econ 1311 chapter 5-8

income elasticity of demand equation

% change in demand for good x / % change income - if income elasticity of demand >0 it is a normal good -if <0 it is an inferior good

cross price elasticity equation

% change in demand for one good / % change in price of another good -if cross price elasticity >0 good x and y are substitutes -if <0 good x and y are complements

Price elasticity of demand equation

% change in quantity demanded of good x / % change in price of good x : [(QD2-QD1/ QD1)x100] / [(P2-P1/P1)x100]

price elasticity of supply equation

% change in quantity supplied of good x / % change in price of good x *price elasticity diminishes as you move up the curve

calculating percentage change with the traditional method

(Q2-Q1/ Q1) x 100

producer surplus equation

*profit amount received by sellers- cost to sellers

Laffer curve

-based on supply sided economics -shows relationship between the size of a tax and tax revenue -when taxes make a market so small, no matter how large the tax is, the tax revenue will still decrease (because the market is so small)

total revenue equation

-consumer surplus + producer surplus -value to buyer - cost to sellers

conclusion of the efficiency of the market process

1. free markets allocate the supply of goods to the buyers who value those units most highly 2. free markets allocate the demand for goods to the sellers who can produce them at the lowest cost 3. free markets produce the quantity of goods that maximizes total surplus 4. a market outcome that maximizes total surplus is efficient both productively and allocatively

What % of national income is collected in taxes by government at all levels (federal, state, local) combined?

36%

if tax is doubled, by how much does deadweight loss rise? if tripled?

4 9

demand v quantity demanded

a change in demand is when the whole curve shifts; a change in quantity demanded is movement along the demand curve due to a change in price

tax

a financial charge placed upon an individual or legal entity by a city, state, or federal government (raises revenue, discourages buying that which is taxed i.e. cigarettes)

elasticity

a measure of the magnitude or size of the change in a dependent variable that results from a change in an independent variable

who bears the burden of a tax on a good/ resource?

a tax falls more heavily on the side of the market with the SMALLER PRICE ELASTICITY -smaller price elasticity of demand: buyers don't have alternatives to purchasing the good -small price elasticity of supply: sellers do not have alternatives to producing the good so, whoever has fewer good alternatives is less willing to leave the market and will then bear more of the burden of the tax -marginal seller: leaves the market first if the price were any lower

consumer surplus

above equilibrium price & below demand curve -measures the benefit that buyers receive from a good as the buyers themselves perceive it

calculating consumer/ producer surplus or DWL from a graph

area= 1/2bh

producer surplus

below equilibrium price & above supply curve

how does tax recede total surplus?

by deadweight loss

when a tax distorts incentives to buyers and sellers so that fewer goods are produced and sold, the tax has...

caused a deadweight loss

what does a tax on a good do to its market?

causes the size of the market for the good to shrink

an increase in the price of a good along a stationary demand curve...

decreases consumer surplus

luxury taxes

demand for such items is relatively elastic; supply of such items is relatively inelastic -major burden of the luxury tax falls on firms and workers who produce the items rather than on wealthy buyers

demand will be more inelastic if...

fewer substitutes, broadly defined market, less time, more of a necessity, costs a smaller percentage of income

price ceiling

government determines the maximum price that can be charged for a good which is BELOW THE EQUILIBRIUM PRICE -intent: to reduce the amount buyers pay -result: unintended consequences (examples: gasoline, rent, price of goods after a natural disaster)

when demand is elastic, deadweight loss is...

greater

note:

if any factor other than price changes, the entire supply curve shifts

major source of tax revenue for federal government is...

income taxes, and for state and local governments: sales and property taxes

an increase in the price of a good along a stationary supply curve...

increases producer surplus

what % of the labor force earns federal minimum wage of 7.25 or less?

less than 5% (of 160 million total)

income elasticity of demand

measures the magnitude of change in demand that results from a change in income

total revenue equation

price x quantity

why is ticket scalping illegal?

reduces the consumer surplus from event & making it illegal reduces gain to consumer, decreases number of mutually beneficial exchanges, decreases total surplus

deadweight loss (grows geometrically)

reduction in total surplus that results from a government policy that prevents mutually beneficial trades from occurring *DWL rises by more whenever a tax increases

ticket scalping

reselling tickets to events at a price that is higher than the price at which it was originally sold (price initially charged is lower than E resulting in a shortage of tickets- seller may not know E price, better ensures a sellout, concern about sacrificing goodwill if a higher price is sold)

supply is more price elastic when..

sellers have more time to adjust to a price change & when firms are producing excess capacity

unintended consequences of price ceilings

shortages of the good/ resource: the further below the E price, the greater the shortage; higher transaction costs; below E price available to all buyers; rationing of the scare good takes place by means in addition to price; lines- wasted time (discriminates most against productive individuals); aggravation/ frustration; black markets arise; reduced quality/ amenities; tie-in sales; increased discrimination

when demand is inelastic, deadweight loss is...

small and the tax only reduces Q a little

why do governments set price controls?

sometimes policy makers believe the equilibrium price is unfair to buyers/ sellers or policy makers will often cater to "special interests"

if price elasticity of supply/ demand is >1

supply/ demand is elastic (an increase in price decreases total revenue and vice versa) the percentage change in quantity supplied is greater than the percentage change in price

if price elasticity of supply/ demand is <1

supply/ demand is inelastic (an increase in price increases total revenue and vice versa) the percentage change in quantity supplied is less than the percentage change in price

if price elasticity of supply/ demand is =1

supply/ demand is unitary elastic (an increase or decrease in price decreases total revenue) the percentage change in quantity supplied is equal to the percentage change in price *occurs only at one point along the curve

unintended consequences of Agricultural Price Floors

surplus of agricultural products, higher prices received by all sellers, higher food prices paid by all buyers (disproportionately affects low income people), higher taxes and/ or reallocation of existing tax dollars

unintended consequences of minimum wage legislation

surplus of labor (unemployment), high labor costs (higher prices of goods drives marginal sellers out of business), reduced fringe benefits to workers, increased work demands (work harder and be more productive to justify increased wage), increased discrimination, increased school drop out rate

opportunity cost of taxation equation

taxes paid + deadweight loss + administrative costs (agencies who collect taxes)

what happens when a tax is levied (imposed) on buyers?

the demand curve shifts downward by the size of the tax

price floor

the government sets the minimum price that can be charged for a good or resource that is ABOVE THE EQUILIBRIUM PRICE -intent: increase price that sellers receive for the good -result: surplus of labor (unemployment)

Tax incidence

the manner in which the burden of a tax is shared among participants in a market

the larger the magnitude...

the more elastic is demand/ supply with respect to the independent variable under consideration (ex: price increases, what is the effect on the quantity demanded? demand for insulin doesn't really change making it inelastic)

what happens when a tax is enacted (make a bill or proposal a law)?

the price paid by buyers rises and the price received by sellers fall

Efficiency

the property of a resource allocation of maximizing the total surplus received by all members of society

Equality

the property of distributing economic prosperity uniformly among the members of society

what happens when a tax is levied (imposed) on sellers?

the supply curve shifts upward by that amount

demand will be more elastic if...

there are close substitutes, the market is narrowly defined, the buyers have more time to adjust to the change in price, the more of a luxury the good is considered to be, the larger the percentage of income spent on the good

why do taxes cause deadweight loss?

they prevent buyers and sellers from realizing some of the gains from trade

what is the function of prices?

to ration or allocate scarce goods and resources

consumer surplus equation

willingness to pay(maximum) - amount actually paid to sellers (value to buyer - amount paid)