Q2W11AnswerExplained

Q2W11AnswerExplained - Quiz 2, Winter 2011 1. If the supply...

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Quiz 2, Winter 2011 1. If the supply curve for a good is perfectly inelastic, a sales tax on that good will have no excess burden. Answer: True The diagram below shows the effect of a $10 tax on buyers when supply is perfectly inelastic. The tax shifts the demand curve for buyers down by $10. The price sellers receive falls by $10, but the quantity sold does not change. The price buyers pay does not change. They pay $10 less to sellers, but they must pay a $10 tax. So, their profits are the same as without the tax. The sellers lose $10*Q, where Q is the amount they sell before and after the tax. The tax revenue is $10*Q. The excess burden is the loss in profits to buyers and sellers minus the tax revenue raised. The loss to buyers and sellers is $10*Q and the tax raises $10*Q in revenue. The excess burden is zero. Another way to see this is to note that deadweight loss occurs because a tax reduces the number of transactions. Some transactions that were profitable without the tax are no longer profitable with the tax. In the case of a perfectly inelastic supply curve, the quantity supplied and demanded does not change because of the tax, so there is no deadweight loss. price quantity demand w/o tax demand with tax supply Q P P-$10
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2. If the supply curve shifts out (more supplied at every price) and the total revenue of suppliers decreases, the demand curve must be elastic. Answer: False If the supply curve shifts out, quantity increases and price falls moving along the demand curve. The percentage change in revenue is approximately equal to the percentage change in price plus the percentage change in quantity. Because total revenue decreases, the percentage change in price must be larger in absolute value than the percentage change in quantity. The price elasticity of demand is the percentage change in quantity divided by the percentage change in price. Because the percentage change in price is larger in absolute value than the percentage change in quantity, this ratio must be between -1 and zero, which means that the demand curve is inelastic. 3. If the production and sale of a good imposes external costs on members of a community, the total profits of community members will be increased if trade in the good is banned. Answer: False In lecture on Friday, February 4, I presented the fable of the Isle of Effluvia. Remember that each pink flamingo produced imposed external costs of $20 on residents of Effluvia. In a competitive equilibrium without taxes, 20 flamingoes were produced and sold, imposing a total of $400 of external costs on island residents. The profits of buyers and sellers totaled $390, ignoring these external costs. Banning the pink birds increased total profits by $10. But suppose the external costs of a pink flamingo was only $10 and everything else was the same. Now, the net benefit of the flamingo market would be $190 including the external costs ($390-$200). Banning the pink birds would lower profits by $190.
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4. If the supply curve for a good is perfectly elastic, a tax on buyers of the good will not
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Q2W11AnswerExplained - Quiz 2, Winter 2011 1. If the supply...

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