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- 1 - ANSWER KEY ECONOMICS 101 - RICHARD BUDDIN - FALL 2003 FINAL EXAMINATION Please answer all questions. You can write on both sides of the exam. If you do not understand a question, you should skip it and return to it later in the exam. All questions are worth 20 points. The points are allocated equally by parts, unless otherwise indicated in the question. You may need to calculate the roots for a quadratic equation. The roots of a quadratic equation ax 2 + bx +c are x b b ac a = - ± - 2 4 2 1. The state of Washington recently considered a tax on espresso to help offset the state’s deficit. Espresso is sold at thousands of small, competitive shops in Washington. The espresso industry is in long-run equilibrium, and input costs are not affected by expansion or contraction of industry output. The demand for espresso in the state is Q D =170-45P where Q D is the number of cups sold per week (measured in thousands) and P is the price per cup (measured in dollars). The short-run supply of expresso in the state is Q S =27P+80. a) Find the equilibrium price and quantity for espresso in the absence of a tax on espresso. b) The tax proposal calls for a 30 percent tax on the consumer' s purchase price of an espresso (i.e., if the sales price of an espresso is $2.50, then the tax is $0.75). Find the new equilibrium price and quantity. c) How much tax revenue will the tax generate? Find the deadweight welfare loss from the tax. d) Suppose that the tax proposal passes. Discuss how the industry would adjust to the tax in the long run. How would the burden of the tax shift as we move from the short run to the long run? Discuss why the tax revenue is larger (or smaller) in the long run than in the short run. Answer: a) P=1.25 & Q=113.75 b) P=1.41 is price paid by consumers, P=0.99 is price received by firms, and Q=106.62. c) Tax revenue is 45.05 per week. Welfare loss for consumers is 0.5*(1.41-1.25)*(113.75- 106.62)=0.57. Welfare loss for producers is 0.5*(1.25-0.99)*(113.75-106.62)=0.9269. Deadweight welfare loss is 1.50. d) The industry began in long-run equilibrium, so we know that P=1.25 is the price associated with the minimum AC for the typical firm in the industry. The tax drives the price that firms receive below 1.25 in the short run. This means that firms will lose money and some firms will leave the industry until the price that firms receive rises back to the original 1.25. The burden of the tax is initially divided between consumers and producers in the short run, but as firm leave the industry, the price will rise and the entire burden will be shifted to consumers in the long run. The tax raises more money per unit in the long run than in the short run because the price is higher. On the other hand, fewer units are sold in the long run because firms
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- 2 - have left and because the price is higher. In the long run, P=1.79, Q=89.64, and tax revenue is 48.02 per week. Tax revenue is higher in the long run than in the short
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