Chapter 4

What is the impact of taxes?

- It constrains the market - it's imposed on producers b/c supply curve changed leftward - both consumers and produces lose because consumers pay more and producers earn less.

Define Consumer Surplus

- measures the dollar benefit consumers receive from buying goods/services in a particular market. - it also is the difference between the highest price consumers are willing to pay for goods/services and the price consumers actually pay. Therefore, the equation is: $(Willingness to pay) - $(what they actually pay) = consumer surplus It is calculated by adding each of the participants in the market's CS and totaling it up. (Hence, adding A + B + C). See notes for detail.

Define Produce Surplus

- measures the dollar benefit firms receive from selling goods/services to a particular market. - it is also the difference between the lowest price a firm would be willing to accept for a good/service and the price it actually receives Therefore, the equation is: $(Willingness to sell) - $(what they actually pay) = producer surplus It is calculated by adding each of the firm in the market's PS and totaling it up. (Hence, adding A + B + C). See notes for detail.

What are two ways to measure economic efficiency?

1) MB = MC 2) CS & PS Both result in the same outcome

What are three ramifications of rent control

1. Deterioration in flouring 2. Discriminatory landlord 3. Black market

What happen when the government imposes price floors/price ceilings?

1. some people win 2. some people loose 3. there is always an economic inefficiency

Define Price Ceiling

A legally determined maximum price that sellers may charge; typically, this is due to the government imposing such maximums on goods.

Define Price Floor

A legally determined minimum price that sellers may receive; typically, this is due to the government imposing such minimums on goods.

Define Black Market

A market in which buying and selling takes place at prices that violate government price regulations

What effect does price have over government rent control policy?

Because consumers want to issue a maximum amount renters can charge, there is a price ceiling. This means that there will be less amount of houses that renters can supply at the maximum amount they can charge. This will cause a shortage, resulting in a deadweight loss. The deadweight loss on a graph will show as B & C.

What effect does price have over minimum wage policy?

Because the policy is over minimum wage, it will have a price floor and therefore have deadweight loss. This shows net gain and net loss.

What is another way the government can intervene?

By imposing taxes....

What do CS and PS measure?

CS measures the net benefit to consumer from participating in a market (rather than measuring the total benefit). In other words, if price was 0, the CS would be all the area under the demand curve. If it wasn't 0, CS is the area above the market price. PS measures the net benefit received by producers from participating in the market. If producers could supply at 0 cost, the PS would be the whole area below the market price. If the cost isn't at 0, then its the area above the supply curve.

What does the health of the economy rely on?

Competitive market equilibrium

Who benefits from imposing a price ceiling?

Consumers

Table of Consumer - Willingness to pay 1. Carly - $50 2. Marvin - $30 3. Leon - $15 Question 1 - The table above lists the highest price three consumers, Carly, Marvin, and Leon, are willing to pay for a bottle of wine. If the price of one of the bottle is 24 dollars a) Carly and Marvin receive a total of $80 of consumer surplus from buying one bottle each. Leon will buy no bottles. b) Carly will buy two bottles, Marvin will buy one bottle and Leon will buy no bottles. c) Leon will receive $15 of consumer surplus since he will buy no bottles d) Carly will receive $26 of consumer surplus from buying one bottle

D) Carly will receive $26 of consumer surplus from buying one bottle

Just know how to calculate, especially when market is not at the equilibrium - 1. CS 2. PS 3. ES 4. DL

Draw a table and a graph...

Define Economic Surplus (ES)

Equation/Definition: CS + PS = ES *Note: ES is maximized at competitive market equilibrium. It also measures how things are going in the economy.

How else can you calculate PS without having the individual firm's PS that is participating in the market?

Equation: (1/2)(b)(h) = PS *NOTE: height or h is found by subtracting: Market price - Firm's Willingness to sell price

How do you find tax?

Equation: Price paid after tax is imposed - price received by producing after paying the tax... Or B - C = Tax; to the right of this line/tax imposition is deadweight loss and the left of it is government revenue.

How do you determine the tax load/who bears the burden of tax?

Find the tax. Subtract --> Price above equilibrium - Price below equilibrium. Producer burden = (Equilibrium Price - Price below equilibrium)/tax Consumer burden = (Price above equilibrium - Equilibrium Price)/tax

Net Gain is described as

Gained - Producer = (B-E) or (-E + B)

Explain inefficiency in the market using MB & MC

If MB > MC, then it is ineffiiciently low because producers can produce more at the amount consumers are willing to pay. In other words, consumers are willing to pay more yet the supply is low... If MB < MC, then it is inefficiently high because producers produced more at a higher cost than the consumers are willing to pay. In other words, consumers AREN'T willing to buy at the amount producers are willing to supply.

What is a competitive market?

It is a market with many buyers and many sellers.

Why is price ceiling below the equilibrium if it is a maximum?

It is below the equilibrium because suppliers want to charge at a higher rate typically, but the demand for the product is higher than the suppliers have in stock; this is because the price is low. Example: rent control

How is the incidence of tax determined?

It is determined by the relative slopes of the demand and supply curve

Why is price floor set above the equilibrium if it is a minimum?

It is set above the equilibrium because the demand for the product is lower than the price amount suppliers want it because the price is higher.

Who is price floor used to protect?

It is typically used to support agriculture/farmers.

What does price ceiling represent?

It represents a shortage in goods.

What does equilibrium in a competitive market result in?

It results in the greatest amount of economic surplus, or total net benefit to society, from the production of a good/service.

When is a market competitive? What does equilibrium in a competitive market result in?

It's competitive ONLY WHEN MB = MC; it results in economic efficiency of output. This means that all the product produced has been sold to where it meets the consumer demand, hence at equilibrium.

Net Loss is described as

Lost - Consumer = (-B & -C)

What does MC and MB measure often times?

MC is a good indicator of producer welfare MB is a good indicator of consumer welfare

Who benefits from imposing a price floor?

Suppliers

Define Tax Incidence

The actual division of the burden of tax between buyers and sellers in a market; the burden is always shared between buyers and sellers.

Define Marginal Benefit (MB)

The additional benefit to the consumer from consuming one more unit of good/service. On a graph, DEMAND = MB

Define Marginal Cost (MC)

The additional cost to a firm of producing one more unit of a good/service. On a graph, SUPPLY = MC Example: When making herbal tea, the marginal cost is the ingredients to make the tea and the wages paid to the workers preparing the tea.

What happens in the absence of a buy-out program?

The quantity sold at the equilibrium price decreases, representing a deadweight loss and a decline in economic efficiency. This is when a price floor is established.

Define Deadweight Loss (DL)

The reduction in economic surplus resulting from a market not being in competitive equilibrium.

When there is a surplus due to MC > MB, what does the government do?

They elevate the price with the price floor and buy-out the goods...

How can CS be calculated without having the price of each individual's CS that is participating in the market?

You can utilize the equation: CS = (1/2)(b)(h) *NOTE: height (or h) is calculated by subtracting ---> Willingness to pay - market price

Define Economic Efficiency

a marketing outcome in which marginal benefit to the consumer of the last unit produced is equal to its marginal cost of production and in which the sum of CS and PS is at maximum.

Suppose the demand curve for a product is vertical and the supply curve is upward sloping. If a unit tax is imposed in the market for this product, a) buyers bear the entire burden of the tax b) sellers bear the entire burden of the tax c) the tax burden will be shared equally between buyers and sellers d) buyers share the burden of the tax with the government

a) buyers bear the entire burden of the tax

The figure represents the market for online music. Assume that this is a competitive market. At quantity of 10,000, (NOTE - Look at practice test for help) a) the marginal benefit of songs, at that level, is greater than the marginal cost; therefore, output is inefficiently low b) the marginal benefit of songs, at that level, is greater than the marginal cost; therefore, output is inefficiently high. c) producers should lower the price to $2 in order to sell the quantity demanded of 10,000 d) the marginal cost of songs, at that level, is greater thanthe marginal benefit; therefore, output is inefficiently high.

a) the marginal benefit of songs, at that level, is greater than the marginal cost; therefore, output is inefficiently low

Refer to the cigarette figure on practice test; the producers bear how much of the tax burden? a) 20% b) 40% c) 100% d) 60%

b) 40% Solution: Tax = 5 Producer Burden = (5-3)/5 = .4

Look at the next figure on the practice test; what area represents consumer surplus AFTER the imposition of the price floor? a) A + B + E b) A c) A + B d) A + B + E + F

b) A

Refer again to cigarette figure on practice test; how much tax revenue is collected by the government (HINT: quantity is given in the 1000's of packs)? a) $350,000 b) $320,000 c) $200,000 d) $120,000

c) $200,000 Solution: Tax is imposed between $8 & $3, therefore $8-$3 =$5; Revenue = P x Q, therefore $5 x 40,000 = $200,000

Look at same figure on the practice test; what is the NET gain in producer surplus as a result of the imposition of the price floor? a) B b) A + B c) B - D d) B - C

c) B - D

Look at same practice test/figure; suppose apartment owners ignore the rent control law and rent at a black market rate. This rate is: a) more than R1 b) R* c) R1 d) R0

c) R1

An economically efficient output level is achieved when a) the marginal benefit of the last unit produced is greater than the marginal cost of producing that unit b) the total benefit must exceed total cost c) the marginal benefit of the last unit produced equals the marginal cost of producing that unit d) the marginal benefit of the last unit produced is less than the marginal cost of producing that unit

c) the marginal benefit of the last unit produced equals the marginal cost of producing that unit

What area represents if there was a decrease in producer surplus when market price goes from P2 to P1? (Look at practice test for help) a) A + B + D b) B c) C d) A + B

d) A + B

Look at practice test for figure; what is the area that represents consumer surplus after imposition of the ceiling? a) A + B + C + D b) A + B + C c) A + B + C + D + E + J d) A + B + D

d) A + B + D

Look at same practice test/figure; what area represents the deadweight loss after the imposition of the ceiling? a) G + H b) C + E + J + H c) J + H d) C + E

d) C + E

Look at same practice test/figure; what is the area that represents the REDUCTION in the producer surplus that results because of imposition of the ceiling? a) D b) F c) D + E + J d) D + E

d) D + E

Consumer surplus in a market for a product would be equal to the area under the demand curve if a) marginal cost was equal to market price b) the product was produced in a perfectly competitive market c) producer surplus was equal to zero d) the market price was zero

d) the market price was zero

Deadweight loss refers to a) the surplus that is transferred from the consumer to the producer (and vice versa) b) the loss of economic surplus when MB equals teh MC of the last unit produced c) the opportunity cost to the firm from producing the equilibrium quantity in a competitive market d) the reduction in economic surplus resulting from not being in competitive equlibirum

d) the reduction in economic surplus resulting from not being in competitive equlibirum

In Germany, the government places a $3,000 tax on the buyers of new automobiles. After the purchase of a new car, a buyer must pay the government $3,000. How would the imposition of the tax on buyers be illustrated in a graph? a) the tax will shift the supply curve to the left such that the horizontal distance between the two supply curves is $3,000 b) the tax will shift the demand curve to the right such that the vertical distance between the two demand curves is $3,000 c) the tax will shift the demand curve to the left such that the horizontal distance between the two demand curves is $3,000 d) the tax will shift the demand curve to the left such that the vertical distance between the two demand curves is $3,000

d) the tax will shift the demand curve to the left such that the vertical distance between the two demand curves is $3,000

What important conclusion can be drawn with consumer surplus?

the total amount of CS in a market = the area below the demand curve + the area above the market price (MP)

What important conclusion can be drawn with producer surplus?

the total amount of producer surplus in a market = the area BELOW the equilibrium + the area above the supply curve