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Q2F11AnswersExplained - Quiz 2 Fall 2011 November 2 2011...

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Quiz 2, Fall 2011, November 2, 2011 True/False Bubble in A for True and B for False 1. If the supply of a good is perfectly elastic, a tax levied on sellers for each unit of the good they sell will not increase the competitive equilibrium price buyers pay for the good. Answer: False A perfectly elastic supply curve is horizontal at a certain price, call it p. As a consequence, the equilibrium price must be p. If a tax of t is applied, the supply curve shifts up by t. Now it is horizontal at the price, p+t. The new equilibrium price must therefore be p+t. The price has shifted up by the amount of the tax. The price buyers pay has risen by the amount of the tax. The picture below illustrates this. Quantity Price Supply without the tax Supply with the tax Demand p p+t

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2. If the demand curve for a good is price elastic, an outward shift in the supply curve for the good (more supplied at every price) will decrease the total revenue of suppliers. Answer: False As shown in the diagram above, an outwardward shift is the supply curve will decrease the price of the good and increase the equilibrium quantity of the good, as the competitive equilibrium moves down along the demand curve. As an approximation, the percentage change in revenue is given by the following formula: , where R is revenue, ∆R is the change in revenue, P is price, ∆P is the change in price, q is quantity, and ∆ q is the change in quantity. The first term on the right (∆P /P) is negative and the second term (∆Q/Q) is positive . Which effect is larger in absolute value? The price elasticity tells us. The price elasticity of demand is the ratio of the percentage change in quantity to the percentage change in price, moving along the demand curve. If a good is price elastic, its price elasticity is below -1, which means that the percentage change in its price must be less in absolute value than the percentage change in quantity. The positive quantity effect dominates the negative price effect and thus the change in revenue is positive. 3. The excess burden of a tax is the loss in buyer and seller profits due to the tax minus the tax revenue collected by the tax. Answer: True See the definition on page 69 of the Bergstrom-Miller text. Price Original Supply Demand New Supply Quantity
Multiple Choice

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Q2F11AnswersExplained - Quiz 2 Fall 2011 November 2 2011...

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