixed costs.

Future Expectation of Prices

If a seller expects the price of a good to rise in the future, the seller will store the goods now in order to sell more in the future. If the prices of good is expected to drop in the near future, sellers will earn more by placing goods on the market immediately, before the price falls.

Rising Costs and Technology

If costs continue to rise, a firm will have to cut production and lower its marginal cost. It is possible for input costs to drop. In many industries, advances in technology can lower production costs. Examples of technology advances include: Automation Computers E-mail

Number of Suppliers

If more suppliers enter a market, the market supply will rise and the supply curve will shift to the right. If suppliers stop producing a good and leave the market, market supply will decline, causing the supply curve to shift to the left.

Measuring Elasticity

If the elasticity of demand for a good at a certain price is less than 1, the demand is inelastic. If the elasticity is greater than 1, demand is elastic. If elasticity is exactly equal to 1, demand is unitary elastic.

Disequilibrium

If the market price or quantity supplied is anywhere but at equilibrium, the market is said to be at disequilibrium. Disequilibrium can produce two possible outcomes: Shortage—A shortage causes prices to rise as the demand for a good is greater than the supply of that good. Surplus—A surplus causes a drop in prices as the supply for a good is greater than the demand for that good. Shortage and surplus both lead to a market with fewer sales than at equilibrium.

Calculating Elasticity of Demand

In order to calculate elasticity of demand, take the percentage change in the quantity of the good demanded and divide this number by the percentage change in the price of the good. The result is the elasticity of demand for the good. The law of demand implies that the result will always be negative. This is because increases in the price of a good will always decrease the quantity demanded, and a decrease in the price of a good will always increase the quantity demanded.

Equilibrium

In order to find the equilibrium price and quantity, you can use supply and demand schedules. When a market is at equilibrium, both buyers and sellers benefit.

Change in Demand Factors

Income Most items that we purchase are normal goods, which consumers demand more of when their income increases. A rise in income would cause the demand curve to shift to the right, indicating an increase in demand. A fall in income would cause the demand curve to shift left, indicating a decrease in demand.

taxes federal gov. collects

Individual income taxes Corporate income taxes Social Security, Medicare, and unemployment taxes Excise taxes and tariffs Estate and gift taxes

Marginal Cost of Production

Knowing the total cost of several levels of output helps determine the marginal cost of production at each level, or the additional costs of producing one more unit. One way to find the best level of output is to figure out where marginal cost is equal to marginal revenue, or the additional income from selling one more unit of a good.

Elasticity and Price Policies

Knowledge of how the elasticity of demand can affect a firm's total revenues helps the firm make pricing decisions that lead to the greatest revenue. If a firm knows that the demand for its product is elastic at the current price, it knows that an increase in price would reduce total revenue. If a firm knows that the demand for its product is inelastic at its current price, it knows that an increase in price will increase total revenue.

Corporate Income Taxes

Like individual income taxes, corporate income taxes are progressive. Determining corporate income taxes can be more difficult than determining an individual's because businesses can take many deductions

Local Government Taxes

Local governments levy property taxes, sales taxes, excise taxes, and income taxes. Many local taxes affect visitors and are designed to raise revenue from nonresidents. Wall-to-wall traffic jams, for example, are prompting a few cities to consider a congestion tax.

local governments manage their money

Local governments manage their money in accordance with priorities set by elected local government officials. Local governments create budgets and collect taxes just like the federal government.

Local Government

Local governments, including towns, cities, countries, and school districts, carry major responsibilities in the public school systems, law enforcement, and fire protection. They also manage public facilities, parks, and recreation facilities. They monitor public health, public transportation, elections, record keeping, and social services.

two types of government spending

Mandatory spending is money that Congress is required by existing law to spend on certain programs or to use for interest payments on the national debt. Discretionary spending is spending about which lawmakers are free to make choices. The federal government spends the funds it collects from taxes and other sources on a variety of programs.

Entitlement Programs

Most of the mandatory spending items are for entitlement programs, which fund social welfare programs. The federal government guarantees assistance for all people who quality for such programs. Entitlements are a largely unchanging part of government spending. Congress can only change the eligibility requirements or reduce benefits if there is a change in the law.

Mandatory Programs

Other means-tested entitlements benefit people and families whose incomes fall below a certain level. These entitlements include: Food stamps and child nutrition programs Retirement benefits and insurance for federal workers Veterans' pensions Unemployment insurance In recent years, there has been a debate over governmentally funded universal healthcare

Price Supports in Agriculture

Price supports in agriculture are another example of a price floor. They began during the Great Depression to create demand for crops. Opponents of price supports argue that the regulations dictate to farmers what they should produce. Supporters say that without government intervention, farmers would overproduce.

What factors affect price

Prices are affected by the laws of supply and demand. They are also affected by actions of the government. Often times the government will intervene to set a minimum or maximum price for a good or service

Fixed Costs

Production costs are divided into two categories - fixed costs and variable costs. Fixed costs mainly involve the production facility and include: Rent Machinery repair Property taxes Worker's salaries

Market Entry

Rising prices encourage new firms to join the market and will add to the quantity supplied of the good.

Why supply curve shift

Shifts in prices Rising costs Technology Changes in the global economy Future expectations of prices Number of suppliers

Why does the demand curve shift?

Shifts in the demand curve are caused by more than just price increases and decreases. Other factors include: Income Consumer Expectations Population Demographics Consumer Tastes and Advertising

Characterisitcs of a good tax

Simplicity—tax law should be easy to understand Efficiency—the tax should be able to be collected without spending too much time or money Certainty—it should be clear when the tax is due, how much is due, and how to pay the tax Equity—the tax system should ensure that no one bears too much or too little of the tax

Social Security

Social Security is a huge portion of federal spending. About 50 million Americans receive monthly benefits from the Social Security Administration. The future of Social Security is uncertain. As the millions of baby boomers—people born after World War II—start to retire, the ratio of existing workers, who pay for Social Security, to retirees will fall.

Shutdown Decision

Sometimes, even though a factory is producing at its most profitable level, the market price is so low that the factory's total revenue is still less than its total cost. The factory owners have two choices: Continue to produce goods and lose money Shut down the factory

State Tax Revenue

States receive most of their revenue through taxes. Sales tax on goods and services is the main source of state revenue. Some goods, like food and clothing, are tax exempt in certain states. Even states without a sales tax impose excise taxes that apply to specific products and activities. Many states also collect an individual income tax, which is paid in addition to the federal income tax. Some states tax at a flat rate while other have progressive rates. Corporate income tax—Most states collect income taxes from corporations that do business in the state. These taxes make up a small amount of state tax revenues. Other state taxes include: Licensing fees on certain businesses Transfer taxes on stock certificates Inheritance taxes Property taxes, including real property and personal property

Law of Supply

Supply is the amount of goods available. As the price of a good increases, producers will offer more of it and as the price decreases, they will offer less. The law of supply includes two movements: Individual firms changing their level of production Firms entering or exiting the market

Supply Schedule

Supply of a good can be measured using a supply schedule. A supply schedule shows the relationship between price and quantity supplied for a particular good. An individual supply schedule shows how much of a good a single supplier will be able to offer at various prices. A market supply schedule shows how much of a good all firms in a particular market can offer at various prices. lists how many slice of pizza one pizzeria will offer at different prices. The market supply schedule represents all suppliers in a market. can be represented graphically by plotting points on a supply curve. A supply curve always rises from left to right because higher prices leads to higher output.

Elasticities of Demand and TaX EFFECT

Taxes affect more than just the people who pay them. Producers often pass on a portion of tax to consumers. Generally, the more inelastic the demand, the more easily the seller can shift the tax to consumers.

Marginal Returns

The addition of more workers to a firm allow for a greater amount of specialization. Specialization increases the output and the firm enjoys increasing marginal returns. Eventually, though, the benefits of specialization end and the addition of more workers increases total output but at a diminishing rate. A firm with diminishing marginal returns will produce less and less output from each additional unit of labor.

Pay as you earn taxation

The amount of federal income tax a person owes is determined on an annual basis. To lessen the burden that one large yearly tax would place on an individual and to make it possible for the government to meet its regular expenses, federal income tax is collected in a "pay-as-you-earn" system.

Elastic Demand

The availability of substitute goods A limited budget that does not allow for price changes The perception of a good as a luxury item.

Consumer Excepectations

The current demand for a good is positively related to its expected future price. If you expect the price to rise, your current demand will rise, which means you will buy the good sooner. If you expect the price to drop your current demand will fall, and you will wait for the lower price.

Complements and Substitutes

The demand curve for one good can also shift in response to a change in demand for another good. There are two types of related goods that interact this way: Complements are two goods that are bought and used together. Substitutes are goods that are used in place of one another.

tax breakers

The federal income tax is a progressive tax, which rises with the amount of taxable income. Your range of income puts you in a specific tax bracket.

Option 1: Continue to Produce

The firm should keep the factory open if the total revenue from the goods is greater than the cost of keeping the factory open. This would work if the benefit of operating the factory is greater than the variable cost.

Taxes Affect Behavior

The government sometimes uses taxes to encourage good behavior, which is known as a tax incentive. Tax credits are often used as an incentive. For example, people who use solar power receive an income tax credit.

Individual Income taxes

The government's main source of revenue comes from the federal tax on individual's taxable income.

Total Revenue and Elastic Demand

The law of demand states that an increase in price will decrease the quantity demanded. When a good has elastic demand, raising the price of each unit sold by 20% will decrease the quantity sold by a larger percentage. The quantity sold will drop enough to reduce the firm's total revenue. The same process can also work in reverse. If the price is reduced by a certain percentage, the quantities demanded could rise by an even greater percentage. In this case, total revenues would increase.

Unemployment

The unemployment tax pays for "unemployment compensation" that people can receive when they are laid off.

Limits on the Government

There are also limits on the government's power to tax. The purpose of a tax must be "for the common defense and general welfare." A tax cannot bring in money that goes to individual interests. Federal taxes must be the same in every state. The government cannot tax exports, only imports.

Variable Costs

Variable costs include: Price of raw materials Some labor Electricity and heating bills Fixed costs and variable costs are added together to find the total cost.

Government's Authority to Tax

We authorize the federal government, through the Constitution and our elected representatives in Congress, to raise money in the form of taxes. Taxation is the primary way that the government collects money. Taxes give the government the money it needs to operate. The first power granted to Congress is the power to tax, which is the basis of all federal laws.

Producer maximize profits

When thinking about how to maximize profits, producers think about the cost involved in producing one more unit of a good. Costs producers take into consideration are: Operating cost Variable cost Total cost Marginal cost

Price Ceiling

While markets tend toward equilibrium on their own, sometimes the government intervenes and sets market prices. Price ceilings are one way the government controls prices. Rent Control Sets a price ceiling on apartment rent Prevents inflation during housing crises Helps the poor cut their housing costs Can lead to poorly managed buildings because landlords cannot afford the upkeep.

Elasticity of Supply

based on the same concept of elasticity of demand, measures how firms will respond to changes in the price of a good. Elastic When elasticity is greater than one, supply is very sensitive to price changes Inelastic When elasticity is less than one, supply is not very responsive to price changes.

income effect

change in consumption that results when a price increase causes real income to decline. Economists measure consumption in the amount of a good that is bought, not the amount of money spent on it. The income effect also operates when the price is lowered. If the price of something drops, you feel wealthier. If you buy more of a good as a result of a lower price, that's the income effect at work.

Demographics

characteristics of populations, such as age, race, gender, and occupation. Businesses use this data to classify potential customers. Demographics also have a strong influence on packaging, pricing, and advertising Hispanics, or Latinos are now the largest minority group in the United States. Firms have responded to this shift by providing products and services for the growing Hispanic population.

demand graph

demand curve is a graphic representation of a demand schedule. The vertical axis is always labeled with the lowers possible prices at the bottom and the highest prices at the top. The horizontal axis should be labeled with the lowest possible quantity demanded at the left and the highest possible quantity demanded on the right.

Total Revenue and Inelastic Demand

demand is inelastic, consumers' demand is not very responsive to price changes. If prices increase, the quantity demanded will decrease, but by less than the percentage of the price increase. This will result in higher total revenues.

Changes in Demand

demand schedule takes into account only changes in price. It does not consider the effects of news reports of any one of the thousands of other factors that change from day to day that could affect the demand for a particular good. A demand curve is accurate only as long as there are no changes other than price that could affect the consumer's decision. demand curve is accurate only as long as the ceteris paribus assumption—that all other things are held constant—is true. When we drop the ceteris paribus rule and allow other factors to change, we no longer move along the demand curve. Instead, the entire demand curve shifts. A shift in the demand curve means that at every price, consumers buy a different quantity than before; this shift of the entire demand curve is what economists refer to as a change in demand.

market demand curves

demand schedules and demand curves reflect the law of demand. Market demand curves are only accurate for one very specific set of market conditions. They cannot predict changing market conditions

Elasticity of Short Run

difficult for a firm to change its output level, so supply is inelastic. Many agricultural businesses, such as harvesting cranberries, have a hard time adjusting to price changes in the short term.

Graphing Changes in Demand

factors other than price cause demand to fall, the demand curve shifts to the left. An increase in demand appears as a shift to the right.

Government's Influence

federal government also has the power to affect the supplies of many types of good. Subsidies The government often gives subsidies to the producers of a good. Subsidies generally lower cost, which allows a firm to produce more goods. Reasons for subsidizing products include: To provide for people during food shortages To protect young industries from foreign competition. Taxes Excise taxes increase production costs by adding an extra cost for each unit sold. They are sometimes used to discourage the sale of a good the government deems harmful, such as cigarettes and alcohol. Regulation Indirectly, government regulation often has the effect of raising costs. When the government regulated the auto industry to cut down on pollution, these regulations led to an increase in the cost of manufacturing cars.

Setting Output

firm's primary goal is to maximize profits. The firm wants to make the most profit with the least amount of total production cost to the firm.

Determining Firm's Profit

graph to the right shows how a firm's profit per hour can be determined by subtracting total cost from total revenue

demand schedules

law of demand explains how the price of an item affects the quantity demanded of that item. To have demand for a good, you must be willing and able to buy it at a specified price. A demand schedule is a table that lists the quantity of a good that a person will purchase at various prices in the market.

Price Floors

price floor is a minimum price set by the government. The minimum wage is an example of a price floor. Minimum wage affects the demand and the supply of workers.

Other Taxes

proportional tax is a tax for which the percentage of income paid in taxes remains the same at all income levels. A regressive tax is a tax for which the percentage of income paid in taxes decreases as income increases.

demand schedule

show that demand for a good falls as the price rises.

market demand schedules

shows the quantities demanded at various prices by all consumers in the market. Market demand schedules are used to predict the total sales of a commodity at several different prices. Market demand schedules exhibit the law of demand: at higher prices the quantity demanded is lower.

Elasticity of Long Run

supply can become more elastic. Just like demand, supply becomes more elastic if the supplier has a longer time to respond to a price change.

Substitution effect

takes place when a consumer reacts to a rise in the price of one good by consuming less of that good and more of a substitute good. The substitution effect can also apply to a drop in prices.