Econ_2030_Second_Exam_Answers - Chapter 8 Taxation and...

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Chapter 8: Taxation and Government Intervention Questions and Exercises 1. With either excess supply or excess demand, the number of trades will be lower than if price were allowed to move to its equilibrium price. That means there is a loss of surplus. 2. Decision making based on costs and benefits means you make purchases if the marginal benefits are greater than the price. Thus, when you decide to make a purchase, you are likely receiving something worth more to you than what you had to spend to buy it, or else you wouldn’t have bought it. That net benefit is consumer surplus. 3. If demand is inelastic, raising a tax increases revenue paid by consumers; similarly with supply. If demand is elastic, however, raising a tax decreases revenue paid by consumers. Thus, what happens to total tax revenue depends on the elasticity of both supply and demand. 4. Because labor supply is elastic, raising the tax rate will reduce the percent of hours worked by more than the percent decrease in wages paid. That is, total income will decline as will total revenue collected by taxes. Social Security cannot be financed by increasing tax rates. Source: “Why Do Americans Work So Much More than Europeans?” Quarterly Review , July 2004. 5. a. Because the elasticity of demand among the top students was greater than one, lowering tuition would lead to a proportionally greater percentage increase in enrollment. Total revenue would rise for the college. b. The program distinguished among top students because their elasticities likely differed. The top 10 percent were likely being offered scholarships at other academic institutions, giving them greater choices, which made their elasticities greater. c. It could be that the President did not reduce tuition for all students because the elasticity of demand for all students was less than one. This scheme allowed them to take advantage of differing elasticities with price discrimination. Another reason is that price is sometimes an indicator for quality. By lowering tuition across the board, they could be sending a signal that their college has lost relative academic standing. In using this scheme, they are sending a signal that they desire to increase their relative standing. 1
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6. Welfare loss is shown by the bolded triangles in the figures below. a. b. c. d. 7. a. Before the tax, equilibrium price is $6 and equilibrium quantity is 200. After the tax, equilibrium price is $8 and equilibrium quantity is 100. b. Producer surplus before the tax is the area above the supply curve and below price. This is a triangle with base 200 and height 4. So, producer surplus is 1/2 (200)(4) = 400. After the tax, the triangle representing producer surplus has a height of 2 and base of 100. So producer surplus is 1/2 (100)(2) = 100. c.
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Econ_2030_Second_Exam_Answers - Chapter 8 Taxation and...

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