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Economics 101: Principles of Economics

Economics 101: Principles of Economics. Queries? Quiz #2 on Ch. 4, 5, and 6. Who Bears the Burden of a Tax?. Two main effects: (1) lower output (2) Wedge is created between price buyers pay and the price sellers take home

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Economics 101: Principles of Economics

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  1. Economics 101: Principles of Economics • Queries? • Quiz #2 on Ch. 4, 5, and 6.

  2. Who Bears the Burden of a Tax? • Two main effects: (1) lower output (2) Wedge is created between price buyers pay and the price sellers take home • The distribution of the tax burden depends on the relative elasticities of D & S. • Example: Demand: P = 12 - 2Q Supply: P = 4Q Find the new equilibrium (P*, Q*) after imposing $6 per unit tax on firms. Find the new equilibrium (P*, Q*) after imposing $6 per unit tax on consumers. Compare the price received by sellers to the price received by buyers in both. Taxing SellerTaxing Buyer Equilibrium (P*,Q*) (10, 1) (4, 1) Price actually paid by buyer $10 $10 Price actually received by seller 4 4 The govt gets 6 6 • Legal incidence of the tax has no effect on the economic incidence

  3. Elasticity and Tax Incidence • The distribution of the tax burden depends on relative elasticities of D & S. • For a given D and per-unit tax, the more inelastic the S curve, • the smaller the tax burden borne by consumers (price rises less) • the larger the tax burden on producers • the smaller the decline in output • For a given S and per-unit tax, the more inelastic the D curve, • the bigger the tax burden borne by consumers (price rises more) • the smaller the tax burden on producers • the smaller the decline in output

  4. Theory of Consumer Choice • Shifts in the Budget Line • Change in Income • Change in Prices • Double I, Triple PX & PY? Yo-yos I/PY 2I/3PY • NB: slope measures the real price, the purchasing power of one good in terms of the other • so if both prices rise by the same % (or fall by same %), their ratio is the same  the slope of budget line stays same! • What if the price changes with quantity purchased? 2I/3PX I/PX Xylophones

  5. Consumer Preferences • Assumptions about preferences 1. They are complete. People can rank all possible combinations. 2. They are transitive. People are rational. 3. “more is better”. This is called non-satiation. • Indifference curve is the locus of points (X,Y) that yield the same level of utility • Utility function transforms consumption of goods & services into an index measuring the level of satisfaction  • Ordinal vs. Cardinal utility

  6. Y U = 750 U = 500 X Properties of Indifference Curves 1. IC’s are downward-sloping 2. Higher IC indicates higher utility 3. IC’s do not intersect 4. IC’s are convex to the origin • Total utility = total “utils” a person gets from consuming a given amount of a good • Marginal utility= the amount that total utility increases when consumption of a good goes up by one unit, ceteris paribus (i.e., holding consumption of other goods constant) Y X U=X*YMUYMUX 400 125 50,000 --- --- 401 125 50,125 125 --- 400 126 50,400 --- 400

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