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The Laffer Curve What

The Laffer Curve What will happen to the government’s tax revenues if tax rates are reduced? The obvious answer would seem to be that lower tax rates will result in less tax revenue. But supply-side economists believe that the opposite may be true. Lower tax rates increase incentives and production. According to supply-side economist Arthur Laffer, the increase in production may increase the tax base (income) enough to more than offset the decrease in tax rates. Thus, lower tax rates may generate more tax revenue. The relationship between tax rates and tax revenue is illustrated on a Laffer curve. The Laffer curve indicates that lowering tax rates may increase tax revenue. Example 9: On the graph below, the tax revenue generated by a tax rate of 0% is \$0. The tax revenue generated by a tax rate of 100% is also \$0. At a tax rate of 100%, producers would have no incentive to produce. If the tax rate is high (point A on the graph), lowering the tax rate (to point B on the graph) would increase tax revenue. Tax Revenue Supply-side Tax Cuts \$0 0% B A 100% Tax Rate Ronald Reagan became President in 1981. That same year, Congress enacted a supply-side tax cut, which lowered the top marginal tax rate from 70% to 50%. In 1986, the top marginal tax rate was lowered to 28%. Did these tax cuts reduce taxes paid by high income taxpayers? On the contrary, the taxes paid by the highest income taxpayers increased, while the taxes paid by most taxpayers stayed essentially the same. Overall, tax revenue increased after the tax cuts. Example 10A: In 1990, the top 1% of income earners paid 51% more federal income taxes (in real dollars) than they had paid in 1980. Likewise, the top 5% of income earners paid 36% more and the top 10% paid 28% more. The bottom 90% of income earners paid essentially the same in 1990 as they had in 1980. Example 10B: The percentage of income tax paid by the top 1% of income earners increased from 17.6% of federal personal income taxes in 1981 to 27.5% in 1988. The percentage paid by the top 10% of income earners increased from 48.0% in 1981 to 57.2% in 1988. The percentage paid by the bottom 50% of income earners decreased from 7.5% in 1981 to 5.7% in 1988. FOR REVIEW ONLY - NOT FOR DISTRIBUTION 9 - 7 Fiscal Policy

The focus of supply-side theory is not on setting tax rates so as to maximize tax revenues. Most supply-side economists are more concerned with maximizing economic growth. Supply-siders support a smaller government and much lower tax rates in order to provide more incentives and to achieve more economic growth. Appendix: History of the Federal Government’s Budget The table below shows the federal government’s tax revenues, expenditures, and budget surplus (or deficit) for the years from 1929 to 2014. The amounts are in billions of dollars. Tax Government Surplus Tax Government Surplus Year Revenues Expenditures (Deficit) Year Revenues Expenditures (Deficit) 1929 \$3.8 \$3.1 \$0.7 1972 207.3 230.7 (23.4) 1930 4.0 3.3 0.7 1973 230.8 245.7 (14.9) 1931 3.1 3.6 (0.5) 1974 263.2 269.3 (6.1) 1932 1.9 4.6 (2.7) 1975 279.1 332.3 (53.2) 1933 2.0 4.6 (2.6) 1976 298.1 371.8 (73.7) 1934 2.9 6.5 (3.6) 1977 355.5 409.2 (53.7) 1935 3.6 6.4 (2.8) 1978 399.6 458.8 (59.2) 1936 3.9 8.2 (4.3) 1979 463.3 504.0 (40.7) 1937 5.4 7.6 (2.2) 1980 517.1 590.9 (73.8) 1938 6.7 6.8 (0.9) 1981 599.3 678.3 (79.0) 1939 6.3 9.1 (2.8) 1982 617.8 745.8 (128.0) 1940 6.6 9.5 (2.9) 1983 600.6 808.4 (207.8) 1941 8.7 13.6 (4.9) 1984 666.5 851.9 (185.4) 1942 14.6 35.1 (20.5) 1985 734.1 946.4 (212.3) 1943 24.0 78.6 (54.6) 1986 769.2 990.4 (221.2) 1944 43.7 91.3 (47.6) 1987 854.3 1004.1 (149.8) 1945 45.2 92.7 (47.6) 1988 909.3 1064.5 (155.2) 1946 39.3 55.2 (15.9) 1989 991.2 1143.7 (152.5) 1947 38.5 34.5 4.0 1990 1032.1 1253.1 (221.0) 1948 41.6 29.8 11.8 1991 1055.1 1324.3 (269.2) 1949 39.4 38.8 0.6 1992 1091.3 1381.6 (290.3) 1950 39.4 42.5 (3.1) 1993 1154.5 1409.5 (255.0) 1951 51.6 45.5 6.1 1994 1258.7 1461.9 (203.2) 1952 66.2 67.7 (1.5) 1995 1351.9 1515.9 (164.0) 1953 69.6 76.1 (6.5) 1996 1453.2 1560.6 (107.4) 1954 69.7 70.9 (1.2) 1997 1579.4 1601.3 (21.9) 1955 65.4 68.4 (3.0) 1998 1722.0 1652.7 69.3 1956 74.6 70.7 3.9 1999 1827.6 1702.0 125.6 1957 80.0 76.6 3.4 2000 2025.5 1789.2 236.2 1958 79.6 82.4 (2.8) 2001 1991.4 1863.2 128.2 1959 79.3 92.1 (12.8) 2002 1853.4 2011.2 (157.8) 1960 92.5 92.2 0.3 2003 1782.5 2160.1 (377.6) 1961 94.4 97.7 (3.3) 2004 1880.3 2293.0 (412.7) 1962 99.7 106.8 (7.1) 2005 2153.9 2472.2 (318.3) 1963 106.5 111.3 (4.8) 2006 2406.9 2655.1 (248.2) 1964 112.6 118.5 (5.9) 2007 2568.0 2728.7 (160.7) 1965 116.8 118.2 (1.4) 2008 2524.0 2982.5 (458.5) 1966 130.8 134.5 (3.7) 2009 2105.0 3517.7 (1412.7) 1967 148.8 157.4 (8.6) 2010 2162.7 3457.1 (1294.4) 1968 153.0 178.2 (25.2) 2011 2303.5 3603.1 (1299.6) 1969 186.9 183.7 3.2 2012 2450.2 3537.1 (1086.9) 1970 192.8 195.6 (2.8) 2013 2775.1 3454.6 (679.5) 1971 187.1 210.2 (23.0) 2014 3020.8 3504.2 (483.4) FOR REVIEW ONLY - NOT FOR DISTRIBUTION Fiscal Policy 9 - 8

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PRINCIPLES OF ECONOMICS JEFF HOLT S

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Principles of Economics, 6th Editio

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16. Study Guide for Chapter 7 17. C

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11. Appendix: Book Review - “The

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20. Appendix: The NCAA Cartel 21. S

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Introduction: A Brief History of U.

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In the twentieth century, per capit

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Appendix: The 35 Largest National E

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Multiple Choice: ___ 1. The Jamesto

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2. Describe the economic cost of th

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Chapter 1 Scarcity and Choices The

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Example 5B: At the end of 1982, the

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Example 11: When Cindy quits her jo

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consequences may result in failure

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An upward sloping curve (as in Exam

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In making decisions, humans tend to

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5. ______________________ _________

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___ 13. If the value of one variabl

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Y Point X Y A 0 1 B 3 3 C 6 5 D 9 7

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Chapter 2 Trade and Economic System

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Example 4B: The following quantitie

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1. An increase in the quantity of r

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3. For whom to produce? This is det

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The graph below illustrates the shi

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The two primary economic systems ar

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___ 12. The capitalist vision sees

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___ 25. According to the book “Ca

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Chapter 3 Demand, Supply, and Equil

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. For inferior goods, income and de

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The same information can be placed

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Not only does a free market elimina

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\$7 - 6 - 5 - S 3 S1 S 2 Price 4 - 3

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Example 17: The graph below illustr

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Questions for Chapter 3 Fill-in-the

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___ 12. Assuming a market originall

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\$8 - 7 - 6 - 5 - Price 4 - 3 - 2 -

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Chapter 4 Inflation and Unemploymen

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Computing the Rate of Inflation The

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Full Employment Though unemployment

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3. Cyclical unemployment - due to d

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During the Great Depression, the ec

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Appendix: Think Like an Economist -

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Answer questions 8. and 9. based on

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___ 25. The extension of unemployme

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Chapter 5 Measuring Total Output: G

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5. Leisure. Leisure time is by defi

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The U.S. is a high per capita GDP c

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Example 17: In “An International

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The simple circular flow diagram be

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___ 3. Which of the following would

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2. Explain what nonproduction trans

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• Page 120 and 121: Notice that the investment demand c
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• Page 132 and 133: Chapter 8 Keynesian Economic Theory
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• Page 152 and 153: Example 5A: The federal government
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3. Borrowers do not have to seek ou

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Appendix: Book Review - “The Age

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Questions for Chapter 12 Fill-in-th

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___ 16. The primary source of incom

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7. According to Alan Greenspan, wha

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Chapter 13 Taxes, Deficits, and the

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Example 5: In 2015, Taxpayer A had

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of \$5 and a quantity of 10 units. T

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The complexity of the tax law also

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the current government spending and

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cut of 1964. The top rate was lower

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___ 6. Federal excise taxes: a. are

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3. How would eliminating the loopho

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Chapter 14 Economic Growth The basi

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2. Labor. Labor can contribute to e

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An improvement in technology (e.g.

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The table below shows the economic

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will increase both Real GDP and per

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___ 8. Which of the following is co

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___ 26. The opinion that economic g

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Chapter 15 Less Developed Countries

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Example 8: Countries A, B, C, and D

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Obstacles to Economic Development f

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c. Restrictions on international tr

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Appendix: Book Review - “The Powe

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Example 25: In Brazil, about half t

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Study Guide for Chapter 15 Chapter

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___ 13. Among the counterproductive

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4. List four ways that governments

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Other Benefits of Free Internationa

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Example 6: The graph below illustra

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is only 25% as productive as before

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Smith was skeptical of government a

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___ 4. For Country X, what is the o

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___ 18. Frédéric Bastiat’s “P

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4. On the graph below: (1) What is

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Chapter 17 Elasticity We are often

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Example 4A: What is price elasticit

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Example 5A: Gertie’s Gas and Go i

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Example 10A: When the price of Good

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Example 13B: On the graph below, su

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\$7 - 6 - 5 - Price 4 - 3 - 2 - 1 -

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In the long run, would the deadweig

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___ 7. The factors that determine w

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3. a. Which price (or prices) from

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Chapter 18 Utility The basic econom

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Nonetheless, society generally assu

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Example 9: Capital City operates a

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Marginal rate of substitution - the

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The diamond-water paradox is the ob

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Complete the table below to answer

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4. The graph below shows indifferen

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Chapter 19 The Firm The basic econo

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than contributing to team productio

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1. Difficulty in raising large amou

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Corporations also use self-financin

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Example 24: A blacksmith who produc

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For financing needs, proprietorship

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___ 13. Corporations: a. are comple

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5. List two things that the absence

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Chapter 20 Production and Costs The

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In Example 5B, Birdwell finds that

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variable cost initially decreases,

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Quantity TC MC AFC AVC ATC 0 240 X

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If the scale of operation is increa

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average total cost. Average fixed c

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___ 11. Concerning the cost curves:

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5. Complete the following cost tabl

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Chapter 21 Perfect Competition The

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Even though a perfect competitor ca

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Example 6C: This example builds on

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At what price will there be neither

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Appendix: Perfect Competition in th

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Multiple Choice: ___ 1. A perfect c

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___ 17. Perfect competition: a. req

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Chapter 22 Monopoly Of the four mar

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3. Exclusive ownership of an essent

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maximizing quantity (4 units) creat

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\$22 - 20 - 18 - 16 - 14 - Deadweigh

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2. Negotiating, beginning at a high

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Legal barriers are created by gover

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___ 8. The slope of the demand curv

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Price Quantity 3. List some of the

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Chapter 23 Monopolistic Competition

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For Percomp (the perfect competitor

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Example 7A: The graph below represe

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Example 9: The Organization of the

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Example 12 illustrates the dilemma

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its current price and quantity. The

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___ 14. Game theory: a. is a method

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Chapter 24 Factor Markets The basic

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\$ \$240 - 200 - 160 - 120 - 80 - 40

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Since producers will attempt to equ

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2. Differences in nonmoney aspects

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were his strikeouts, walks, and hom

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___ 3. To maximize profits, a produ

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___ 19. According to the book, “M

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Multiple Choice: 1. a. 8. c. 15. d.

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Chapter 25 Labor Unions The primary

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The elasticity of demand for union

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Example 4A: Assume that the graph b

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Notice from the graph in Example 6

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Wage Factory A Quantity of Labor S

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As a cartel, a labor union faces a

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___ 10. For a monopsony: a. there i

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3. The graph below represents a lab

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Chapter 26 Interest, Present Value,

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An increase in expected rates of re

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An asset is valuable because we exp

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Example 13B: General Ordnance prove

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Appendix: Present Value Table One f

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___ 4. An increase in expected rate

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Problems: 1. List and explain the t

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Chapter 27 Market Failure The basic

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External Benefit If a market genera

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Example 2: To encourage the consump

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\$100 - 90 - 80 - MSC 70 - \$ 60 - 50

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A common good is nonexcludable. Non

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Study Guide for Chapter 27 Chapter

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___ 5. What government policy would

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4. Based on the information on the

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Chapter 28 Public Choice and Govern

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Candidates and the Median Voter Mod

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Example 8: According to State and F

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Example 10: When Elvis Presley was

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4. Pessimistic bias. This is the te

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___ 5. An elected official will: a.

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2. If a certain policy will yield s

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Chapter 29 Government Regulation of

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underproduction is the amount that

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market. They may agree with their c

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Questions for Chapter 29 Fill-in-th

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___ 10. The public interest theory

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4. List the four types of costs imp

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Chapter 30 Agriculture and Health C

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weather may cause bumper crops. Bad

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Security and Rural Investment Act o

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Example 12: From 1960 to 2013, the

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1. NHI would provide universal heal

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d. Insurance providers are not allo

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Study Guide for Chapter 30 Chapter

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Answer questions 7. through 10. by

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___ 21. If there were no individual

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Chapter 31 Income Distribution and

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Income is more equally distributed

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over a typical career is the accumu

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Ideal Income Redistribution The ide

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Poverty - a family whose income fal

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Appendix: Income Inequality around

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How is this story an analogy for th

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___ 2. In 2013, the Lowest Income 6

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Problems: 1. Explain the two primar

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Absolute advantage - when one natio

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Fiat money - money by government de

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Nonrivalrous good - a good for whic

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“Company town”, 25-6 Comparativ

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Eli Lilly and Company, 22-1 Emergen

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Houston, Texas, 15-10 Human capital

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Market, 3-1, 3-8-9 Market basket, 4

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Political bias, 9-4, 12-7 Political

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Short run production, 20-2-3 Short-

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Upturns, 9-4 USDA, 27-9, 30-1-2, 30

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