Exam 2 - Microeconomics

How does a tax on a good affect the price paid by buyers, the price received by sellers, and the quantity sold?

A tax on a good raise the price buyers pay, lowers the price sellers receive and reduces the quantity sold.

Which of the following would increase quantity supplied, increase quantity demanded, and decrease the price that consumers pay? a. the imposition of a binding price floor b. the removal of a binding price floor c. the passage of a tax levied on producers d. the repeal of a tax levied on producers

a. the imposition of a binding price floor

Willingness to pay

the maximum amount that a buyer will pay for a good

Efficiency

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

Imagine that you are a nonsmoker sharing a room with a smoker. According to the Coase theorem, what determines whether your roommate smokes in the room? Is this outcome efficient? How do you and your roommate reach this solution?

According to the Coase theorem, you and your roommate will bargain over whether your roommate will smoke in the room. If you value clean air more than your roommate values smoking, the bargaining process will lead to your roommate not smoking. But if your roommate values smoking more than you value clean air, the bargaining process will lead to your roommate smoking. The outcome is efficient as long as transaction costs do not prevent an agreement from taking place. The solution may be reached by one of you paying off the other either not to smoke or for the right to smoke

What happens to the deadweight loss and tax revenue when a tax is increased?

As a tax grows larger, it distorts incentives more, and its DW loss grows larger. Because a tax reduces the size of the market, however, tax revenue does not continually increase. It first rises with the size of a tax, but if the tax gets large enough, tax revenue starts to fall.

What are corrective taxes? Why do economists prefer them to regulations as a way to protect the environment from pollution?

Corrective taxes are taxes enacted to correct the effects of a negative externality. Economists prefer corrective taxes over regulations as a way to protect the environment from pollution because they can reduce pollution at a lower cost to society. A tax can be set to reduce pollution to the same level as a regulation. The tax has the advantage of letting the market determine the least expensive way to reduce pollution. The tax gives firms incentives to develop cleaner technologies to reduce the taxes they have to pay

Why do experts disagree about whether labor taxes have small or large deadweight losses?

Economists disagree about these issues in part because there is no consensus about eh size of the relevant elasticities. Also the general lesson is that a change in tax revenue from a tax change depends on how the tax change affects peoples behavior.

List some of the ways that the problems caused by externalities can be solved without government intervention.

Externalities can be solved without government intervention through moral codes and social sanctions, charities, merging firms whose externalities affect each other, or by contract.

What mechanisms allocate resources when the price of a good is not allowed to bring supply and demand into equilibrium?

If there is a surplus, sellers may try to appeal to the personal biases of the buyers. If there is a shortage, seller can ration the good according to their personal biases.

Name two types of market failure. Explain why each may cause market outcomes to be inefficient

Market power and externalities. When market can no longer regulate its resources efficiently.

What is efficiency? Is it the only goal of economic policymakers?

Maximizing the total surplus received by all members of society. Total surplus is value of buyers - cost to sellers

Give an example of a negative externality and an example of a positive externality.

Negative: Pollution, barking dogs, consumption of alcohol Positive: restoring historic buildings, research on new tech, education

Give an example of a price ceiling and an example of a price floor.

Price ceiling: leads to a shortage, rent, price controls, water during a drought Price floor: leads to a surplus, minimum wage and farm price supports

Which causes a shortage of a good—a price ceiling or a price floor? Justify your answer with a graph.

Price ceilings, Binding, below equilibrium price

Explain why economists usually oppose controls on prices.

Prices have the crucial job of coordinating economic activity by balancing demand and supply. When there are controls signals are obscured that guide the allocation of resources. Price controls often hurt those they are trying to help.

Suppose the government removes a tax on buyers of a good and levies a tax of the same size on sellers of the good. How does this change in tax policy affect the price that buyers pay sellers for this good, the amount buyers are out of pocket (including any tax payments they make), the amount sellers receive (net of any tax payments they make), and the quantity of the good sold?

Removing a tax paid by buyers and replacing it with a tax paid by sellers has no effect on the price that buyers pay, sellers receive and the quantity of the good sold.

How do the elasticities of supply and demand affect the deadweight loss of a tax? Why do they have this effect?

Taxes have deadweight loss because they cause buyers to consume less and sellers to produce less and hence shrink the size of the market. Elasticity measures how the market participants behave given the market conditions so elasticities of supply and demand affect the deadweight loss of a tax. They have this effect because the side of the market that is less elastic have less room for moving around and they face high tax incidence.

What determines how the burden of a tax is divided between buyers and sellers? Why?

The burden of the tax is divided among buyers and sellers depending on the elasticity of demand and supply. Elasticity represents the willingness of buyers or sellers to leave the market depending on the alternatives. When a good is taxed the side of the market with fewer alternatives cannot easily leave which bears more burden of the tax. Tax imposed who bears the most burden whoever has the most inelastic curve.

In what way does the patent system help society solve an externality problem?

The patent system helps society solve the externality problem from technology spillovers. By giving inventors exclusive use of their inventions for a certain period, the inventor can capture much of the economic benefit of the invention. In doing so, the patent system encourages research and technological advance, which benefits society through spillover effects.

Explain how sellers' costs, producer surplus, and the supply curve are related.

The sellers cost is how much they pay to obtain a good. The producers surplus is the amount they pay minus the cost of providing it. The supply curve measure this amount by looking at the area above the supply curve.

Explain how buyers' willingness to pay, consumer surplus, and the demand curve are related.

They all measure the buyer's willingness to pay. The demand curve helps use measure this relationship by looking at the area below the demand curve and above the price is the sum of the consumer surplus.

What happens to consumer and producer surplus when the sale of a good is taxed? How does the change in consumer and producer surplus compare to the tax revenue? Explain.

When the sale of a good is taxed both consumer surplus and producer surplus decline. The decline in consumer surplus and producer surplus exceeds the amount of government revenue that is raised, so society's total surplus declines. The tax distorts the incentives of both buyers and sellers, so resources are allocated inefficiently.

Price ceiling

a legal maximum on the price at which a good can be sold

Price floor

a legal minimum on the price at which a good can be sold

Binding price floor

a price floor that is set above the equilibrium price

Corrective tax

a tax designed to induce private decision makers to take into account the social costs that arise from a negative externality

The demand curve for cookies is downward-sloping. When the price of cookies is $2, the quantity demanded is 100. If the price rises to $3, what happens to consumer surplus? a. It falls by less than $100. b. It falls by more than $100. c. It rises by less than $100. d. It rises by more than $100.

a. It falls by less than $100.

A $1 per unit tax levied on consumers of a good is equivalent to a. a $1 per unit tax levied on producers of the good. b. a $1 per unit subsidy paid to producers of the good. c. a price floor that raises the good's price by $1 per unit. d. a price ceiling that raises the good's price by $1 per unit.

a. a $1 per unit tax levied on producers of the good.

Jen values her time at $60 an hour. She spends 2 hours giving Colleen a massage. Colleen was willing to pay as much at $300 for the massage, but they negotiate a price of $200. In this transaction, a. consumer surplus is $20 larger than producer surplus. b. consumer surplus is $40 larger than producer surplus. c. producer surplus is $20 larger than consumer surplus. d. producer surplus is $40 larger than consumer surplus.

a. consumer surplus is $20 larger than producer surplus.

Peanut butter has an upward-sloping supply curve and a downward-sloping demand curve. If a 10 cent per pound tax is increased to 15 cents, the government's tax revenue a. increases by less than 50 percent and may even decline. b. increases by exactly 50 percent. c. increases by more than 50 percent. d. The answer depends on whether supply or demand is more elastic.

a. increases by less than 50 percent and may even decline.

When the government levies a tax on a good equal to the external cost associated with the good's production, it ________ the price paid by consumers and makes the market outcome ________ efficient. a. increases, more b. increases, less c. decreases, more d. decreases, less

a. increases, more

If a policymaker wants to raise revenue by taxing goods while minimizing the deadweight losses, he should look for goods with elasticities of demand and elasticities of supply. a. small, small b. small, large c. large, small d. large, large

a. small, small

Which of the following would increase quantity supplied, decrease quantity demanded, and increase the price that consumers pay? a. the imposition of a binding price floor b. the removal of a binding price floor c. the passage of a tax levied on producers d. the repeal of a tax levied on producers

a. the imposition of a binding price floor

A tax on a good has a deadweight loss if a. the reduction in consumer and producer surplus is greater than the tax revenue. b. the tax revenue is greater than the reduction in consumer and producer surplus. c. the reduction in consumer surplus is greater than the reduction in producer surplus. d. the reduction in producer surplus is greater than the reduction in consumer surplus.

a. the reduction in consumer and producer surplus is greater than the tax revenue.

Internalizing the externality

altering incentives so that people take into account the external effects of their actions

Sofia pays Sam $50 to mow her lawn every week. When the government levies a mowing tax of $10 on Sam, he raises his price to $60. Sofia continues to hire him at the higher price. What is the change in producer surplus, change in consumer surplus, and deadweight loss? a. $0, $0, $10 b. $0, −$10, $0 c. +$10, −$10, $10 d. +$10, −$10, $0

b. $0, −$10, $0

The government auctions off 500 units of pollution rights. They sell for $50 per unit, raising total revenue of $25,000. This policy is equivalent to a corrective tax of _____ per unit of pollution. a. $10 b. $50 c. $450 d. $500

b. $50

If the production of a good yields a negative externality, then the social-cost curve lies ________ the supply curve, and the socially optimal quantity is ________ than the equilibrium quantity. a. above, greater b. above, less c. below, greater d. below, less

b. above, less

John has been working as a tutor for $300 a semester. When the university raises the price it pays tutors to $400, Jasmine enters the market and begins tutoring as well. How much does producer surplus rise as a result of this price increase? a. by less than $100 b. between $100 and $200 c. between $200 and $300 d. by more than $300

b. between $100 and $200

The Laffer curve illustrates that, in some circumstances, the government can reduce a tax on a good and increase the a. deadweight loss. b. government's tax revenue. c. equilibrium quantity. d. price paid by consumers.

b. government's tax revenue.

When a market is in equilibrium, the buyers are those with the ________ willingness to pay and the sellers are those with the ________ costs. a. highest, highest b. highest, lowest c. lowest, highest d. lowest, lowest

b. highest, lowest

When a good is taxed, the burden of the tax falls mainly on consumers if a. the tax is levied on consumers. b. the tax is levied on producers. c. supply is inelastic, and demand is elastic. d. supply is elastic, and demand is inelastic.

b. the tax is levied on producers.

Which of the following is an example of a positive externality? a. Dev mows Hillary's lawn and is paid $100 for performing the service. b. While mowing the lawn, Dev's lawnmower spews out smoke that Hillary's neighbor Kristen has to breathe. c. Hillary's newly cut lawn makes her neighborhood more attractive. d. Hillary's neighbors pay her if she promises to get her lawn cut on a regular basis.

c. Hillary's newly cut lawn makes her neighborhood more attractive.

Which of the following statements about corrective taxes is generally NOT true? a. Economists prefer them to command-and-control regulation. b. They raise government revenue. c. They cause deadweight losses. d. They reduce the quantity sold in a market.

c. They cause deadweight losses.

An efficient allocation of resources maximizes a. consumer surplus. b. producer surplus. c. consumer surplus plus producer surplus.—total surplus d. consumer surplus minus producer surplus.

c. consumer surplus plus producer surplus.—total surplus

In a market with a binding price ceiling, an increase in the ceiling will ________ the quantity supplied, ________ the quantity demanded, and reduce the ________. a. increase, decrease, surplus b. decrease, increase, surplus c. increase, decrease, shortage d. decrease, increase, shortage

c. increase, decrease, shortage

Eggs have a supply curve that is linear and upward-sloping and a demand curve that is linear and downward-sloping. If a 2 cent per egg tax is increased to 3 cents, the deadweight loss of the tax a. increases by less than 50 percent and may even decline. b. increases by exactly 50 percent. c. increases by more than 50 percent. d. The answer depends on whether supply or demand is more elastic.

c. increases by more than 50 percent.

Producing a quantity larger than the equilibrium of supply and demand is inefficient because the marginal buyer's willingness to pay is a. negative. b. zero. c. positive but less than the marginal seller's cost. d. positive and greater than the marginal seller's cost

c. positive but less than the marginal seller's cost

The Coase theorem does NOT apply if a. there is a significant externality between two parties. b. the court system vigorously enforces all contracts. c. transaction costs make negotiating difficult. d. both parties understand the externality fully.

c. transaction costs make negotiating difficult.

When the government imposes a binding price floor, it causes a. the supply curve to shift to the left. b. the demand curve to shift to the right. c. a shortage of the good to develop. d. a surplus of the good to develop.

d. a surplus of the good to develop.

Consumer surplus

the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it

Producer surplus

the amount a seller is paid for a good minus the seller's cost of providing it

Transaction costs

the costs that parties incur during the process of agreeing to and following through on a bargain

Deadweight loss

the fall in total surplus that results from a market distortion, such as a tax

Tax incidence

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

Equality

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

Coase theorem

the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own

Welfare economics

the study of how the allocation of resources affects economic well-being

Externality

the uncompensated impact of one person's actions on the well-being of a bystander

Cost

the value of everything a seller must give up to produce a good

Binding price ceiling

when a price ceiling is set below the equilibrium price