Q2F10AnswersExplained

Q2F10AnswersExplained - November 3 2010 Quiz 2 Economics 1...

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November 3, 2010 Quiz 2 Economics 1 True-False Questions: Fill in Bubble A for True, Bubble B for False. 1. In a competitive equilibrium, buyers are better off if a per unit tax is levied on sellers than they would be if a tax of the same amount were levied on them. Answer: False In Table 3.9 of your homework, you compared the competitive prediction in Session 2, where sellers pay the tax, with the competitive prediction in Session 3, where buyers pay the tax. The total profits of buyers is the same in both sessions. In fact, the economic effects of the tax do not differ between the two sessions. On page 68 of Bergstrom and Miller, this result is stated as a general proposition that holds in all cases. Proposition 3.1 is as follows: The real effects of a per-unit sales tax are no different, whether the tax is collected from sellers or from buyers. I proved this proposition in class when we discussed the incidence of a tax
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2. If the demand curve for a good is downward sloping and the supply curve for the good is upward sloping, the loss in buyers' and sellers' profits from a per unit tax on the good will be greater than the revenue the government receives from the tax. Answer: True The loss in buyers’ and sellers’ profits from a per unit tax minus the revenue from the tax is the excess burden of the tax. So, is excess burden positive when the demand curve slopes down and the supply curve slopes up? Yes, as the diagram below demonstrates. In this case, a tax is levied on suppliers. The supply curve shifts up by the amount of the tax. Either the price to buyers is higher, the price to sellers is lower, or the price to buyers is higher and the price to sellers is lower, as depicted. Because demand is downward sloping, a higher price to buyers means lower quantity in equilibrium. Because supply is upward sloping, a lower price to sellers means lower quantity in equilibrium. Because either the price to buyers must rise and/or the price to sellers must fall, the quantity must also fall. Some trades that were profitable before the tax are not longer profitable. This causes an excess burden, as illustrated. If supply were perfectly inelastic, quantity would not change, and excess burden would be zero. An upward sloping supply curve rules out this case. Alternatively, if demand were perfectly inelastic, quantity would not change, and excess burden would be zero. A downward sloping demand curve rules out this case.
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