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ECON 1011, Week 4 Notes

by: Samantha Notetaker

ECON 1011, Week 4 Notes ECON 1011

Samantha Notetaker

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Taxes, subsidies and demand elastics
Principles of Economics I
Yezer, A
Class Notes
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This 2 page Class Notes was uploaded by Samantha Notetaker on Wednesday September 28, 2016. The Class Notes belongs to ECON 1011 at George Washington University taught by Yezer, A in Fall 2016. Since its upload, it has received 3 views. For similar materials see Principles of Economics I in Economics at George Washington University.


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Date Created: 09/28/16
9/19/2016 I. Supply and Demand in the Short and Long Term a. In the short term the response of quantity demanded to price changes is generally small  because consumption is based on habit, or on technology. i. In the long run, consumers are much more flexible b. In the short term, quantity supplied responds slowly to price changes because it takes  time to open or close plants and for new firms to enter or old firms to leave an industry i. In the long run, new firms can enter or old firms can leave and the size or number of plants can change c. The market must always be in short term equilibrium, but not necessarily long term II. Effects of Specific Taxes a. A specific tax is a fixed “per unit” tax b. Producers add the specific tax to the net of tax supply curve as if it were an increase in  the cost of production c. Adding a tax shifts the supply curve to the ‘gross of tax’ supply curve (includes tax) from the ‘net of tax’ supply curve (without tax) d. Taxes cause consumers to pay more and producers (and their workers) to get less i. Causes deadweight loss (the triangle between Q’ and Q* where output is not  allocatively efficient e. The tax drives a ‘wedge’ between marginal benefit on demand curve and marginal cost  on supply curve III. Effects of Ad Valorem Taxes a. Ad Valorem tax is a percentage tax b. Producers add the ad valorem tax to the net of tax supply curve as if it were an increase in the cost of production c. The gross of tax supply curve has a higher slope than the net of tax supply curve d. Market equilibrium is where the gross of tax supply curve is cut from above by demand IV. Tax Incidence a. Statutory incidence of taxes­ Statutory incidence refers to the individual or group of  individuals who are responsible for physically remitting a particular tax to the  government.  b. Economic incidence of taxes­ In economics, tax incidence or tax burden is the analysis of the effect of a particular tax on the distribution of economic welfare. Tax incidence is  said to "fall" upon the group that ultimately bears the burden of, or ultimately has to pay,  the tax. c. Economic and statutory incidence may or may not coincide. For example, the statutory  incidence of the corporate income tax falls on corporate executives. 9.21.2016 I. Short & Long Term Effects of Tax a. In the short term, the effect of taxes on quantity demanded is generally small because  consumption is based on habit b. In the short term, the quantity supplied responds slowly to price changes because  firms/providers/producers have long term contracts and technology. It also takes time to  open or close new/old firms. c. In the long term, supply curve is pretty flat because number of firms and providers  fluctuates d. Total Tax revenue in the short term = (tax) x B S e. Total tax revenue in the long term = (tax) x B L f. Tax revenue falls over time, B  < L S g. Over time the share of tax incidence paid by customers rises and the share of taxed paid  by firms falls h. The deadweight loss is the triangle between B*, B  and B L This lSss rises over time. i. Base of the triangle is the difference between the willingness to pay and the  amount supplied i. Supply curve can’t shift if it’s vertical, so shift the demand curve instead II. Subsidies a. Can either be specific or ad valorem b. Some interact with the tax system, allow tax payers to deduct centering expenditures  form taxable income so taxes are reduced c. Subsidy is a ‘negative tax’ shifting the gross of subsidy supply schedule down below the  original net of subsidy supply curve d. Price is found where the demand curve cuts the gross subsidy curve from above (higher  Q and lower P) III. Demand Elasticities a. Own price elasticity of demand  E  = (% Phange in quantity) / (% change in price) i. Elasticity is always negative because Q and P change on opposite directions on a  negatively sloped demand curve. b. Three possibilities i. |%ΔQ| > |%ΔP| ‘elastic’ E  < P1 (Q flexible) ii. |%ΔQ| < |%ΔP| ‘inelastic’ E > ­1 (Q inflexible) P  iii. |%ΔQ| = |%ΔP| demand is ‘unit elastic’ E  = ­1P(P and Q are equally flexible) c. With elastic demand, P and Revenue move in opposite directions, Q and Revenue move  in the same direction d. With inelastic demand, P and Revenue move in the same direction, Q and R move in  opposite directions e. Unit elasticity of demand i. A small change in percentage in price results in a compensating change of the  same percentage in quantity in the opposite direction so that revenue is  unchanged f. Income elasticity of Demand i. E  =(%ΔQ) / (%Δincome) income   ii. If E income< 0 the good is ‘inferior’ iii. If E income 0  the good is ‘normal’ iv. If E income 1 the good is ‘superior’ v. As income rises, the fraction of income spent on superior goods rise and the  fraction spent on good with E income< 1 falls vi. All superior goods are also ‘normal’ but all normal goods are not superior


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