Practice Free Response Solved

1) Ed = 8.3 (using mid-point method)

%∆ Qty D / % ∆ Price

Qty D = (40 - 0)/20 = 2.0Price = [($28- 22)/$25] = .24

2/.24= 8.3

2) Less Elastic, as you move downward along Demand curve (towards x-axis) demand becomes less elastic. That is Ed becomes a

smaller number

Know this:- Mid-point of all linear demand curves is UNIT ELASTIC. - Bottom part is inelastic range - Top part is elastic range

$25

20

Practice Free Response Handout Solved

3) Calculate Original:a) 480 consumer surplus

b) 640 producer surplus

c) 1120 total welfare

d) Zero loss of welfare

4) Tax of $14 on sellersa) Modify….b) 22 buyers pay

c) 8 seller receive

d) 560 tax revenue

e) 120 new c.s.

f) 160 new p.s.

g) 280 deadweight loss

h) 840 total surplus

5) Sellers--more inelastic curve has Higher tax incidenceBuyers pay $6 of taxSellers pay $8 of tax

S2$14 Tax on sellers

Deadweightloss

You shift the supply curve because the tax was on sellers-but draw the wedge first!

CS

PS

TAX REVENUE

PB

PS

Tax Revenue

6) Ed < 1 (inelastic)

No good subs, necessity

7) See graph i)buyer pays more Sellers receive less Qty sold fallsii) – iv) labeled on graphv) CS + PS + Tax Revenue

8) See below:i)Qty falls more, Sellers pay more, buyers pay lessii) Less Gov’t revenueiii)Shared more equally (buyer paid most of tax before)

iv)Bigger DWL (quantity shrinks more)

Deadweight Loss

Cigarettes

4)

Q1

-----------------

Q2

CS

PS

TAX REVENUE E1

P1

Notice buyers pay most of tax & DWL is small because of inelastic demand!

Equilibrium MC = MBEquilibrium MC = MB

Quantity0

Price

MBMB

MC)

MC)

MSC

QOPTIMUMQOPTIMUM

OptimumOptimum

QMARKETQMARKET

SpilloverCost

SpilloverCost

P1

9) Spillover Costs of Smoking

Tax suppliers the exact size of the spillover cost (external cost)

Total Welfare would rise even though the market Shrinks

Both external &internal costs!

Basic Tax Example & DWL

Price Ceiling & DWL

Subsidy & DWL

                                                                      

(

Subsidy & DWL

                                                                      

(

.

.