Elasticity, Microeconomic Policy, and Consumer Theory ‹ 99- The competitive market equilibrium is at point
C. If a per unit excise tax is imposed on the pro-
duction of this good, the revenue collected by the
government is
(A) the area BDE.
(B) the area BADH.
(C) the area GDH.
(D) the area DAC.
(E) the area GDAB.á Answers and Explanations
- D—You must know the formula for elasticity:
Ed=(%DQd)/(%DP) =1/5. Since Ed<1, this is
inelastic demand, and you can quickly eliminate
any reference to elastic demand. Although calcula-
tors are not allowed on the AP exam, simple calcu-
lations can be made in the margins of your exam. - A—If you know your elasticity measures, you see
that with Ed=3, you can eliminate any reference
to inelastic demand. Choice E is incorrect, as
total revenue is maximized at the midpoint of the
demand curve where Ed=1. If Ed>1, the firm
increases total revenue by decreasing the price
because the quantity demanded rises by a greater
percentage than the fall in price. - D—Mrs. Johnson needs to find the combination
of chips and dip where the ratio of marginal util-
ity per dollar is equated. Currently, MUc/Pc= 12
and MUd/Pd=15, so choice A is ruled out. Since
she is receiving more “bang for her buck” from
dip consumption, she increases dip consumption
and therefore decreases chip consumption. MUd
falls and MUc rises. She adjusts her spending
until MUc/Pc=MUd/Pd.
4. C—Price floors are installed when the market
equilibrium price is believed to be “too low.” This
price lies above the equilibrium price, decreasing
Qdand increasing Qs, thus creating a surplus.
Price controls worsen total welfare and create
deadweight loss.
5. D—Deadweight loss is total welfare that used to
be gained by society prior to the tax. When look-
ing for deadweight loss, narrow your focus by
comparing the quantity produced with and with-
out the tax. The horizontal distance between Q 0
and Q 1 is the unattained output from the tax.
The vertical distance between points D and A
illustrates that the MB > MC and is therefore an
inefficient outcome.
6. B—Revenue collected by the government is
equal to the per unit tax multiplied by the new
quantity. The vertical distance between supply
curves is the tax.
á Rapid Review
Elasticity:Measures the sensitivity, or responsiveness, of a choice to a change in an exter-
nal factor.Price elasticity of demand (Ed):Measures the sensitivity of consumer quantity demanded
for good X when the price of good X changes.Price elasticity formula:Ed=(%DQd)/(%DP). Ignore the negative sign.