Micro Economics Exam II Textbook Checkpoints/Quizes
1. Which income tax is the most efficient and which is the most inefficient, and why: a tax on labor income, a tax on capital income, or a tax on land income? 2. Comparing a tax on labor income, a tax on capital income, and a tax on land income, who pays more of each tax, and why? 3. Explain why Jordan Spieth pays his own Social Security tax and the PGA (the Professional Golfers' Association) pays none of it.
Checkpoint 8.2 Practice Problems 1. The income tax that is most efficient is that on the income earned by the factor of production that has the lowest elasticity of demand or supply. The reason is that the deadweight loss from a tax (the excess burden) is smaller if the tax decreases the equilibrium quantity of the factor by a small amount. The supply of land is perfectly inelastic, while the supplies of labor and capital are elastic. So the tax on land income is the most efficient tax. For a similar reason, the income tax that is most inefficient is that on the income earned by the factor of production that has the highest elasticity of demand or supply. The supply of capital is highly elastic, perhaps perfectly elastic, so the tax on capital income is the most inefficient. 2. Who pays more of a tax depends on the relative elasticities of demand and supply. The demand for labor is more elastic than the supply of labor, so workers bear a larger share of the tax on labor income than employers. The supply of capital is more elastic than the demand for capital, so business owners pay more of the tax on capital income than savers and lenders pay. The supply of land is less elastic than the demand for land, so land owners pay more of the tax on land income than renters pay. 3. Jordan Spieth pays his Social Security tax and the PGA pays none of it because the supply of Jordan Spieth's services is (most likely) perfectly inelastic. The elasticities of demand and supply determine who pays the tax.
California voters overwhelmingly back $2-a-pack increase in the cigarette tax with the revenue being used to fund healthcare for the poor. Source: Los Angeles Times, September 3, 2015 1. Which principle of fairness would California use to justify this big tax hike?
Checkpoint 8.3 In the News 1. The two principles of fairness are the benefits principle and the ability-to-pay principle. California will justify the tax on the benefits principle because the funds raised will pay for healthcare of the poor, who are most of the smokers.
1. "Retired seniors should pay higher taxes than college students because gov- ernment-funded healthcare for seniors costs more than government-funded tuition." Is this statement consistent with a principle of tax-system fairness? 2. Florida levies the following taxes: a 5.5 percent corporate income tax; a 6 per- cent sales tax; taxes of $0.34 a gallon on gasoline, $1.34 a pack on cigarettes, $0.48 a gallon on beer, and $2.25 a gallon on wine; and property taxes that vary across the counties and range from 1.4 percent to 2.0 percent of property values. Classify Florida's taxes into progressive, proportional, and regressive taxes. 3. What are the main differences between a flat tax and the FairTax? Which of the two taxes places a greater weight on efficiency and a smaller weight on fairness in the big tradeoff?
Checkpoint 8.3 Practice Problems 1. The statement "Retired seniors should pay higher taxes than college students because government-funded healthcare for seniors costs more than government- funded tuition." is consistent with the benefits principle of tax-system fairness, which is the proposition that people should pay taxes equal to the benefits they receive. 2. If counties with the higher rates are those with high property values, then Florida's property taxes are progressive. The corporate income tax does not vary with income, so this tax is a proportional tax. Because saving increases with income, expenditure as a fraction of income decreases as income increases. The taxes on expenditure (sales tax, gasoline tax, cigarette tax, beer tax, and wine tax) are regressive taxes. 3. The tax base for the flat tax is income and the tax base for the FairTax is expenditure on consumption goods and services. The flat tax is proportional while the FairTax is progressive at low income levels but regressive at high income levels because consumption expenditure decreases as a percentage of income as income increases. The FairTax places a greater weight on efficiency and a smaller weight on fairness.
Colorado companies plan to hire in 2016 Nearly a quarter of Denver-area technology executives plan to increase production and add new positions in 2016. Source: Denver Business Journal, December 21, 2015 1. Explain how increasing production by adding new positions changes a Denver- area firm's short-run average cost and marginal cost. How will the firm's short- run average cost curve and marginal cost curve change if the wage rate rises?
Checkpoint 14.3 In the News 1. An increase in output and employment increases the firm's short-run average cost and marginal cost as the firm moves along its ATC and MC curves. If the wage rate rises, average cost and marginal cost increase at all output levels and the MC, AVC, and ATC curves shift upward.
Hiring spree at Tesla Motors Bay Area-based electric car maker Tesla is looking to hire 1,648 workers to expand its model lineup, build a battery factory, and develop self-driving cars. Source: CBS San Francisco, December 8, 2015 1. Explain the effects of the expansion plan on Tesla's total fixed cost, total variable cost, short-run ATC curve, and LRAC curve.
Checkpoint 14.4 In the News 1. Expanding the model lineup, building a battery factory, and developing a self- driving car will raise Tesla's total fixed cost; hiring 1,648 workers will raise Tesla's total variable cost. As Tesla increases output, it will move along its ATC curve. With a larger capacity, Tesla will move rightward along its LRAC curve
Samsung and LG slash prices to take sales from Apple Apple's new iPhone 6 sold out quickly in the United States and to avoid the same outcome in other national markets, Samsung and LG cut the prices of their Galaxy and V10 smartphones by over 10 percent. Source: International Business Times, October 27, 2015 1. Will a price cut by Samsung and LG increase their total revenue? If Apple also cuts its prices, what will happen to the total revenue from all smartphone sales?
Checkpoint 5.1 In the News 1. The Apple 6s, Galaxy S6, and LG V10 offer similar features and functions, so they are close substitutes and the demand for any one of them alone is elastic. If the prices of only Samsung and LG fall by 10 percent, the quantity sold will increase by more than 10 percent and the two firms' total revenue will increase. But a smartphone has poor substitutes, so if Apple also cuts its prices, the total revenue of all three firms will decrease because the demand for smartphones is inelastic.
Could u.s. pollution regulations help smog-enshrouded China? Beijing officials issued a "red alert" for air quality, closed schools, limited automobile traffic, and kept people indoors to avoid toxic smog. Most of Beijing's energy comes from carbon-emitting coal. The U.S. EPA is working with China to develop a national cap-and-trade system. Source: The Christian Science Monitor, December 8, 2015 1. Explain the inefficiency in Beijing's market for electricity and contrast it with the U.S. market. How can cap-and-trade achieve an efficient outcome?
Checkpoint 10.1 In the News 1. The Beijing market for electricity is inefficient because it has a large external cost arising from carbon (and other) emissions from coal powered generators. The marginal social cost of electricity exceeds its marginal benefit by a large amount. The U.S. market for electricity is also inefficient but less so than Beijing's. Cap-and-trade can achieve an efficient outcome by confronting power utilities with the marginal social cost of their production.
Figure 1 illustrates the unregulated market for a pesticide. When factories produce pesticide, they also create waste, which they dump into a lake on the edge of the town. The marginal external cost of the dumped waste is equal to the marginal private cost of producing the pesticide (that is, the marginal social cost of producing the pesticide is double the marginal private cost). 1. What is the quantity of pesticide produced if no one owns the lake and what is the efficient quantity of pesticide? What is the deadweight loss? 2. If the town owns the lake, what is the quantity of pesticide produced and how much does the town charge the factories to dump waste? 3. If the pesticide factories own the lake, how much pesticide is produced? 4. If no one owns the lake and the government levies a pollution tax, what is the tax per ton of pesticide that achieves the efficient outcome?
Checkpoint 10.1. Practice Problems 1. In Figure 2, production is 30 tons a week, the efficient quantity is 20 tons a week, and the deadweight loss is the area of the gray triangle. 2. The quantity of pesticide produced is the efficient quantity, 20 tons a week, and the town charges the factories $50 a ton of pesticide, which is the marginal external cost of the pollution produced by that quantity. 3. The factories produce the efficient quantity: 20 tons a week. 4. A pollution tax of $50 a ton paid by the factories achieves the efficient quantity of pesticide because the pollution tax equals the external cost.
Students across America march for tuition-free college Students at colleges and universities from Los Angeles to New York are demonstrating in support of free education. The website studentmarch.org says: "Education should be free. The united States is the richest country in the world, yet students have to take on crippling debt in order to get a college education." Sources: Reuters, November 12, 2015, and www.studentmarch.org 1. If college becomes tuition free, how will the number of students enrolled change and will the outcome be efficient?
Checkpoint 10.2 In the News 1. Setting tuition at zero will increase the number of students enrolled in colleges and universities—a movement downward along the demand curve. College edu cation has an external benefit, so an efficient outcome occurs when tuition is less than marginal cost and marginal social benefit equals marginal cost. It is unlikely that zero tuition is efficient and it is likely that it would bring overproduction.
Figure 1 shows the marginal private benefit from college education. The marginal cost of a college education is a constant $6,000 a year. The marginal external benefit from a college education is a constant $4,000 per student per year. 1. What is the efficient number of students? If colleges are private (no government involvement), how many people enroll, what is the tuition, and what is the deadweight loss? 2.If the government provides public colleges, what is the tuition that will achieve the efficient number of students? How much must taxpayers pay? 3. If the government subsidizes private colleges, what subsidy will achieve the efficient number of college students? 4. If the government offers each student a voucher, what value of the voucher will achieve the efficient number of students?
Checkpoint 10.2 Practice Problems 1. In Figure 2, the efficient number of students is 50,000 a year. With no government involvement, enrollment is 30,000 students a year and tuition is $6,000 a year. The gray triangle shows the deadweight loss. 2. To enroll the efficient 50,000 students, public colleges would charge $2,000 per student and taxpayers would pay $4,000 per student (Figure 2). 3. A subsidy of $4,000 per student (equal to marginal external benefit). 4. A voucher valued at $4,000 will achieve an efficient enrollment of 50,000. The private college tuition is $6,000. 50,000 students will enroll if the dollar cost is $2,000 per student. So the value of the voucher will have to be $4,000.
Gas price could fall below $2 a gallon The price of gasoline keeps falling. It was close to $3.50 a gallon a year ago, is $2.59 a gallon now, and is expected to fall below $2 a gallon by year's end. Source: CNBC, August 11, 2015 1. Donna buys only two goods: gasoline and pasta. Explain how the events in the news clip change Donna's consumption possibilities, the relative price of pasta, and her budget in terms of pasta.
Checkpoint 13.1 In the News 1. When the price of gas falls, Donna's consumption possibilities expand—her budget line rotates outward. The relative price of pasta is its price divided by the price of gas. A fall in the price of gas raises the relative price of pasta. Donna's budget in terms of pasta is the maximum quantity of pasta that she can buy. This quantity does not change when the price of gas falls.
Jerry's burger and magazine budget is $12 a week. The price of a burger is $2, and the price of a magazine is $4. 1. List the combinations of burgers and magazines that Jerry can afford. 2. What is the relative price of a magazine? Explain your answer. 3. Draw a graph of Jerry's budget line with the quantity of magazines plotted on the x-axis. Describe how his budget line changes if, other things remain ing the same, the following changes occur one at a time: • The price of a magazine falls. • Jerry's budget for burgers and magazines increases.
Checkpoint 13.1 Practice Problems 1. Jerry can afford 3 magazines and no burgers; 2 magazines and 2 burgers; 1 magazine and 4 burgers; no magazines and 6 burgers. 2. The relative price of a magazine is the number of burgers that Jerry must forgo to get 1 magazine, which equals the price of a magazine divided by the price of a burger, or 2 burgers per magazine. 3. The budget line is a straight line from 6 burgers on the y-axis to 3 magazines on the x-axis (Figure 1). With a fall in the price of a magazine, Jerry can buy more magazines. His budget line rotates outward (Figure 2). With a bigger budget, Jerry can buy more of both goods. His budget line shifts outward (Figure 3).
Bird flu spikes egg prices; some hit $3 a dozen Egg prices have tripled at some supermarkets as buyers scramble for solutions. Source: USAToday, June 9, 2015 1. How does the event described in the news clip change the budget line and the quantity of eggs that Americans buy?
Checkpoint 13.2 In the News 1. The budget line rotates inward. Consumers allocate their budget between eggs(E) and other items (X) such that (MUE/PE) = (MUX/PX). As the price of eggs (PE) rises, (MUE/PE) falls. So with (MUE/PE) < (MUX/PX), consumers will reallocate their income to make (MUE/PE) rise and equal (MUX/PX). To make (MUE/PE) rise, (MUE) must rise, which will occur as the quantity of eggs bought decreases.
Table 1 shows Jerry's total utility from burgers and magazines. The price of a burger is $2, the price of a magazine is $4, and Jerry has $12 a week to spend. 1. Calculate Jerry's marginal utility and marginal utility per dollar from burgers when he buys 4 burgers a week. Calculate Jerry's marginal utility per dollar from magazines when he buys 1 magazine a week. 2. If Jerry buys 4 burgers and 1 magazine a week, does he maximize his total utility? To maximize total utility will he buy more or fewer burgers? Explain. 3. What quantities of burgers and magazines maximize Jerry's utility?
Checkpoint 13.2 Practice Problems 1. The marginal utility from the 4th burger equals the total utility from 4 burgers minus the total utility from 3 burgers, which is 6 units. Jerry's marginal utility per dollar from burgers (MUB/PB) equals his marginal utility of 6 units divided by the price of a burger, $2, which equals 3 units per dollar. The marginal utility from the first magazine is 100 units. Jerry's marginal utility per dollar from magazines (MUM/PM) equals his marginal utility, 100 units, divided by the price of a magazine, $4, which is 25 units per dollar. 2. If Jerry buys 4 burgers for $8 and 1 magazine for $4, he spends his $12 bud get. Marginal utility per dollar from burgers (MUB/PB) = 3 (Solution 1) is less than his marginal utility per dollar from magazines (MUM/PM) = 25 (Solution 1), so Jerry does not maximize total utility. To do so, he must buy fewer burgers and more magazines. 3. Jerry maximizes utility if he buys 2 burgers and 2 magazines a week. He spends $4 on burgers, $8 on magazines, his $12 budget. His marginal utility from burgers (24 - 14) is 10. Dividing 10 by $2 gives (MUB/PB) = 5 units per dollar. His marginal utility from magazines (120 - 100) is 20. Dividing 20 by $4 gives (MUM/PM) = 5 units per dollar. Jerry's marginal utility per dollar from each good is 5 units per dollar, so his utility is maximized.
1. In a year, Tony streams 50 movies at $3 each and pays $50 for 10,000 gallons of tap water. Tony is maximizing total utility. If Tony's marginal utility from water is 0.5 unit per gallon, what is his marginal utility from a movie? 2. Over the years, Americans have spent a smaller percentage of income on food and a larger percentage on cars. Explain the paradox of value.
Checkpoint 13.3 Practice Problems 1. Marginal utility from a movie , $3 = Marginal utility from a gallon of tap water , 0.5.. So the marginal utility from a movie is 600 times the marginal utility from a gallon of water: 600 * 0.5 or 300 units. 2. The average person has one car and the marginal utility from driving the car exceeds the marginal utility from food. While food is cheap and cars are expensive, consumers allocate their income to make the marginal utility per dollar from food and cars equal. There is no paradox of value.
What does it cost to make 100 pairs of running shoes? An Asian manufacturer of running shoes pays its workers $275 to make 100 pairs an hour. Workers use company-owned equipment that costs $300 an hour in forgone interest and economic depreciation. The materials cost $900. Source: washpost.com 1. Which costs are explicit costs? Which are implicit costs? With total revenue from the sale of 100 pairs of shoes of $1,650, calculate economic profit.
Checkpoint 14.1 In the News 1. Explicit costs are wages ($275) and materials ($900). Implicit costs are the for- gone interest and economic depreciation ($300). Economic profit equals total revenue ($1,650) minus total cost ($1,475), which is $175.
Lee, a programmer, earned $35,000 in 2015, but in 2016, he began to manufacture body boards. After one year, he submitted the following data to his accountant. *He stopped renting out his cottage for $3,500 a year and used it as his factory. The market value of the cottage increased from $70,000 to $71,000. *He spent $50,000 on materials, phone, utilities, etc. *He leased machines for $10,000 a year. *He paid $15,000 in wages. *He used $10,000 from his savings account, which pays 5 percent a year interest. *He borrowed $40,000 at 10 percent a year from the bank. *He sold $160,000 worth of body boards. *Normal profit is $25,000 a year. 1. Calculate Lee's explicit costs, implicit costs, and economic profit in 2016. 2. Lee's accountant recorded the depreciation on Lee's cottage during 2016 as $7,000. What did the accountant say Lee's profit or loss was in 2016?
Checkpoint 14.1 Practice Problems 1. Lee's explicit costs are costs paid with money: $50,000 on materials, phone, utilities, etc; $10,000 on leased machines; $15,000 in wages; and $4,000 in bank interest. These items total $79,000.Lee's implicit costs are $35,000 in forgone wages; $3,500 in forgone rent; the $1,000 increase in the value of his cottage is economic depreciation of - $1,000; $500 in forgone interest; and $25,000 in normal profit. These items total $63,000.Economic profit equals total revenue ($160,000) minus total cost, which equals $79,000 + $63,000, or $142,000. So economic profit in 2016 was $160,000 - $142,000, or $18,000. 2. The accountant measures Lee's profit as total revenue minus explicit costs minus depreciation: $160,000-$79,000-$7,000, or $74,000.
Deere, struggling with sales, to lay off 220 Deere & Co. plans to lay off 220 workers and decrease its output of farm equipment. Source: The Wall Street Journal, November 30, 2015 1. If Deere & Co. is operating at maximum total product before it cuts its workforce, how will the marginal product of a worker change in the short run?
Checkpoint 14.2 In the News 1. As Deere cuts its workforce, output at the plant will decrease as Deere slides back down along its total product curve. At the same time, Deere's marginal product will increase in the short run (see Fig 14.3 on p. 355).
Tom leases a farmer's field and grows pineapples. Tom hires students to pick and pack the pineapples. Table 1 sets out Tom's total product schedule. 1. Calculate the marginal product of the third student and the average product of three students. 2. Over what range of numbers of students does marginal product increase? 3. When marginal product increases, is average product greater than, less than, or equal to marginal product?
Checkpoint 14.2 Practice Problems 1. The marginal product of the third student is the change in total product that results from hiring the third student. When Tom hires 2 students, total product is 220 pineapples a day. When Tom hires 3 students, total product is 300 pineapples a day. Marginal product of the third student is the total product of 3 students minus the total product of 2 students, which is 300 pineapples - 220 pineapples or 80 pineapples a day.Average product equals total product divided by the number of students. When Tom hires 3 students, total product is 300 pineapples a day, so average product is 300 pineapples / 3 students, which equals 100 pineapples per student. 2. Marginal product of the first student is 100 pineapples a day, of the second student is 120 pineapples a day, and of the third is 80 pineapples a day. So marginal product increases when Tom hires the first and second students. 3. When Tom hires 1 student, marginal product is 100 pineapples and average product is 100 pineapples per student. When Tom hires 2 students, marginal product is 120 pineapples and average product is 110 pineapples per student. When Tom hires the second student, marginal product is increasing and average product is less than marginal product.
Tom leases a farmer's field for $120 a day and grows pineapples. He pays students $100 a day each to pick pineapples and he leases capital at $80 a day. Table 1 shows Tom's daily output. 1. What is Tom's total cost and average total cost of 300 pineapples a day? 2. What is the marginal cost of picking a pineapple when the quantity increases from 360 to 400 pineapples a day? 3. At what output is Tom's average total cost a minimum?
Checkpoint 14.3 Practice Problems 1. Total cost is the sum of total fixed cost and total variable cost. Tom leases the field for $120 a day and capital for $80 a day, so Tom's total fixed cost is $200 a day. Total variable cost is the wages of the students. To produce 300 pineapples a day, Tom hires 3 students, so total variable cost is $300 a day and total cost is $500 a day. Table 2 shows the total cost (TC) schedule. Average total cost is the total cost divided by total product. The total cost of 300 pineapples a day is $500, so average total cost is $1.67 a pineapple. Table 2 shows the average total cost schedule. 2. Marginal cost is the increase in total cost that results from picking one additional pineapple a day. When the quantity picked increases from 360 to 400 pineapples a day, total cost (from Table 2) increases from $600 to $700. The increase in the number of pineapples is 40, and the increase in total cost is $100. Marginal cost is the increase in total cost ($100) divided by the increase in the number of pineapples (40), which is $2.50 per pineapple. So the marginal cost of a pineapple is $2.50. 3. At the minimum of average total cost, average total cost equals marginal cost. Minimum average total cost of a pineapple between 300 and 360 pineapples is $1.67. Table 2 shows that the marginal cost of increasing out-put from 300 to 360 pineapples a day is $1.67 a pineapple.
To grow pineapples, Tom leases 1 field for $120 a day and capital for $80 a day and hires students at $100 a day each. Suppose that Tom now leases 2 fields for $240 a day and twice as much capital for $160 a day. Table 1 shows his outputs. 1. What is Tom's average total cost of a pineapple when he farms 2 fields and produces 220 pineapples a day? 2. Make a graph of Tom's average total cost curves using 1 field and 2 fields. Show on the graph Tom's long-run average cost curve. Over what output range will Tom use 1 field? 2 fields? 3. Does Tom experience constant returns to scale, economies of scale, or diseconomies of scale?
Checkpoint 14.4 Practice Problems 1. Total cost equals fixed cost ($400 a day) plus $100 a day for each student. Tom can produce 220 pineapples with 2 fields and 1 student, so total cost is $500 a day. Average total cost is the total cost divided by output, which at 220 pineapples a day is $500 divided by 220, or $2.27. The "ATC (2 fields)" column of Table 2 shows Tom's average total cost schedule for 2 fields. 2. Figure 1 shows Tom's average total cost curve using 1 field as ATC1. This curve graphs the data on ATC (1 field) and TP (1 field) in Table 2, which was calculated in Table 2 on p. 366. Using 2 fields, the average total cost curve is ATC2. Tom's long-run average cost curve is the lower segments of the two ATC curves, highlighted in Figure 1. If Tom produces up to 300 pineapples a day, he will use 1 field. If he produces more than 300 pineapples a day, he will use 2 fields. 3. Tom experiences economies of scale up to an output of 740 pineapples a day because as he increases his plant and produces up to 740 pineapples a day, the average total cost of picking a pineapple decreases. (We don't have enough information to know what happens to Tom's average total cost if he uses three fields and three units of capital.)
When the price of a good increased by 10 percent, the quantity demanded of it decreased by 2 percent. 1. Is the demand for this good elastic, unit elastic, or inelastic? 2. Does this good have close substitutes or poor substitutes? Is this good more likely to be a necessity or a luxury and to be narrowly or broadly defined? Why? 3. Calculate the price elasticity of demand for this good; explain how the total revenue from the sale of the good has changed; and explain which of the following goods this good is most likely to be: orange juice, bread, toothpaste, theater tickets, clothing, blue jeans, or Super Bowl tickets.
Checkpoint 5.1 Practice Problems 1. The demand for a good is inelastic if the percentage decrease in the quantity demanded is less than the percentage increase in its price. In this example, a 10 percent price rise brings a 2 percent decrease in the quantity demanded, so demand is inelastic. 2. Because the good has an inelastic demand, it most likely has poor substitutes, is a necessity rather than a luxury, and is broadly defined. 3. Price elasticity of demand equals the percentage change in the quantity demanded divided by the percentage change in price. In this example, the price elasticity of demand is 2 percent divided by 10 percent, or 0.2. An elasticity less than 1 means that demand is inelastic. When demand is inelastic, a price rise increases total revenue. This good is most likely a necessity (bread), or has poor substitutes (toothpaste), or is broadly defined (clothing).
Tuition and enrollment data Enrollment increased from 15,539,000 in 2000 to 20,618,000 in 2013. The net cost of college (average for all types) increased from $12,357 to $14,860. Source: trends.collegeboard.org, 2015 1. Calculate the price elasticity of supply of college. Is the supply of college elastic or inelastic?
Checkpoint 5.2 In the News 1. The demand for college increased, so we can use these data to calculate the price elasticity of supply of college. The price elasticity of supply equals the percentage change in the quantity supplied divided by the percentage change in the price. Using the midpoint method (see the calculations in the margin), the quantity supplied increased by 28.1 percent and the price increased by 18.4 percent. The elasticity of supply is 28.1 percent divided by 18.4 percent, which is 1.53. Because the elasticity of supply is greater than 1, the supply of college is elastic.
A 10 percent increase in the price of a good increased the quantity supplied of the good by 1 percent after one month and by 25 percent after one year. 1. Is the supply of this good elastic, unit elastic, or inelastic? Is this good likely to be produced using factors of production that are easily obtained? What is the price elasticity of supply of this good? 2. What is the price elasticity of supply after one year? Has the supply of this good become more elastic or less elastic? Why?
Checkpoint 5.2 Practice Problems 1. The supply of a good is inelastic if the percentage increase in the quantity supplied is less than the percentage increase in price. In this example, a10 percent price rise brings a 1 percent increase in the quantity supplied, so supply is inelastic. Because the quantity supplied increases by such a small percentage after one month, the factors of production that are used to produce this good are more likely to be difficult to obtain. The price elasticity of supply equals Percentage change in the quantity sup- plied divided by Percentage change in the price. In this example, the price elasticity of supply equals 1 percent divided by 10 percent, or 0.1. 2. The price elasticity of supply equals Percentage change in the quantity sup- plied divided by Percentage change in the price. After one year, the price elasticity of supply is 25 percent divided by 10 percent, or 2.5. The supply of the good has become more elastic over the year since the price rise. Possibly other producers have gradually started producing the good and with the passage of time more factors of production can be reallocated.
China is the world's fastest-growing market for "vanity" spending China's market for the consumption of goods aimed at enhancing one's appearance or status grew an average of 15.6 percent a year for the past five years. Source: qz.com, April 23, 2015 1. Given the information that incomes grew at about 7 percent a year, is the demand for "vanity" goods in China income elastic or income inelastic? Explain.
Checkpoint 5.3 In the News 1. To know whether the demand for a good is income elastic, we need to calculate the income elasticity of demand. A good with an income elastic demand is one that has an income elasticity of demand greater than 1. If spending on "vanity" goods increased by 15.6 percent per year when incomes grew by 7 percent per year, the income elasticity of demand for "vanity" goods is 15.6 divided by 7, which equals 2.2. The income elasticity of demand for "vanity" goods is greater than 1, so the demand for "vanity" goods is income elastic.
1. The quantity demanded of good A increases by 5 percent when the price of good B rises by 10 percent and other things remain the same. Calculate the cross elasticity of demand. Are goods A and B complements or substitutes? Describe how the demand for good A changes. 2. When income rises by 5 percent and other things remain the same, the quantity demanded of good C increases by 1 percent. Calculate the income elasticity of demand for good C. Is good C a normal good or an inferior good? Describe how the demand for good C changes.
Checkpoint 5.3 Practice Problems 1. Cross elasticity of demand = Percentage change in the quantity demanded of good A / Percentage increase in the price of good B. Cross elasticity of demand = 5 / 10, or 0.5. Goods A and B are substitutes because the cross elasticity of demand is positive. When the price of good B rises, the quantity demanded of good A increases and people switch from good B to good A. The demand for good A increases. 2. Income elasticity of demand = Percentage change in the quantity demanded of good C / Percentage increase in income. Income elasticity of demand = 1 / 5, or 0.2. Income elasticity of demand is positive, so good C is a normal good. As income rises, the quantity demanded of good C increases. The demand for good C increases.
Gas tax increases by 7 cents in Washington State Washington State gas taxes will rise by 7¢ a gallon now and by a further 4.9¢ a gallon next summer. Source: The Seattle Times, August 1, 2015 1. If the demand for gasoline is inelastic and the supply of gasoline is elastic, who will pay more of the increase in Washington's gas tax: drivers or the gasoline companies? If there is a big switch to natural gas for big trucks, how will the tax incidence change?
Checkpoint 8.1 In the News 1. If the demand for gasoline is inelastic and supply is elastic, drivers will pay more of the increase in Washington's gas tax than the gasoline companies will pay. Although the demand for gasoline is inelastic, the availability of natural gas and big trucks switching to natural gas makes the demand for gasoline (and diesel) less inelastic, so the share of the tax paid by drivers will fall and the share paid by the gasoline companies will rise.
Figure 1 shows the market for basketballs, when basketballs are not taxed. 1. If buyers of basketballs are taxed $6 a ball, what price does the buyer pay and how many basketballs do they buy? What is the tax revenue collected? 2. If sellers of basketballs are taxed $6 a ball, what price does the seller receive and how many basketballs do they sell? What is the tax revenue collected? 3. If basketballs are taxed at $6 a ball, what is the excess burden of the tax? Is the demand for basketballs or the supply of basketballs more inelastic? Explain your answer.
Checkpoint 8.1 Practice Problems 1. With a $6 tax on buyers, the demand curve shifts downward by $6 a ball as shown in Figure 2. The price that the buyer pays is $16 a basketball and8 million basketballs a week are bought. The tax revenue is +6 * 8 million, which is $48 million a week (the purple rectangle in Figure 2). 2. With a $6 tax on sellers, the supply curve shifts upward by $6 a ball as shown in Figure 3. The price that the seller receives is $10 a basketball and 8 million basketballs a week are sold. The tax revenue is +6 * 8 million, which is $48 million a week (the purple rectangle in Figure 3). 3. The excess burden of the tax is $12 million. Excess burden equals the dead- weight loss, the area of the gray triangle, which is (4 million * +6) , 2. The $6 tax increases the price paid by buyers by $1 and lowers the price received by sellers by $5. The seller pays the larger share of the tax because the supply of basketballs is more inelastic than the demand for basketballs.
Want Arizona jobs? Phase out the state income tax Arizona's state income taxes rank in the middle among U.S. states. The state can promote job creation by abolishing its income taxes. Source: azcentral, November 30, 2015 1. Is the news clip correct? Explain the effects of abolishing the state personal in- come tax and corporation income tax. Will workers or employers benefit most?
Checkpoint 8.2 In the News 1. Because the demand for labor is elastic and the supply of labor is inelastic, most of the personal tax cut will benefit workers and it will increase employment. Because the supply of capital is perfectly elastic, most of the corporation tax cut will benefit employers and it, too, will create jobs. So the news clip is correct.
