MT1Solutions - Econ 100A Spring 2004 Midterm 1 Solutions...

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Econ 100A Spring 2004 Midterm 1 Solutions A1. 17 Points (a) [8 points] Neither analyst is correct. When a tax is placed on producers, they will raise the price they charge consumers (P’ to Pc); thus, consumers are harmed by a tax on producers. When a tax is placed on consumers, they will be willing to pay less to producers than before; thus, producers are harmed by a tax on consumers. Grade Guide: [5 points for correct answers with no/incorrect explanation],[4 points for incorrect answer with a partially correct explanation] (b) [9 points] Graphical Method: When a tax (t) is placed on this market, the price consumers pay rises from P* to P C while the price producers receive remains at P*. From the graph, t = P C – P*. Using the basic formula, Tax incidence on consumers = p = P C – P* = P C P* = 1 ∆τ t P C – P* Alternative Method: Applying the Elasticity form of the tax incidence on consumers formula, η = η = 1 η ε η η is the elasticity of supply, and ε = 0 is the elasticity of demand. Grade Guide: [6 points for correct answer with no/incorrect explanation], [4 points for incorrect answer with correct graph or formula], [2 points for only identifying ε = 0, or that consumers pay more of tax], [-1 point for not reducing or a wrong ε ]
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Solution: A2 Figure 1 shows the world market in the absence of US subsidies Q P p * Q d world Q s world q * US +q * BF= q * world q * US q * BF Q s US Q s BF Figure 2 shows the world market with US subsidies Q P p * Q d world Q s world q US +q BF= q world q US q BF Q s US Q s BF Q s US -- subsidy Q s world -- subsidy p Initially, the world price is determined by world demand and world supply, where world supply is simply the horizontal sum of US and Burkina Faso supply. This price is denoted by p * . World quantity is q * world , US supply is q * US , and Burkina Faso supply is q * BF . Once a subsidy is introduced for US suppliers, the US supply curve shifts to the right. This increases world supply and drives the world price down. While US supply increases to q’ US , Burkina Faso’s supply decreases falls to q’ BF . US suppliers benefit from the subsidy because their output increases and they receive more (price plus subsidy) than before. Burkina Faso suppliers are harmed – their supply decreases and they receive a lower price. World consumers of cotton benefit from the lower prices. US taxpayers are harmed – they have to foot the bill for the subsidy.
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MT1Solutions - Econ 100A Spring 2004 Midterm 1 Solutions...

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