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Final

[Exam Tutorial] ECO206 Final Exam Full Study Package

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Department
Economics
Course
ECO206Y1
Professor
All Professors
Semester
Winter

Description
ECO206 – last topics for Final Exam Last Topics for the Final: Four main topics will be covered: Distortions, Externalities, Information Asymmetry, and Public Goods. Based on a study of past finals in 2011 and 2012, the number of questions on these topics is very minimal. There is a greater emphasis on utility maximization and profit maximization, and several other topics before the third midterm. Final Statistics 2011 2012 Utility Maximization 1 2 Profit Maximization 3 1 Monopoly 1 1 Strategic Games 1 1 Labor Supply 1 1 Competitive Equilibrium 1 1 Labor-leisure decisions 1 1 Externalities 0 1 Subsidies 0 1 Expected Wealth/Risk 0 1  Note: the graphs within the knowledge summary sections and the answers to practice questions are handwritten and are attached as separate, scanned files. Topic 1: Distortions Knowledge Summary:  When discussing “distortions” we are referring to the effect of a policy (e.g. tax, subsidy, price floor/ceiling) on the market. Specifically, we look at changes in consumer and producer surplus and total deadweight loss faced by the market. These policies can “distort” the market by creating inefficiencies in the form of deadweight loss.  For the most of our models, we are discussing inefficiencies resulting from taxes/subsidies in the context of competitive setting in which there are no other distortions  Taxes and subsidies are very similar, can think of subsidies as negative taxes  Taxes raise revenue for the government and subsidies create expenses for the government  Sales tax: two types to be aware of (i) excise tax – fixed tax per unit (ii) ad valorem tax – percent of total sales or price  Elements to consider in the analysis of distortion: 1. Consumer Surplus (CS), Producer Surplus (PS) and Deadweight loss (DWL) 2. Economic incidence of a tax: how the tax burden is divided among buyers and sellers when a new equilibrium emerges after imposition of the tax on the market 3. Elasticity of demand/supply 4. Partial versus general equilibrium setting (most of the analysis is in partial setting)  Who bears the tax burden? Depends on elasticity of demand/supply  When demand is relatively inelastic (e.g. oil) the economic incidence of a tax falls disproportionately on those who are less responsive to price changes. When demand is perfectly elastic, the full tax burden falls on the consumers and no deadweight loss is incurred.  When demand is perfectly elastic, the full tax burden falls on producers. Consumers will still face the same price with or without the tax, but a deadweight loss is incurred because producers will reduce quantity supplied. Graphically:  Quotas and Tariffs: also create distortions. Quota: restriction on amount of imports allowed and supplied into the country. Tariff: tax on imports  Who wins from protectionist tax policies? Domestic suppliers. Losers? Consumers and international suppliers. P* is the world price and WS is the World Supply (perfectly elastic because we assume that there are infinitely many international suppliers)  Tariffs raise price to P’ therefore it decreases consumer surplus and increases surplus of domestic suppliers  Logic of Collective Action: Tariffs are mainly imposed on commodities (e.g. sugar, coffee) Loss from aggregate consumer surplus under tariffs is typically very large, so why are tariffs still imposed? Loss from every individual consumer is small relative to the losses incurred from each individual domestic producer. Summary of Questions to be asked:  Calculate optimal tax, subsidy or tariff policy  Find the loss or gain in consumer surplus, producer surplus and/or deadweight loss  Calculate the economic incidence of a tax  Relate tax burden with elasticity of demand and supply Topic 2: Externalities Knowledge Summary:  Externalities: concept that either the costs or the benefits of production or consumption are directly imposed on nonmarket participants  Example: consumption of music – loud party next door has a negative externality on neighbors. Production of steel – externality: pollution, emits Sulfur dioxide  Externalities can be both positive and negative  Marginal External Costs (MEC): additional environmental costs incurred by producing an additional unit of steel, for example  Marginal Social Cost (MSC): Marginal Cost (private- of a firm) + MEC. It shifts the MC in a nonlinear way  Marginal External Benefit (MEB): benefits reaped by nonmarket participants as a result of a positive externality  Marginal Social Benefit (MSB): marginal benefit of each additional unit produced that is generating a positive externality. It is equal to the private benefit (also demand curve) + MEB  Negative Externality, graphically: pollution from steel mill, MEC causes MC to shift inwards. As a consequence of pollution, we are producing too much of steel (more than socially optimal) at Q1. According to MSC (intersects demand curve), socially optimal quan
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