Economics (McConnell), AP Edition, 20th Edition Chapter (13).docx

Chapter 18: Public Finance: Expenditures and Taxes Multiple-Choice Questions 1. Which of the following taxes illustrates the benefits-received principle of taxation? (A) Income taxes used to pay for national defense (B) Gasoline taxes used to pay for highway building and maintenance (C) Cigarette taxes used to pay for NASA (D) Sales taxes used to pay for the local police force (E) Property taxes used to pay for local economic development (B) The benefit principle calls for those who benefit most from a program to pay the most taxes to support it. Those who use highways the most are most likely to buy the gasoline and, therefore, support funding for highways. This is also known as the user-pay principle. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Benefits Received versus Ability to Pay 2. A tax that charges those with higher incomes a higher tax rate is (A) progressive (B) regressive (C) proportional (D) excise (E) efficient (A) A progressive tax is based on the ability-to-pay principle, stating that those with the highest incomes are best able to afford the burden of taxation. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Progressive, Proportional, and Regressive Taxes 3. The federal government primarily redistributes income through (A) regressive Social Security taxes and highway programs (B) proportional property taxes and education programs (C) progressive excise taxes and law enforcement programs (D) regressive sales taxes and national defense programs (E) progressive income taxes and safety net programs (E) The federal government taxes those with the highest incomes at higher tax rates and then redistributes that money to those with lower incomes. Some of the programs that redistribute incomes include food stamps, rent subsidies, and other welfare programs. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: The Role of Government Book Section: The U.S. Tax Structure 4. The state places an excise tax on a product with relatively elastic demand. How will this tax affect the supply curve, the equilibrium output, and price? Supply Output Price (A) Increase Increase Increase (B) Decrease Decrease Decrease (C) Decrease Decrease Increase (D) Increase Increase Decrease (E) Increase Decrease Increase (C) The supply curve shifts leftward, decreasing the equilibrium output and increasing the equilibrium price. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Elasticity and Tax Incidence 5. If an excise tax were placed on a product with relatively inelastic demand and relatively elastic supply, who would pay most of the burden of the tax? (A) The firm (B) Consumers (C) The firm and consumers equally (D) The government (E) Foreign consumers who purchase those products as exports (B) Consumers of the product pay the majority of the tax burden, because with their inelastic demand, the quantity purchased falls very little when the price rises. Therefore, the firm can pass the tax increase on to consumers. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Elasticity and Tax Incidence 6. The deadweight loss associated with a tax increase is largest when (A) demand is perfectly inelastic (B) demand is relatively inelastic (C) demand is unit elastic (D) demand is relatively elastic (E) supply is perfectly inelastic (D) When consumers are sensitive to the change in price due to the tax, the quantity sold drops significantly, causing a greater deadweight loss. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Efficiency Loss of a Tax 7. Governments impose taxes in order to I. provide public goods II. redistribute incomes III. resolve positive externalities (A) I only (B) III only (C) I and II only (D) II and III only (E) I, II, and III (C) Taxes are used in the case of negative (not positive) externalities to force firms to absorb all of their costs of production, in order to try to move the market back to allocative efficiency. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Market Failure and the Role of Government Book Section: Government Purchases and Transfers Use the graph below to answer questions 8-10. 8. The government decides to impose a per-unit tax on the bottle industry to help cover revenue shortfalls in the annual budget. In this case, the burden of the per-unit tax is (A) $1 to the producer and $2 to the consumer (B) $2 to the producer and $1 to the consumer (C) $1 to the producer and $1 to the consumer (D) $2 to the producer and $2 to the consumer (E) $8 to the producer and $9 to the consumer (C) In this case, the burden of the per-unit excise tax is equally shared by both the producer ($1) and the consumer ($1). Difficulty: Medium Style: Application AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Tax Incidence and Efficiency Loss 9. The per-unit tax has generated total tax revenue of (A) $1 million (B) $2 million (C) $5 million (D) $10 million (E) $12 million (D) The per-unit tax is $2. The total number of bottles sold after the tax was imposed is 5 million. $2 x 5 million = $10 million. Difficulty: Medium Style: Application AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Tax Incidence and Efficiency Loss 10. The deadweight loss created by the per-unit tax is equal to the area (A) AKB (B) KBC (C) ACM (D) ABL (E) ABC (E) The economy has the ability to produce 6 million units for a retail price of $8. With the new per-unit tax, a deadweight loss, only 5 million units will be produced and sold at $9. That loss of output and the higher price is deadweight loss (efficiency loss) represented by the triangle ABC. Difficulty: Medium Style: Application AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Tax Incidence and Efficiency Loss 11. Assume a per-unit tax is imposed in the graphs above. The least efficiency loss occurs in graphs (A) (a) and (d) because the greater the inelasticities of supply and demand, the less the efficiency loss (B) (c) and (d) because the greater the inelasticities of supply and demand, the less the efficiency loss (C) (b) and (c) because the greater the inelasticities of supply and demand, the less the efficiency loss (D) (a) and (d) because the greater the elasticities of supply and demand, the less the efficiency loss (E) (b) and (c) because the greater the elasticities of supply and demand, the less the efficiency loss (C) All other factors equal, the greater the inelasticities of supply and demand, the less the efficiency loss that results from a per-unit tax. Difficulty: Medium Style: Application AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Tax Incidence and Efficiency Loss 12. The goal of government is to reduce the quantity demanded of a good. In this case, a per-unit tax on the producer would be most effective if the (A) demand curve were highly elastic (B) demand curve were highly inelastic (C) supply curve were more elastic than the demand curve (D) supply and demand curves were equally inelastic (E) supply and demand curves were highly inelastic (A) The more elastic the demand curve, the greater the impact that a per-unit tax on the producer would have on the quantity demanded. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Elasticity and Tax Incidence 13. In the graph above, a per-unit excise tax placed on glass bottles would increase allocative efficiency if the tax is imposed to I. distribute income more equitably II. correct positive externalities III. fund aid to dependent children IV. correct for spillover costs (A) II only (B) IV only (C) I and IV only (D) I, II, and III only (E) I, III, and IV only (B) If there were spillover costs (negative externalities), the tax would reduce output, raise prices, and lessen the negative externalities associated with the use of glass bottles. Difficulty: Medium Style: Application AP Economics Curricular Requirement Microeconomics: Market Failure and the Role of Government Book Section: Efficiency Loss of a Tax 14. A tax that increases the average amount paid in taxes as income increases is a (A) proportional tax that is founded on the idea of ability to pay (B) flat average tax that is founded on the idea of equalizing tax burden (C) progressive tax that assesses tax based on the ability to pay (D) regressive tax that encourages saving and discourages consumption (E) wealth tax that redistributes income and wealth (C) A tax that increases the average amount paid in taxes as income increases is a progressive tax, based on the principle of ability to pay. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Progressive, Proportional, and Regressive Taxes 15. Which of the following taxes are based on the benefits-received principle? I. Residential sewer tax II. General sales tax III. Hotel tax IV. Theater ticket tax (A) I only (B) II only (C) III only (D) III and IV only (E) I, III, and IV only (A) Households that pay the residential sewer tax receive government sewer services, so households are paying for the government benefits they receive. Sales taxes and excise taxes on hotel rooms and theater tickets are based on the purchase of a particular item, not a particular benefit the household receives from paying the tax. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Benefits Received versus Ability to Pay 16. Government transfer payments I. do not exhaust resources II. cover wages paid to government employees III. pay for the use of resources IV. are paid to individuals who have rendered no services (A) I only (B) II only (C) III only (D) I and IV only (E) II and III only (D) Government transfer payments are payments that do not exhaust resources and are paid to individuals who have rendered no services for the government transfer payments (for example, unemployment benefits). Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: The Role of Government Book Section: Government Purchases and Transfers 17. In the short run for a profit-maximizing corporation, the tax burden of a lump-sum corporate income tax falls on the I. consumers who purchase the goods and services that the corporation produces II. workers who receive their wages and compensation from the corporation III. stockholders who receive income from dividends and payments from retained corporate earnings (A) I only (B) II only (C) III only (D) I and III only (E) II and III only (C) The profit-maximizing output and price will not change after a lump-sum corporate income tax (a tax on profits) is paid to the government. The only ones that will bear the tax burden will be those who receive dividend income and payments from retained earnings. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Corporate Income Tax 18. To fund Social Security, the government increases Social Security taxes. Employees and employers jointly share these taxes. Which of the following would most likely happen to the level of employment and workers’ wages? Employment Wages (A) Decreases Uncertain (B) Increases Uncertain (C) Decreases Decreases (D) Decreases Uncertain (E) Uncertain Decreases (C) The demand for labor will decrease because the increase in social insurance taxes will make each worker more expensive to hire. The supply of labor would not change, but there would be a decrease in the quantity supplied. As a result, the level of employment would decrease, as would wages. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Payroll Taxes 19. A per-unit producer tax is imposed in a market free of externalities. How will this tax impact equilibrium price, equilibrium output, and efficiency losses? Price Quantity Efficiency Losses (A) Increases Increases Increase (B) Increases Decreases Decrease (C) Increase Decreases Increase (D) Decreases Decreases Decrease (E) Decreases Decreases Increase (C) Provided there are no externalities, a per-unit producer tax will shift the supply curve to the left, increase market price, decrease the quantity demanded, and result in a loss of efficiency (deadweight loss). Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Sales and Excise Taxes 20. New legislation raises property taxes, a fixed cost, on forestry land owned by timber firms. Which of the following would most likely happen to a timber firm’s profit-maximizing price and quantity? Price Quantity (A) Increases Decreases (B) Constant Constant (C) Uncertain Decreases (D) Decreases Uncertain (E) Decreases Decreases (B) An increase in property taxes will increase fixed costs and average total costs, but will not affect the profit-maximizing firm’s marginal cost, marginal revenue, or demand curves. Because neither marginal revenue nor marginal cost changes, the profit-maximizing price and quantity will not change. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Property Taxes 21. Assume you pay a tax of $4,000 on a taxable income of $24,000. If your taxable income were $30,000, your tax payment would be $5,000. This suggests that the tax is (A) progressive (B) proportional (C) regressive (D) negative (E) discriminatory (B) For each $6000 of taxable income, you are charged $1000 in taxes, regardless of your income level. Because the tax rate does not change as your income changes, the tax is proportional. Difficulty: Easy Style: Applied AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Progressive, Proportional, and Regressive Taxes 22. Which combination of policies would most effectively reduce income inequality in the United States? (A) Proportional taxes and a reduction in spending for highways (B) Regressive taxes and an increase in spending for foreign policy (C) Progressive taxes and a reduction in spending for the federal court system (D) Regressive taxes and a reduction in spending for education ( E) Progressive taxes and an increase in spending for social welfare programs (E) Progressive taxes increase tax rates for those with higher incomes. Social welfare programs redistribute those tax dollars to those with lower incomes, reducing the inequality of incomes. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Equity Book Section: The U.S. Tax Structure 23. Assume that the Environmental Protection Agency imposes an excise tax on polluting firms. In which of the following situations would the additional costs be borne most heavily by consumers?  (A) Demand is highly elastic and supply is highly inelastic. (B) Demand and supply are both highly elastic. (C) Demand and supply are both highly inelastic. (D) Demand is perfectly elastic and supply is highly elastic. (E) Demand is highly inelastic and supply is highly elastic. (E) Because consumers are not sensitive to the price change but the firm is sensitive, the firm will pass on most of the price change to consumers. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Elasticity and Tax Incidence 24. If the demand for a product is perfectly inelastic and the supply curve slopes upward, a $1 excise tax per unit of output will  (A) raise the price by less than $1 (B) raise the price by more than $1 (C) put the entire burden of the tax on consumers (D) put the entire burden of the tax on producers (E) decrease the equilibrium quantity (C) Because consumers are completely insensitive to the price change and will buy exactly the same quantity at the higher price, producers will shift the entire incidence of the tax to consumers. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Elasticity and Tax Incidence 25. The efficiency (deadweight) loss of a tax is  (A) the loss of producer and consumer surplus caused by the tax (B) that portion of the tax paid by producers minus the portion paid by consumers (C) that portion of the tax paid by consumers minus the portion paid by producers (D) the total tax revenue minus the output loss caused by the tax (E) the amount of the tax per unit (A) The tax causes firms to decrease output and increase the price of the product, reducing both producer surplus and consumer surplus. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Efficiency Loss of a Tax Free-Response Question Assume that the government imposes a per-unit sales tax in each of the three markets below, all of which have identical upward-sloping supply curves. (a) In the pharmaceutical industry, consumers buy exactly the same amount of heart medicine, regardless of the price. (i) Using a correctly labeled graph, show each of the following. (a) Equilibrium price and quantity before the tax (b) Equilibrium price and quantity after the tax (ii) Explain how the burden of the tax will be distributed between the consumers and the producers. (b) In the fast food industry, consumer demand for fish sandwiches is relatively elastic. (i) Using a correctly labeled graph, show each of the following. (a) Equilibrium price and quantity before the tax (b) Equilibrium price and quantity after the tax (ii) Explain how the burden of the tax will be distributed between the consumers and the producers. (c) In the fruit industry, consumer demand for apples is perfectly elastic. (i) Using a correctly labeled graph, show each of the following. (a) Equilibrium price and quantity before the tax (b) Equilibrium price and quantity after the tax (ii) Explain how the burden of the tax will be distributed between the consumers and the producers. (d) Is a deadweight loss more likely to develop in the pharmaceutical industry or in the fast food industry as a result of the tax? Explain. (e) Assume that the quantity of heart medicine and the quantity of fish sandwiches sold per day are equal. The government decides to place a $1 per-unit tax on either heart medicine or fish sandwiches. On which good, heart medicine or fish sandwiches, should the government impose the per-unit tax to maximize revenue? Explain. Free-Response Explanation 16 points (4 + 4 + 4 + 2 + 2) (a) 4 points: 1 point is earned for identifying the price and quantity before the tax. 1 point is earned for identifying a higher price and no change in quantity. 1 point is earned for stating that consumers will pay the entire tax. 1 point is earned for explaining that because demand is perfectly inelastic, the firm can pass the entire tax on to the consumers. (b) 4 points: 1 point is earned for identifying the price and quantity before the tax. 1 point is earned for identifying a higher price and a lower quantity. 1 point is earned for stating that firms will pay a larger burden of the tax than consumers will. 1 point is earned for explaining that because consumers are so sensitive to the price change, the firm must absorb more of the tax in order to avoid losing sales. (c) 4 points: 1 point is earned for identifying the price and quantity before the tax. 1 point is earned for identifying a lower quantity and no change in price. 1 point is earned for stating that firm will pay the entire tax. 1 point is earned for explaining that because demand is perfectly elastic, the firm must absorb the entire tax or the quantity demanded will fall to zero. (d) 2 points: 1 point is earned for stating that the deadweight loss will develop in the fast food industry. 1 point is earned for explaining that the quantity of fish sandwiches demanded fell as a result of the tax, while the quantity of heart medicine demanded did not change. (e) 2 points: 1 point is earned for stating that the government would earn more revenue from a tax on heart medicine. 1 point is earned for explaining that, with the tax, the same quantity of heart medicine would be sold, but a lower quantity of fish sandwiches would be sold, which would lower the revenue. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Tax Incidence and Deadweight Loss Book Section: Tax Incidence and Efficiency Loss