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Q2W10AnswersExplained - February 12, 2010 Quiz 2 True-False...

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February 12, 2010 Quiz 2 True-False Questions 1. If the supply curve for a good is upward sloping and the demand curve for the good is elastic, a per-unit tax on the good paid by sellers will decrease the total amount buyers spend on the good. Answer: True Below are the supply and demand curves for a good. demand curve price before tax price price after tax supply curve before tax supply curve after tax quantity A tax on sellers shifts the supply curve up by the amount of the tax. The supply curve after the tax is the dashed line in the figure above. The price that buyers pay increases and the quantity decreases. The price increase will have a positive effect on the amount buyers spend on the good. The quantity decrease will have a negative effect. Which effect dominates? If demand is elastic, the quantity effect dominates. The total amount buyers spend on the good falls.
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2. If the supply curve for a good is perfectly elastic and buyers pay a tax for each unit of the good they buy, an increase in that tax will not change the equilibrium price of the good. Answer: True A perfectly elastic supply curve is a horizontal line as depicted below. supply curve price demand curve w/o tax demand curve with higher tax quantity demand curve with tax The demand curve without a tax is the solid downward sloping line. A tax on buyers shifts the demand curve down by the amount of the tax. That curve is the dashed line. An even higher tax shifts the curve down even further, the dotted line in the figure. The equilibrium price is the same for both tax rates, however. With a perfectly elastic supply, buyers pay the full burden of the tax. The price that sellers receive is not affected the tax. 3. The deadweight loss of a tax is the reduction in the profits of buyers and sellers because of the tax minus the revenue raised by the tax. Answer: True See the definition of deadweight loss on page 69 of Bergstrom and Miller.
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4. When there are negative externalities from the production of a good, all buyers and sellers of the good will be better off if that good is taxed. Answer: False As I showed in the lecture on negative externalities (February 5), the competitive equilibrium may fail to be efficient if transactions of a good produce negative externalities. In that case, a tax on the good equal to the cost of the negative externalities will result in an efficient outcome. Total profits will increase. However, total profits will not necessarily increase for everyone. The buyers and sellers who still transact after the tax will now have to pay a tax, which may reduce their profits. To see this in a simple case, imagine that the supply curve of pink flamingoes is perfectly elastic and that the production of each pink flamingo imposes a cost of $1 on each of 100 members of a community. Without a tax on pink flamingoes, imagine that two flamingoes are produced and sold. Each resident of the community suffers damages of $2. Now a tax is imposed on the good. The tax is $100, the damage each flamingo imposes on third
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This note was uploaded on 12/12/2011 for the course ECON 1 taught by Professor Bergstrom during the Fall '07 term at UCSB.

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Q2W10AnswersExplained - February 12, 2010 Quiz 2 True-False...

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