E201 Final Exam
ANSWERS to Homework #7
E201 Spring 2009
1.
If the government places a $500 tax on luxury cars, will the price paid by consumers rise more than $500, less than $500, or exactly $500? Explain.
Price will rise by less than $500. The only way price could rise by exactly $500 is if demand (or supply) is perfectly inelastic.
2.
The FICA tax funds Social Security programs. Congress established a 15.3% FICA tax rate; by law, the tax burden is split 50-50 between employer and employee. So, 7.65% of the employee’s earnings on each paycheck is deducted for FICA taxes, and 7.65% of the employee’s earnings is paid in FICA taxes by the employer. Is the economic incidence of the FICA tax shared equally by employer and employee? Explain. …show more content…
Similarly, find Ernie’s quantity supplied at prices of $2, $4, and $6.
Which of these prices brings the amount supplied and the amount demanded into equilibrium? P
$6
$4
$2
Qd
1
2
3
Qs
3
2
1
Equilibrium price is $4 because Qd = Qs = 2 at that price.
b.
c.
If Ernie produced and Bert consumed one less bottle of water, what would happen to total surplus?
Total surplus would fall by $2.
d.
6.
What are consumer surplus, producer surplus, and total surplus at this equilibrium? CS = $4
PS = $4
Total surplus = CS + PS = $4 + $4 = $8
If Ernie produced and Bert consumed one additional bottle of water, what would happen to total surplus?
Total surplus would fall by $2.
Note: A free market would not produce this result. Only if government compelled production or granted a subsidy would this occur.
An early freeze in California sours the lemon crop. What happens to consumer surplus in the market for lemons? What happens to consumer surplus in the market for lemonade?
Illustrate your answers with diagrams.
Decrease supply. Decrease in CS from (A + B + C) to just A.
Lemons are an input in the market for lemonade, so a higher price of …show more content…
If the cost of each procedure is truly $100, and if individuals have health insurance as described above, will the number of procedures performed maximize the total surplus? Explain.
At a price of $20, Q2 is the Qd, which is much larger than the Qd at price of
$100.
At Q2, the value to consumers is less than the true costs of each procedure
($100). So Q2 is too big to maximize total surplus.
c.
Economists often blame the health insurance system for excessive use of medical care. Given your analysis, why might the use of care be viewed as “excessive”?
For all quantities greater than Q1, the value to consumers is less than the cost to society to produce the procedures. Units beyond Q1 represent an inefficient allocation of resources, so the economy’s total surplus is reduced.
d.
What are two solutions that would prevent this excessive use?
Economic efficiency requires consumption of medical care at quantity Q1. If that quantity is to be provided, consumers must bear the marginal cost of each procedure. Alternatively, some third party (insurance company or government) could limit consumption to Q1. The third party does
E201 Spring 2009
1.
If the government places a $500 tax on luxury cars, will the price paid by consumers rise more than $500, less than $500, or exactly $500? Explain.
Price will rise by less than $500. The only way price could rise by exactly $500 is if demand (or supply) is perfectly inelastic.
2.
The FICA tax funds Social Security programs. Congress established a 15.3% FICA tax rate; by law, the tax burden is split 50-50 between employer and employee. So, 7.65% of the employee’s earnings on each paycheck is deducted for FICA taxes, and 7.65% of the employee’s earnings is paid in FICA taxes by the employer. Is the economic incidence of the FICA tax shared equally by employer and employee? Explain. …show more content…
Similarly, find Ernie’s quantity supplied at prices of $2, $4, and $6.
Which of these prices brings the amount supplied and the amount demanded into equilibrium? P
$6
$4
$2
Qd
1
2
3
Qs
3
2
1
Equilibrium price is $4 because Qd = Qs = 2 at that price.
b.
c.
If Ernie produced and Bert consumed one less bottle of water, what would happen to total surplus?
Total surplus would fall by $2.
d.
6.
What are consumer surplus, producer surplus, and total surplus at this equilibrium? CS = $4
PS = $4
Total surplus = CS + PS = $4 + $4 = $8
If Ernie produced and Bert consumed one additional bottle of water, what would happen to total surplus?
Total surplus would fall by $2.
Note: A free market would not produce this result. Only if government compelled production or granted a subsidy would this occur.
An early freeze in California sours the lemon crop. What happens to consumer surplus in the market for lemons? What happens to consumer surplus in the market for lemonade?
Illustrate your answers with diagrams.
Decrease supply. Decrease in CS from (A + B + C) to just A.
Lemons are an input in the market for lemonade, so a higher price of …show more content…
If the cost of each procedure is truly $100, and if individuals have health insurance as described above, will the number of procedures performed maximize the total surplus? Explain.
At a price of $20, Q2 is the Qd, which is much larger than the Qd at price of
$100.
At Q2, the value to consumers is less than the true costs of each procedure
($100). So Q2 is too big to maximize total surplus.
c.
Economists often blame the health insurance system for excessive use of medical care. Given your analysis, why might the use of care be viewed as “excessive”?
For all quantities greater than Q1, the value to consumers is less than the cost to society to produce the procedures. Units beyond Q1 represent an inefficient allocation of resources, so the economy’s total surplus is reduced.
d.
What are two solutions that would prevent this excessive use?
Economic efficiency requires consumption of medical care at quantity Q1. If that quantity is to be provided, consumers must bear the marginal cost of each procedure. Alternatively, some third party (insurance company or government) could limit consumption to Q1. The third party does