ECON 221Exam # 2 Study Guide Lectures: 10 - 15Lecture 10 (September 25)Elasticity - Elasticity – responsiveness to price changes - Price Changes – impact of price decreases depends on whether the gain in quantity sold outweighs the loss stemming from the lower price. - Elasticity of demand- measures how responsive buyers are to changes in prices. o ED = % change in QD / % change in Po Measures percentage change in quantity demanded for each percentage change in price o Changes throughout the demand curveo If we’re comparing two demand curves, we can say the shallower one is relatively more elastic- Elasticity of Supply – how responsive are producers to prices when deciding how much they are willing to supply. o Es = % change in Qs / % change in P o Determined by: Availability of inputso Time (short run vs. long run elasticity of supply) - Other types of elasticity o Income elasticity (% change in QD) /(% change in income) Positive or negative matters o Cross-price elasticity (% change in QD of X) / (% change in P of Y) positive or negative matter- Calculating Elasticity – use midpoint formula o Midpoint formula - % ΔX (change X) = ((Xnew – Xold) /.5 (Xnew + Xold)) x 100- Steepness and elasticityo More shallow demand curve, the more relatively elastic it iso What determines relative elasticity? Availability of substitutes – “broad categories” tend to be less elastic that specific goods within those two categories. Demand for “coffee drinks” is less elastic than demand for latteso Necessity – gas priceso Share of income spent on a good – toothpaste vs. apartmento Time Long run vs. short run elasticity Gas prices o Elasticity is defined at particular price levels Elasticity changes as we move throughout the demand curve When comparing two demand curves, we say the shallower one is relatively more elastic All goods are elastic at some point and inelastic at other points So when we measure elasticity we measure the elasticity of a particular good at a particular price level. - Elasticity and revenueo Impact of price change on Revenue (= Price x Quantity sold) depends on elasticity o Decrease in price yields -> Less money sold per unity, but an increase in the number of sales. o ED >1 means QD change is proportionally larger than P change. o ED < 1 means QD change is proportionally smaller than P change. If ED < 1: Price Decrease -> Revenue Decrease If ED > 1: Price Decrease -> Revenue Increase If ED < 1: Price Increase -> Revenue Increase If ED > 1: Price Increase -> Revenue Decrease Lecture 11 & 12 (September 30 – October 2) Taxes o Governments need to tax citizens to provide services Federal, state and local, total These taxes all impact the price of various goods Like price ceilings and price floors, inefficiency will result. o "Lump sum" tax - doesn't impact prices on any one specific good Avoids inefficiency - because it is not linked to anything in particular Not common because they are not perceived at "equitable" In thinking about how "fair" tax is, we might care about two principles- "Benefit principle" - tax is fair if the people paying the tax are benefitting from it- "Ability to pay principle" Margaret Thatcher- "Community charge" - Caused terrible riots, concerns went back to the "ability to pay principle"o Taxation Governments need money and must tax Often face a trade-off between equity and efficiency Government must balance these two goals o Model taxes Main focus on excise tax Excise taxes - taxes on the purchase or sale of a good that raise the price of a particular good by some specified amount- Ex. Cigarettes: $1.58 per packo $1.01 per pack (fed)o $0.57 per pack (SC)- Gasoline: $0.35 per gallono $0.18 per gallon (fed)o $0.17 per gallon (SC) o Who bears the burden of a tax "Statutory incidence" who the government assigns the tax to "Economic incidence" who actually bears the burden of the tax Measured by [price paid/price received after tax - pre-tax price]• 3 lessons: o Economic incidence (almost) never the same as statutory incidenceo Statutory incidence has no impact on economic incidence o Economic incidence is determined by relative elasticities Taxes aren't always equally shared Probably more realistic to think cigarette demand is relatively inelastic- "Tax incidence" – analyze who is impacted by a tax- "Tax efficiency" – analyze the impact of taxes on efficiency and think about when taxes lead to more inefficiency • Consider the market for laboro Short run: Labor demand is perfectly inelastic – perfectly vertical demand curveo Long run: Labor demand is downward sloping - Tax Efficiency o Main result – tax efficiency is dictated by elasticity; more elasticity -> more inefficiencyo Benefits from taxes Taxes distort decisions in markets they are imposed on, but they also lead to things that people like and need (roads, schools, etc.) Often means nothing for the market in question because taxes generate inefficiency in one market (taxes on lottery tickets) and benefits in another (schools). Sometimes taxes directly benefit participants of the market being taxed – ex. Mandated Maternity Benefits o Measuring Inefficiency Model the impact of a tax using a supply and demand graph and use that to calculate deadweight loss. Know the “geometric” formula for deadweight loss (1/2(base)(height) of the triangle… where “base” is loss in quantity and “height” is price)o Policy Implications Ex. You are a government official up for re-election and want to avoid imposing a tax that will increase the price too much on consumers. Should you tax cigarettes or lattes? Tax the product with less elasticity -> efficiency - **Be able to model a tax graphically using supply & demand. o What impact does a tax have on the supply and/or demand curveo Use the graph to identify change in price paid by consumers, change in price received by firms, deadweight loss, and government revenue.Lecture 13 (October 10)Externalities - Transactions sometimes impact people other than those voluntarily buying and selling.- Ex. Production and pollutiono Factory producing a good, often creates pollution at the same time. Impacts everyone, regardless of whether they’re buying or selling the goods made at this factory. Makes everyone generally worse offo From society’s
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