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Unformatted text preview: ECON 101: Midterm 2 Review Session * Aaron Flaaen November 8, 2010 1 Tax Incidence Tax Incidence refers to how the burden of a tax is split between producers and consumers. If you think of a subsidy as the equivalent of a negative tax, this applies to how the benefit of a subsidy is split as well. General Rule: Whichever is more inelastic bears the larger burden from a tax, or the larger benefit from a subsidy. Helpful Tips 1. A Tax/Subsidy separates the price P orig into a P prod and P cons . Relative to the initial price, which is higher/lower? Consumers like low prices and producers like high prices Both dont like taxes: P prod after tax P cons after tax Both like subsidies: P prod after tax P cons after tax 2. After a tax: The change in price for consumers: P cons- P orig and the change in price for producers: P orig- P prod . Whichever is more inelastic (supply or demand) will face a greater change in price. Be able to calculate changes in CS and PS after a tax or subsidy. 2 Price Controls and Quotas These are measures that the government uses to directly intervene in a market. In the simple case: Government merely decrees a price (either a floor or ceiling) or a quantity (quota). There is no government expenditures or revenue. A (binding) price ceiling is BELOW the market price; a (binding) price floor is ABOVE the market price Remember it this way: The purpose of floors (that people stand on) is to prevent them from going lower. Similarly, a price floor prevents the price from going lower (to the market equilibrium price). Similar reasoning for ceilings! * This document does not claim to constitute a complete nor sufficient review of the material covered for the 2nd midterm. In other words, be sure to study the lecture notes, book, section notes, and other study materials as well!...
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This note was uploaded on 01/24/2011 for the course ECON 101 taught by Professor Gerson during the Fall '08 term at University of Michigan.
- Fall '08