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EC111 Introduction To Economics

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EC111 Introduction To Economics

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EC111 Introduction To Economics

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Course Code: EC111
University: University Of Essex

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Country: United Kingdom

Question:

a) If you have assumed that demand is elastic while supply is less elastic than demand, the tax burden falls mainly on the suppliers. So the rich consumers actually do not pay most of the tax. Deadweight loss is higher than in the case where demand is inelastic. In this case this may be considered not a good policy.
b) If instead you have assumed that demand is inelastic supply is elastic, then most of the tax is paid by the consumers (the rich), the government obtains more revenues and the deadweight loss is lower than in the case where demand is elastic. So this may be considered a good policy overall or at least consistent with the government’s objective.

Notice the way economic reasoning is done here: you start with assumptions; you explain the effects on the market of this policy on the basis of your assumption to get predictions. You then use those predictions to make a statement on the how good the policy is.
In terms of mark allocation: here you should expect 25 marks for the explanation and 15 marks for the Graph (CORRECTLY made, which means, right labels, correct demand andsupply consistent with your assumption on their elasticities, equilibrium points correctly labelled, appropriate display of relevant information, like tax burdens, deadweight loss, etc.
England is relatively more expensive than in continental Europe. Analyse how the increase in University fees in England can affect the market for Higher Education in continental Europe. Use a graph to illustrate your answer.

Answer:

Question 1
In the present situation, the government is considering two situations i.e either to charge specific taxed on the vehicle which shall depend on the quantity sold. Thus, if the quantity exceeds a particular limit, additional tax shall be imposed or setting a price floor to reduce the sale of SUVs in the economy. Both the propositions have been analysed here-in-below:
Proposal 1: Introducing a Specific Tax on Suppliers
For ascertaining the impact of introducing specific tax in supplier, it has been assumed that market is in equilibrium. Further, under this type of tax the tax bill is not dependent in price rather the same is driven by the quantity sold. Further, the concept assumes that the same is paid by supplier. Thus, the burden shall fall on the seller resulting in the price paid by customer shall not be equal to the receipt of seller. The receipt of seller shall be presented as follows:
Ps =PD – Specific Tax
Where Ps  = the Price received by seller
PD = the Price paid by buyer.
To analyse the impact of the same on the equilibrium demand and supply, one needs to see the situation before introduction and post introduction of taxes:
Initial equilibrium situation before taxes
P*= (a-c)/(b+d)
Wherein QD = a-bP and QS = c+ dP
Q*= (ad+bc)/(b+d)
Wherein QD = a-bP and QS = c+ dP
Equilibrium situation after taxes
QD = a-bPD
QS = c+ dPS
P*D =P* +dt/(b+d)
P*S = P*- dt/(b+d)
Q*D =Q*-bdt/(b+d)
The above results in lowering of equilibrium and shifting of supply curve to the left resulting in the following situation:

Lower Quantity Demanded;
Higher Price paid by Buyer;
Lower amount received by supplier reducing profit.

The graph of burden on buyer and seller has been presented below:
Right hand side Q* represents original equilibrium and left hand side equilibrium post tax. Further, supply curve to the left is the curve post tax and demand curve remains intact resulting in lower quantity sold at higher price.
Under the above graph, A represents, the tax burden of producers and B represents the tax burden of consumer. The burden of consumer shall increase if seller pass on the tax based on elasticity of demand.
The advantage of introducing the above proposition is the purpose of reducing the demand is achieved along with tax revenue which shall increase on account of higher taxes provided the decrease in tax on account of reduced quantity offsets it.
The impact of the above method shall best be justified when both the above advantages stated are crystallised. However, the method is characterised by deadweight loss as sum total of producer and consumer surplus is reduced.
Proposal 2: Introducing Price floor
The second method that government can think of is imposing price floor. Price floor can be defined as the lowest legal price at which goods can be sold. It restricts the price of a product to fall below a particular level and is generally used for wage market so as to prevent from labour pay falling below a particular level. In the present situation, the impact of introducing price floor has been discussed here-in-under:
The price floor shall be set above the equilibrium price in order to effectively reduce demand, however, the same does not result in decrease in quantity supplied. Accordingly, quantity supplied shall exceeded the quantity demanded and the price under this situation shall be controlled price.
The difference between quantity supplied and quantity demanded shall be defined as surplus and the diagrammatic representation has been presented in below:
Pf represents: Price floor set by the government which is above the equilibrium price
The above method shall result in increased profit to seller per unit and shall dissuade the buyer and shall reduce the quantity demanded. However, under the said proposition government might lose funds on account of lower tax revenue and reduction in quantity demanded.
Impact of introducing Price floor on Producer Surplus and Consumer Surplus
The impact has been presented graphically here-in-below:
On perusal of the above table it shall be seen that there is a dead weight loss on account of difference between the price that the marginal demander is willing to pay and the price under equilibrium. The deadweight welfare loss is the loss of buyer and producer. The same has been represented in the table as DWL.
Thus, on the basis of above it can be inferred that option 1 is better compared to option 2 as the same help to achieve the objective along with increase in revenue of government by imposition of tax. Further, under option 2 there is a dead weight loss which is not a good sign. The method of Price floor is generally opted for Labour pay and setting minimum wages.
Note: The choice may change if different market is chosen for anlaysis.
Question 2
In the present question, the consumer consumes only two products i.e. vegetable and Meat. The income of the person is denoted by M and the prices of vegetable and meat are denoted by Pv and Pm respectively. Further under first situation, the individual receives gift voucher from government which can be used for the purchase of vegetables only. In the second situation, cash is received by individual and can be spent of both the products.
Situation 1: Voucher from the Government for T value which can be used for purchasing Vegetables
 In the present condition let the quantity of vegetable demanded be x and quantity of meat demanded be y. Thus, the equation under the before change situation is
M=x*Pv+y*Pm
Assuming that consumer spend all his income. Further the graph is presented simply based on the budget constraint:
m= M/Pm-Pv/Pm*x
Under the initial stage, the slope of budget constraint shall be represented by –Pv/Pm, that is it shall be negative of the price ratio of two goods and represents opportunity cost of X in terms of Y. It represents if I wish to have one unit of vegetable, how many units of meat shall be sacrificed.
Further, an increase in income shall shift the budget line to the right as it shall increase the consumption possibility and customer shall be able to afford more bundles of goods with an additional income. In the present case more of vegetables shall be purchased on account of constraint thereby increasing the consumption and quantity demanded of quantity x. Thus, if graph is plotted keeping the quantity of vegetable demanded on Y axis and quantity of  meat demanded on x axis, then as a result of income and no change in prices of commodity. The same has been presented via a graph annexed to this report as represented by point b on the curve. Further, it is assumed that consumer shall consume the entire amount
Situation 2: Cash received from government for T value which can be used for purchasing Vegetables and meat
In the present condition let the quantity of vegetable demanded be x and quantity of meat demanded be y. Thus, the equation under the before change situation is
M=x*Pv+y*Pm
Assuming that consumer spend all his income. Further the graph is presented simply based on the budget constraint:
m= M/Pm-Pv/Pm*x
Under the initial stage, the slope of budget constraint shall be represented by –Pv/Pm, that is it shall be negative of the price ratio of two goods and represents opportunity cost of X in terms of Y. It represents if I wish to have one unit of vegetable, how many units of meat shall be sacrificed.
Further, an increase in income by T shall increase the purchasing capacity of the consumer and as a result of the same, budget line shall shift to the right. In the present case, cash shall increase the income which can be used on both vegetable and meat. Thus, if graph is plotted keeping the quantity of vegetable demanded on Y axis and quantity of  meat demanded on x axis, then as a result of income and no change in prices of commodity, the curve shall shift to the right  . The same has been presented via a graph point ‘b’ annexed to this report. Further, it is assumed that consumer shall consume the entire amount
Further point ‘a’ in the curve represents the initial consumption without any offer introduced by the government.
Thus, in short customer is different between voucher from government with restriction and cash where there is no restriction as there is same indifference curve as customer shall manage its quantity demand in line with the product possibility curve as stated in graph annxed.

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