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AU / Economics / ECON 200 / Who bears the burden of tax?

Who bears the burden of tax?

Who bears the burden of tax?


School: American University
Department: Economics
Course: Principles of Microeconomics
Professor: O ozay
Term: Fall 2016
Cost: 50
Name: Exam 2 Study Guide
Description: ECON 200 - Microeconomics Chapters: 6,8,9,10,19,24 (Cowen and Tabarrok) Exam 2 Study Guide
Uploaded: 03/29/2017
6 Pages 39 Views 3 Unlocks

ECON 200 - Microeconomics

Who bears the burden of tax?

Chapters: 6,8,9,10,19,24 (Cowen and Tabarrok)

Exam 2 Study Guide

Chapter 6 - Taxes & Subsidies 

Taxes​: Government decides who pays a tax, but not who feels the burden of it. ● Elasticity determines the burden of the tax

■ More inelastic demand, larger the burden 

■ More elastic demand, smaller the burden 

Price of an object is $2

■ $2 tax on sellers / buyers

● Quantity falls

● Price buyers pay = $3

● Price sellers receive = $1

○ If on seller's, supply decreases

○ If on buyers, demand decreases

Subsidies​: Government decides who receives a subsidy, but not who feels the benefit of it. ○ Elasticity determines the benefit of a subsidy

How do subsidies affect the government?

■ More inelastic, larger the benefit

■ More elastic, smaller the benefit

○ Price of an object is $2

■ $2 subsidy on sellers / buyers

● Quantity rises

● Price buyers pay = $1

● Price sellers receive = $3

○ If on seller's, supply increases

○ If on buyers, demand increases If you want to learn more check out What is a risk and what is a hazard?

● Demand

○ Inelastic: fixed supply, few substitutes, short run, necessary

○ Elastic: Many substitutes, long run, luxury good

● Supply

○ Inelastic: hard to produce more at same cost, global supply chain ○ Elastic: eary to produce more at same cost, local supply chain Don't forget about the age old question of What are the characteristics of friendship?

Chapter 8 - Price Ceilings & Price Floors 

Why is supply inelastic in the short run?

Price ceiling:​ Maximum legal price on a good / service

● This creates:

○ Shortages (QD>QS)

○ Lower quantity

○ Black markets

○ Bundling

○ Wasteful lines

○ Favoritism

○ Poorly targeted

○ Lower quality

● Rent controls cause larger shortages over time

Price floor:​ Minimum legal price

● This creates:

○ Surplus (QD<QS)

○ Lower quantity

○ Black markets

○ Favoritism

○ Concessions by sellers

○ Poorly targeted

● If we increased the minimum wage we would lose jobs (3-16 million)

● People in poverty would see a 7% increase or maybe a 7% decrease in household pay

● Ban: a price ceiling at $0

○ Shortage is huge

○ Gap between price and marginal value is huge

○ Human Organ waiting list in USA

○ If let the market control it, they would reach P=MV (equilibrium) We also discuss several other topics like What are the different stages of mitosis?

Minimum Wage V Wage Subsidy

● Minimum Wage: (a price floor)

○ Higher wage

○ Lower employment

○ Weakly targeted

○ Regressive

■ The way is too high so firms don’t hire as many workers

● Wage Subsidy:

○ Higher wage

○ Higher employment

○ Strongly targeted

○ Progressive

■ The wage firms pay goes down, so they can hire more employees,

and the employee makes more with the subsidy

Chapter 9 - Analyzing Trade w/ S&D, Tariffs, Subsidized Imports, & Jobs Imports​: Occur when Pw<P, and are equal to the difference between Qs and Qd ● No foreign trade (P):

○ CS = A

○ PS = B + E

○ TS = A + B + E

● Free trade (Pw):

○ CS = A + B + C + D

○ PS = E

○ TS = A + B + C + D +


■ Benefits the country as a whole, even though We also discuss several other topics like What is the content of the eggshell plaintiff rule?

producer surplus drops, total surplus increases

Tariffs​: Raise the price of imported goods and decreases imports

● Trade with tariff (Pt):

○ CS = A + B If you want to learn more check out What is social aggregate?

○ PS = C + G

○ Government = E

○ TS = A + B + C + E + G

■ Hurts the country as a whole, consumer and total

surplus go down, producer and government surplus

goes up

■ Consumers lose money for jobs “saved” through


Subsidized Imports​: Argument: Foreign companies receive subsidies, allowing them to compete unfairly with domestic companies

● Subsidized imports (Ps): If you want to learn more check out What is the definition of spontaneous?

○ CS = A + B + C + D + E + F

○ PS = none

○ TS = A + B + C + D + E + F

■ Benefits the country as w hole, consumer and total surplus


Jobs​: Argument: When you buy a foreign product, you destroy a domestic job ● Buy a domestic item = domestic job

● Buy a foreign item = two different kind of domestic jobs

○ You will lose a job in the import-competing industry, BUT will create a job in an exporting industry through lower prices (import cheaper than

domestic good)

○ Causes a shift in jobs, not a loss

○ This increases overall consumption

○ The money will always come back to US, because of the currency


Chapter 10 - Externalities, Government Solutions, Market Solutions, & Tradeable Allowances Externalities​: Costs or benefits that affect bystanders

● Invisible hand: self-interest leads to efficient outcomes

● Institutional failure: self-interest leads to inefficient outcome

○ Goods with external benefits are underproduced (demand shifts to the right and is higher than equilibrium, so not enough available in market)

○ Goods with external costs are overproduces (supply is lower than

equilibrium, so there is more available in the market than needed)

Government Solutions​:

● Command and Control: make actions forbidden or mandatory

○ Effective when solution is well-known and success requires widespread compliance

○ Ineffective when solution must be discovered or when there is no

universal solution (vaccine)

● Pigouvian tax: tax on a good with external costs

○ Alcohol creates external costs, so the market produces too much alcohol ○ If make an alcohol tax = to external cost market would produce an

efficient quantity (supply would decrease).

● Pigouvian subsidy: subsidy on a good with external benefits

○ Honey creates external benefits, so the market produces too little honey ○ If make a honey subsidy = to external benefit, market would produce enough (demand would increase).

Market Solutions​:

● Coase Theorem: when transaction costs are low, bargaining can solve externality problems

○ Honey creates external benefit for farmers

○ Honey producers make less than efficient quantity of honey

○ If the farmer pays the producer to make more honey

○ Honey output rises toward efficient quantity

Tradable Allowances​:

● Command and Control: government requires each firm to reduce pollution by 1 ton

○ Firm A

■ $200 to reduce each ton of pollution

○ Firm B

■ $800 to reduce each ton of pollution

○ Total cost: $1,000

● Tradeable allowances: government issues an allowance that allows the owner to pollute a certain amount

○ Try to limit pollution by limiting the number of allowances

■ Firm B buys Firm A’s allowance, so they don’t have to reduce


■ Firm A reduces two tons of pollution

○ Total cost: $400

● Allowances reduce the cost of pollution reduction

● If a private group buys allowance from Firm A, but does not pollute more than allowances enable private efforts to reduce pollution

Chapter 19 - Non-Excludability, Public Goods, Common Resources, & Property Rights Excludable:​ Someone can be prevented from using it

Rival​: One person’s use reduces amount available for others

● Excludable & Rival = private good (painting)

● Excludable & Non-Rival = non-rival private good (TV subscription)

● Non-excludable & Rival = common resource (TOC - fish)

● Non-excludable & Non-Rival = public goods (radio)

○ Markets may fail to produce non-excludable goods even when they are desired

Public Goods​:

● Free-rider problem​: people will refuse to pay for goods if they can receive the benefits for free

○ Government solution: force beneficiaries to pay for public goods

■ Difficult to determine efficient quantity of these goods without

market prices

■ Someone has to pay for goods even if they aren’t seen as

valuable to them (Forced-rider problem​)

○ Market solution: bystanders may provide public goods to beneficiaries ■ Aka companies that buy ads on radio/tv

Common Resources​:

● Tragedy of the Commons​: common resources will be overused and under-maintained

○ Solution: limit the number of users

○ Individual Transferable Quota (ITQ): government issues an allowance that allows the owner to catch a certain amount of fish

■ Limit total catch by limiting number if ITQ’s issued

Property Rights​: institution that uses self-interest to avoid the TOC

● Limits the number of users

● Creates a link between effort and reward

● Aligns owner’s interests with interests of others

Chapter 24 - Asymmetric Information & Signaling 

Asymmetric Information​: One side knows more about product quality

● Low quality = $8,000 (50%)

● High quality = $12,000 (50%)

○ No way for consumer to tell which is which

○ Offer $10,000 for car of unknown quality

○ All high-quality cars leave market

● Adverse selection​: when product quality is uncertain, low quality drives out high quality and market may fail to produce goods even though buyers will pay for them

Signaling​: Action taken by informed party to send information to uninformed party ● Effective signal is costly but less costly for high-quality party than low-quality party

○ Car, dating, gift giving examples

Countersignaling​: Lack of signaling as a signal of high quality

● Now we have: Low, Medium, and High quality

○ Enough information to separate highs from lows

○ Not enough to separate high from medium or low from mediums

■ Mediums signal heavily to separate from lows

■ Highs refrain from signaling to separate from mediums

Signaling Theory of Education: College Wage Premium & Implications 

Human Capital Theory​: college teaches skills desired by employers

● Problems:

○ Most students study subjects unrelated to their work

○ Most classes teach no job skills

○ Most professors only know how to be professors (no real work xp)

Signaling Theory​: college diploma is a signal of desirable skills

● Desirable skills are hard to observes, so a college diploma correlates to them ○ Intelligence

○ Motivation

○ Obedience

○ Meeting deadlines

○ Conformity

● You view college as signaling if:

○ Pay tuition

○ Celebrate when class is canceled

○ Cheat

○ Worry about exams, not forgetting info later in life

○ Worry if one credit short of graduating

● If college is human capital accumulation ,then it is in your self-interest and it makes society better off

● If college is signaling, then it is in your self-interest and makes society worse off ○ Wasteful competition, wasting time and resources to get this piece of paper

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