Write down course objectives 4 through 6 from text
page 127.
4.
5.
6.
3. Outline
III. Taxes
A. The question — "Who pays a
sales tax: the buyer or seller?" — can be studied with the demand and supply
model.
1. As illustrated in Figure 7.3, a sales tax shifts the supply curve so that the
vertical distance between the supply curves equals the amount of the tax. As a result, the
equilibrium price and equilibrium quantity of the good are affected. The price rises from P
to and the quantity decreases
from Q to
B. In general, the tax is divided between supplier and demander.
1. The buyer pays part of the tax in the form of the higher price, and the seller
pays part in the form of lower receipts (the new price minus the tax paid to the
government).
C. In extreme cases, the seller or the buyer may pay the entire tax.
1. The seller pays the entire tax if:
a) the demand is perfectly elastic (the demand curve is horizontal).
b) the supply is perfectly inelastic (the supply curve is vertical).
2. The demander pays the entire tax if:
a) the demand is perfectly inelastic (the demand curve is vertical).
b) the supply is perfectly elastic (the supply curve is horizontal).
D. Given the supply curve, the more elastic the demand, the less the demander pays of
the tax; and given the demand curve, the more elastic the supply, the less the supplier
pays of the tax.
1. Heavy taxes usually are levied on products with an inelastic demand because the
quantity purchased does not decrease by much, so the government collects relatively large
tax receipts.
E. In general, imposing a tax creates a deadweight loss. (In the extreme case of
perfectly inelastic demand or perfectly inelastic supply, the quantity does not change and
there is no deadweight loss.)
IV. Markets for Prohibited Goods
A. The government prohibits trade of some
goods, such as illegal drugs.
B. Prohibiting transactions in a good raises the cost of such trading. The impact of
the prohibition depends on how effectively the ban is policed and whether the penalty is
levied on the buyer, seller, or both. Compared to an unrestricted market:
1. If the penalty is levied on the seller, the penalty is added to the other
costs of doing business. Hence the supply curve shifts so that the vertical distance
between the initial supply curve and the supply curve with the penalty equals the amount
of the penalty. In this case, the equilibrium price of the product rises and the
equilibrium quantity decreases.
2. If the penalty is levied on the buyer, the penalty is subtracted from the
value of the good. Hence the vertical distance between the demand curve with the penalty
and that without is the amount of the penalty. As a result, the equilibrium price of the
product falls and the equilibrium quantity decreases.
3. If buyers and sellers face sanctions, both the demand and supply curves
shift leftward. If the shift in the supply curve is larger, the equilibrium price rises
and quantity decreases; if the shift in the demand curve is larger, the price falls and
quantity decreases; if the shifts are the same magnitude, the price is unchanged and the
quantity decreases.
C. A prohibited good can be legalized and then taxed so that, compared to free and
untaxed trade, the price is higher and the quantity consumed is less. To decrease
consumption to the level that occurs when trade is prohibited, a very large tax likely
would be necessary. A policy of legalizing and taxing has advantages and disadvantages.
1. An advantage is that the government raises revenues, which can be used for
education against the product.
2. A disadvantage is that legalization may signal that use of the good is acceptable,
which could increase demand for the product. In addition, if the demand for the product is
inelastic, to reduce consumption to the level that occurs with prohibition a high tax is
needed, which might lead to tax evasion.
V. Stabilizing Farm Revenue
A. The demand for farm products is
inelastic. Because the demand is inelastic, a poor harvest, which shifts the supply curve
leftward, raises total farm revenues; a bumper crop, which shifts the supply curve
rightward, lowers total farm revenues.
B. Speculative markets in inventories result in storage of farm products and help
limit fluctuations in farm revenues. The mechanism works as follows:
1. Inventory holders speculate by buying when the current price is lower than they
expect it to be in the future and selling when the current price is higher than the
expected future price.
2. Inventories can be used to absorb output if supply increases or provide it if
supply decreases.
3. The (idealized) behavior of inventory owners makes the supply to consumers
perfectly elastic at the price expected by inventory holders.
4. A perfectly elastic supply completely stabilizes the price of the product; in
reality speculation decreases but does not completely eliminate price fluctuations.
5. Speculation does not stabilize revenue from the product. However, total revenue now
increases with bumper crops and decreases with crop failures.
C. Most governments have instituted programs designed to limit fluctuations in the
prices of agricultural products. Some of the most extensive programs are in the European
Union.
1. These programs can set production limits, that is, quotas, which restrict
the quantity produced.
2. These programs also set price floors above the equilibrium price, which creates
surpluses. The government must buy the excess supply, which the results in the government
owning inventories of agricultural products.
1. Review Helpful Hints in your study guide.
2. Complete even-numbered Questions in your study guide
and check your answers.
3. If you watched the video, write one or more sentence about each of its three
episodes which will bring the episodes and lessons learned from them to mind.
4. If not done in class, complete the Two-Minute-Feedback.
8.
Summary of Key Points (from text page 146)
Markets for Prohibited Goods
12. Penalties on sellers of an illegal good increase the cost
of selling the good and decrease its supply. Penalties on buyers decrease their
willingness to pay and decrease the demand for the good.
13. The higher the penalties and the more effective the law enforcement,the smaller
is the quantity bought. The price is higher or lower than the unregulated
price, depending on whether the penalties on sellers or buyers are higher.
14. A tax set at a sufficiently high rate will decrease the quantity of a drug
consumed, but there will be a tendency for the tax to be evaded.
Stabilizing Farm Revenue
15. Farm revenues fluctuate because supply fluctuates.
16. The demand for most farm products is inelastic, so a decrease in supply
increases the price and increases farm revenue, while an increase in supply
decreases price and decreases farm revenue.
17. Inventory holders and government agencies act to stabilize farm prices and
revenues.
9.
Preview
Organizing Production introduces the firm,
the forms of business organization, and discusses how firms raise funds by issuing
stock and selling bonds. The chapter explains the differences between explicit and
implicit costs which lead to higher measures of profit when calculated by accountants than
when measured by economists. Finally, the chapter introduces the concept of economic
efficiency.
10.
Two Minute Feedback
Take a minute and jot down the problem, idea, or concept that was
most interesting to you from this chapter.
Take another minute and jot down the problem, idea, or concept with which you struggled
the most.
and the quantity decreases
from Q to 
