ECON1001 Study Guide - Final Guide: Economic Equilibrium, Economic Surplus, Externality

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14 Jun 2020
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2. When would introducing a tax on a good be justified for efficiency in a particular
market?
When that good is associated with a negative externality
3. Is it better to tax a consumer or a producer if you identify an inefficiency? Why?
The effect will be the same either way. The burden of the tax will be determined by the
relative elasticities of demand and supply, but the reduction in quantity will be the same
either way. The decision should instead be made on the basis of compliance and
administration costs.
4. If you received the same utility from me giving you $500 today or $800 in one year’s
time, what does that mean?
5. Separately, if you were rational, why would you accept $900 in two years’ time
instead of $1000 today?
Part a) It means that your discount rate is very high (62.5%)you have a strong preference
for present over future consumption.
Part b) you would only accept a smaller amount in the future if the interest rate was negative
6. If a government introduces a 10 per cent tax on cigarettes at the point of sale and
demand is relatively inelastic (with a normal upward sloping supply curve that is
relatively more elastic than demand at current equilibrium), how will consumer
surplus change relatively to producer surplus?
You can see from the graphic below that the tax burden would fall mostly on the consumers
(above the market equilibrium price) i.e. the smokers. This is because their addiction makes
their demand elastic. As such, they cannot alter their behaviour in response to the tax, and so
producers pass on most of the tax to the smokers.
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