ec-19 - ANSWERS to Homework#7 E201 Spring 2009 1 If the...

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ANSWERS to Homework #7 E201 Spring 2009 1. If the government places a $500 tax on luxury cars, will the price paid by consumers rise more than $500, less than $500, or exactly $500? Explain. Price will rise by less than $500. The only way price could rise by exactly $500 is if demand (or supply) is perfectly inelastic. 2. The FICA tax funds Social Security programs. Congress established a 15.3% FICA tax rate; by law, the tax burden is split 50-50 between employer and employee. So, 7.65% of the employee’s earnings on each paycheck is deducted for FICA taxes, and 7.65% of the employee’s earnings is paid in FICA taxes by the employer. Is the economic incidence of the FICA tax shared equally by employer and employee? Explain. The supply of labor is very inelastic (for prime-age workers), so the payroll tax is borne almost entirely by employees (suppliers of labor services). To show this, draw a labor market with the supply curve very steep relative to the demand curve. Insert the tax wedge (of 15.3%) and note that the burden of the tax falls heavily on the sellers (workers) in the form of lower after-tax wage received. 3. It is a hot a day and Bert is very thirsty. Here is the value he places on a bottle of water: Value of first bottle $7 Value of second bottle 5 Value of third bottle 3 Value of fourth bottle 1 If the price of a bottle of water $4, how many bottles does Bert buy? How much consumer surplus does Bert get from his purchases? At $4 Bert would buy 2 bottles. The consumer surplus from the first bottle is $3 and $1 from the second, for a total of $4. 4. Ernie owns a water pump. Because pumping large amounts of water uses more resources than pumping small amounts, the cost of producing rises as he pumps more. Below is the cost he incurs to produce each bottle of water: Cost of first bottle $1 Cost of second bottle 3 Cost of third bottle 5 Cost of fourth bottle 7 If the price of a bottle of water is $4, how many bottles does Ernie produce and sell? How much producer surplus does Ernie get from these sales?
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