AREC 202 FINAL EXAM QUESTIONS SOLVED CORRECTLY
Excise Tax - Answers Tax on sales of a good or service: "per-unit" tax
Effects:
1. It raises price paid by buyer
2. Reduces price received by sellers
3. Drives a wedge between the two
** If the producer is taxed, the supply curve will shift up...
Excise Tax - Answers Tax on sales of a good or service: "per-unit" tax
Effects:
1. It raises price paid by buyer
2. Reduces price received by sellers
3. Drives a wedge between the two
** If the producer is taxed, the supply curve will shift upwards by the amount of the tax.
** If the consumer is taxed, the demand curve will shift downwards by the amount of the tax.
**It does not matter who is actually paying the tax, the burden is shared between producers and buyers.
How do you calculate the amount of the per-unit tax that is imposed on sellers? - Answers Subtract S2
and S1 curves
How do you calculate the amount of the per-unit tax that is imposed on buyers? - Answers Subtract D2
and D1 curves
Tax incidence - Answers A measure of who is really paying the tax (buyers or sellers). Remember,
whoever bares the burden of the tax does not depend on who pays it.
Tax Incidence depends on the elasticity's of supply and demand.
Tax Incidence and Elasticity - Answers In general, whoever is the least flexible (inelastic) is the party that
will pay the tax.
If price elasticity of demand is low (inelastic) and price elasticity of supply is high (elastic): Excise tax falls
on consumers.
If price elasticity of demand is high (elastic) and price elasticity of supply is low (inelastic): Excise tax falls
on producers.
How do you figure this out graphically?
1. Plot Equilibrium price (point where demand and supply curve intersect)
2. Look at the quantity that is being sold and mark the price on the demand curve and on the supply
curve that is associated with that quantity.
3. Whoever has the largest gap from the equilibrium price is who the tax incidence falls on.
Who pays the FICA? - Answers FICA: Federal Insurance Contributions Act
,Workers pay 7.65% of their earnings in FICA
Each employer: matching amount
Is FICA really shared equally by workers and employers?
NO- price elasticity of demand is high (around 3) and price elasticity of supply is very low
FICA falls mainly on the suppliers of labor (lower wages) rather on employers (in form of lower profits)
Revenue from an Excise Tax - Answers Revenue of an excise tax is equal to the area of the rectangle
(height of the tax wedge between the supply and the demand curve, and the width is the new
equilibrium quantity transacted under the tax.
Revenue= Tax incidence * equilibrium quantity
Does doubling the excise tax rate on a good double the amount of revenue collected? - Answers No,
because tax incidence will reduce the quantity of the good or service transacted. in some cases, raising
the tax rate may actually reduce the amount of revenue the government collects.
Think about it: if there is a higher tax, do you think more people would demand that good? In most
cases, probably not, which will decrease the quantity consumed under that tax.
Tax Effects on Consumer and Producer Surplus - Answers A tax reduces consumer and producer surplus.
The area within the rectangle is the tax revenue the government collects.
The area to the right of the rectangle (sideways triangle >) is the deadweight loss. This is the area that
government is loosing out on and does not get to collect by imposing the tax.
The area of the rectangle PLUS the area of the deadweight loss is the total fall in consumer/producer
surplus. The area above the price equilibrium (closest to the demand curve) is the total loss in consumer
surplus. The area below the price equilibrium 9closest to the supply curve) is the total loss in producer
surplus.
Deadweight Loss and Elasticity - Answers Deadweight loss is larger when demand/supply are elastic.
Deadweight loss is smaller when demand/supply are inelastic.
To minimize the efficiency costs of taxation, tax those goods for which demand, supply, or both are
relatively inelastic since the behavior will not change (unresponsive) when their is a change in price.
Thus, with less deadweight loss, the more tax revenue the government will gain.
Extreme cases: perfectly inelastic supply or demand curves will result in no deadweight loss.
Benefits Principle - Answers Tax fairness
Those who benefit from public spending should bare the burden of the tax that pays for the spending.
, Ability to Pay Principle - Answers Tax fairness
Those with greater ability to pay a tax should pay more tax.
Utility - Answers A measure of the satisfaction the consumer derives from consumption of goods and
services.
Util: a unit of utility
To maximize total utility, consumers must focus on marginal utility.
Utility Function - Answers Relationship between an individual's consumption bundle and total amount of
utility it generates for that individual consumer.
Consumption Bundle - Answers Collection of all the goods and services consumed by that individual.
Marginal Utility - Answers Change in total utility generated by consuming one additional unit of a good
or service.
Similar to marginal benefit, only calling it marginal utility.
To calculate marginal utility, subtract the total utils from the previous total utlits.
The Principal of Diminishing Marginal Utility - Answers Each successive unit of a good or service
consumed adds less to total utility than the previous units.
What does the Principle of Diminishing Marginal Utility imply for marginal utility?
A. Marginal utility is always negative
B. Starting at some point, the marginal utility function is upward-sloping
C. Starting at some point, the marginal utility function is downward-sloping - Answers C: Regardless of
where you start from, consuming one more additional unit will decrease the total amount of utility each
time you consume it.
**Welfare you are getting from each successive unit is decreasing
What does the Principle of Diminishing Marginal Utility imply for total utility (for most goods)?
A. Total Utility is first positive, than negative
B. Total Utility is always negative
C. The Total Utility function is becoming steeper and steeper with an increase in units
D. The Total Utility function is first upward-sloping, but becomes less steep with an increase in units until
eventually it might have a negative slope. - Answers D: When you initially consume more of something,
you tend to gain more utility, but as you continue to consume it will eventually decrease.
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