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DP 1 – Study Guide for Economics chapter 5 and 6

Students please use your textbook to study for the test on Friday December
4, 2015
CHAPTER 5
1. What is the difference between a specific tax and a percentage (ad
volarem) tax?
 Specific Tax - Is where a fixed amount of tax is imposed upon a product. is where
a fixed amount of tax is imposed upon a product.
 Shifts supply curve vertically upward by the amount of the tax
 Ad valorem tax: is where the tax is a percentage of the selling price.
 Gap between S & S+tax gets bigge
 Gap between S & S+tax gets bigger
 When either specific taxes or valorem taxes are imposed, the market will shrink
in size (decrease in quantity), thus possibly lower the level of employment in the
market, since firms might employ fewer people. (Curve shifts up because it
increases costs of production.)
 A flat rate tax is a tax which is the same rate regardless of price or income
 Greater burden on those with lower income
 An ad valorem tax is a tax which is a percentage of the price of a good
 The United States has an ad valorem tax of ten percent
2. Why is the burden of tax different than who actually pays the tax?



Firms try to pass these increased costs on to consumers
An indirect tax raises the price of a good: its elasticity determines if the burden of
the tax is on the producer or on the consumer
In the case of a good with inelastic demand the tax burden can be easily passed
on to the consumer (PED is less than PES)
Who actually pays the tax very much depends on the elasticities of the two
curves

If the product is demand inelastic or supply elastic, the consumer
would need to bear the majority of the burden of tax
 If demand is more inelastic than supply the consumer will pay a
greater proportion or incidence of tax
 It is easier for consumers to shift the tax back to the producer if there
are easily available substitutes
 If the product is demand elastic or supply inelastic, the producer

the incidence of a profits tax could be shared by shareholders (lower profits on capital). thus the producer bears the full burden If the govt imposed a 15% tax. then profits would fall. the supplier will pay a greater proportion or incidence of tax A tax on pure profits should not have any influence on price or output. the supplier will pay a greater proportion or incidence of tax A tax on pure profits should not have any influence on price or output. thus the producer bears the full burden If the govt imposed a 15% tax. but this would be true no matter what level of output would be produced If the definition of profits includes payments to factors such as shareholders. the incidence of a profits tax could be shared by . the producer would need to bear the majority of the burden of tax If supply is more inelastic than demand. then profits would fall.    would need to bear the majority of the burden of tax If supply is more inelastic than demand. but this would be true no matter what level of output would be produced If the definition of profits includes payments to factors such as shareholders. How is the burden of tax different depending on the elasticity of demand or supply? Page 65         If the product is demand inelastic or supply elastic. the consumer would need to bear the majority of the burden of tax If demand is more inelastic than supply the consumer will pay a greater proportion or incidence of tax It is easier for consumers to shift the tax back to the producer if there are easily available substitutes If the product is demand elastic or supply inelastic. wage earners (lower wages) or by consumers (higher prices) 3.

6. Maximum rent controls?ensure affordable accommodation for those on low incomes. Maximum food price controls during food shortage?ensure low-cost food for the poor. What is the impact of subsidy on the demand and supply of a product? Page 68  A subsidy is a form of financial assistance paid by the government to a business or economic sector. I. Explain with examples and the help of diagrams the challenge of imposing a.  Subsidy reduces the cost of production.e.     Set to protect consumers Usually in markets of necessity or merit goods (good that would be underprovided if the market were allowed to operate freely) I. wage earners (lower wages) or by consumers (higher prices) 4. Thus the supply curve for the product shifts vertically downwards by the amount of subsidy provided. Price Ceiling Price floor .shareholders (lower profits on capital). 5.e. Why does the government use price controls? How are market forces of demand and supply NOT ALWAYS the best solution to the problem of scarcity? Give examples.

Accountants Profit g.CHAPTER 6 1. Opportunity costs i.total costs per unit of output: AC = TC/Q c. Marginal Costs . Total Costs – Sum Of total fixed cost and total variable cost b. Variable Costs . Identify the following: a. Recognize and practice drawing the shape of different cost and revenue curves.costs that do vary with the amount of output produced f. Average Costs .firms total earnings from a specified level of sales within a specified period Marginal revenue: period of time) MR = ∆ in TR ∆ in Q the total extra revenue by selling one more unit (per Average Revenue is the amount that the firm earns per unit sold AR = TR Q 2. . Economic Profit h.the cost of producing one more unit of output d. Total Revenue . Fixed Costs -: costs that do not vary with the amount of output produced e.

the marginal product of the variable unit declines As more and more of the variable factor is applied to a fixed amount of the other factor. total product will increase  Average and marginal productivity will rise at first and then tend to fall as workers have less and less capital equipment to work with  In the long run capital can be varied. What is the shut down point for a firm? Draw and explain with the help of an example. firms do not have time to build new plant and equipment or get rid of obsolete ones  Only labour can be varied in the short run  As more labour is added to a fixed plant. . What is the law of Diminishing returns? How does it apply to different industries?  As additional variable units are added to fixed units. old ones destroyed or sold off  It is a planning period to allow the building of new capital. new plant and equipment can be built. eventually each additional unit of the variable factor will add less to productivity 4. In the short run capital is fixed. after a certain point. it is assumed that new techniques can be invented and applied which will increase productivity 3. it can actually be shorter than the short run!  In the very long run. What are the Economies and Diseconomies of Scale? 5.

The supply curve is the marginal cost curve above the shut down point Short run: The short run is the conceptual time period in which at least one factor of production is fixed in amount and others are variable in amount. Over this time period the firm can only expand production by using more of the variable factor. Abnormal Profit a profit that exceeds the amount that a company must make to be able to continue trading . Profit maximizationProfit maximization is the process of identifying the most efficient manner of obtaining the highest rate of return from its production model. Shut down Price Short run: The short run is the period of time in which at least one factor of production is fixed. then in the short-run it is not profitable to stay in business The shut down price for a business in the short run is assumed to be the price which covers average variable cost. Therefore if price < AVC then the supplier is better off closing down a plant.Shut down Price When Marginal Revenues (MR) falls below Average Total Cost (ATC or AC). We can use the concept of the shut down price to derive the competitive firm’s supply curve.

or sales turnover. total revenue is less than total cost but greater than variable cost c. without making a loss.Maximising total revenue means gaining the maximum possible revenue from selling a product. This means the firm must produce an output where the total revenue generated from sales just covers the total costs of production. . total revenue is greater than fixed cost e. and where winning market share from rivals is less risky and costly than trying to win brand new customers. total revenue is less than total cost but greater than fixed cost d. Economic theory suggest that a price can be identified which achieves this goal. total revenue is more than the variable cost The shutdown occurs if marginal revenue is below average variable cost at the profit-maximizing output. The Short run should shut down when: a. First. maximisation is associated with 'managerial' theories of business motives. What are different aims of a firm other than profit maximization?  To maximise sales volume means to sell as many products as possible. called oligopolies.  Sales revenue maximisation. total revenue is less than total cost b. Producing anything would not generate returns significant enough to offset any fixed cost and part of the variable cost. the firm should shutdown rather than operate if it can reduce losses by doing so.  Market share Some firms may wish to increase their share of a market. Second. the firm should operate where MR = MC. 6.  Survival Some firms take a short-term view and simply want to survive. Sales revenue.Loss Situation in which a producer does not earn the level of profit that would justify remaining in business in the long run. This motive is significant for firms operating in markets with a few large competitors. which stress the importance of management decision making in large organisations.

   Survival is significant for new firms and those in highly competitive markets. Ethical goals Increasingly. Shareholder value To increase shareholder value means to increase the asset value of the business. For example. managers may first try to ensure that shareholder's get a reasonable rate of return first.  PLEASE CHECK THE GRAPHS AND MAKE SURE YOU KNOW HOW TO COMPUTE DIFFERENT COSTS . Satisficing can also be referred to as 'profit satisficing'. and means attempting to take into account a number of different and competing objectives. and then seek to reward themselves. It is also common when there is a downturn or recession in the macroeconomy. meaning that consumer spending falls across the whole economy. Satisficing Satisficing is a term first used by Herbert Simon in 1957. Shareholder value is defined as the remaining value of the business once all debts have been paid. firms are introducing ethical goals such as those associated with the environment and carbon emissions and with fair trade. without attempting to ‘maximise’ any single one.