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SC ECON 221 - Exam 2 Study Guide

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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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