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1. What are some of the unique characteristics of the competitive market?
2. Discuss the role of elasticity in tax incidence and burden.
3.Competitive Markets Concepts. Indicate whether each of the following statements is true or false, and explain why.
A. In long-run equilibrium, every firm in a perfectly competitive industry earns zero profit.
B. Perfect competition exists in a market when all firms are price takers as opposed to price makers.
C. In competitive markets, P > MC at the profit-maximizing output level.
D. Downward-sloping industry demand curves characterize perfectly competitive markets.
E. A firm might show accounting profits in a competitive market but be suffering economic losses.
4. In 1990, Congress adopted a luxury tax to be paid by buyers of high-price cars, yachts, private airplanes, and jewelry. Proponents see the levy as an effective means of taxing the rich. Critics point out that those bearing the hardship of a tax may or may not be the same as those who pay the tax (the point of tax incidence). Explain how the elasticities of supply and demand in competitive markets can have direct implications for the ability of buyers and sellers to shift the burden of taxes imposed upon them. Also explain how elasticity information has implications for the amount of social welfare lost due to the deadweight loss of taxation.
1.
Atomicity -An atomistic market is one in which there are a large number of small producers and consumers on a given market, each so small that its actions have no significant impact on others. Firms are price takers, meaning that the market sets the price that they must choose.
Homogeneity
Goods and services are perfect substitutes- that is, there is no product differentiation.
Perfect and complete information -All firms and consumers know the prices set by all firms (see perfect information and complete information).
Equal access -All firms have access to production technologies, and resources (including information) are perfectly mobile.
Free entry- Any firm may enter or exit the market as it wishes (see barriers to entry).
2. Elasticity is the slope of the demand or supply curve and describes the sensitivity to changes in the price of the good. The steeper (less elastic) the curve, the less the quantity demanded or supplied will be affected by a change in price. Thus, when a tax is imposed, the elasticity of the demand curve will determine how much of the tax is borne by consumer. vs. the producer. See the attached file "taxincidence". You can see that when the the demand is more elastic (less steep) the tax burden falls more heavily on producers.
3.
A. True. In short-run equilibrium, competitive firms can earn profits or suffer losses. In long-run equilibrium, after entry or exit has occurred, economic profit is always zero: Profit = 0.
B. True. Because of the horizontal supply curve, all firms are price takers.
C. False. Competitive firms are price takers so MR = P and firm's profit-maximizing output choice is P = MC.
D. False. Because perfect competition is characterized by infinite substitutions, the demand curve is horizontal. Firms can sell any quantity desired at the market price, but cannot sell anything above the market price.
E. True. Economic profits are the excess of total revenues (TR) over the total opportunity costs (TC) of all the resources a firm uses. Economic profits (TR - TC) are a premium to the entrepreneur for innovating, bearing risks and uncertainty, and they are viewed as a reward for an entrepreneur if they exceed the minimum necessary for the firm to survive. Accounting profits do not include opportunity costs and may therefore be higher than economic profits.
4. See response to #2. Clearly the slope of the demand and supply curves affect the distribution of the tax. Taxes cause deadweight losses because they prevent buyers and sellers from realizing some of the gains from trade. The deadweight loss caused by the decrease in the quantity sold is not captured by the government. See attached file "deadweight." The deadweight loss of the tax is the triangle formed by the supply and demand curves right of the new tax. When the supply curve is less elastic, the deadweight loss is less than when it is more elastic. The same is true for the supply curve. Thus the government should focus on taxing goods with low elasticities of supply and demand in order to maximize social welfare. The tax on luxury goods falls mainly on sellers, because the demand for luxury goods is more elastic than the supply. Furthermore, the deadweight loss is great because of the elasticity of the demand curve.
PFA
