Check Your Understanding

47

  1. Question

    Study the four accompanying diagrams. Consider the following statements and indicate which diagram matches each statement. For each statement, tell which variable would appear on the horizontal axis and which on the vertical. In each of these statements, is the slope positive, negative, zero, or infinity?

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    1. If the price of movies increases, fewer consumers go to see movies.

    2. Workers with more experience typically have higher incomes than less experienced workers.

    3. Regardless of the temperature outside, Americans consume the same number of hot dogs per day.

    4. Consumers buy more frozen yogurt when the price of ice cream goes up.

    5. Research finds no relationship between the number of diet books purchased and the number of pounds lost by the average dieter.

    6. Regardless of its price, there is no change in the quantity of salt that Americans buy.

  2. Question

    During the Reagan administration, economist Arthur Laffer argued in favor of lowering income tax rates in order to increase tax revenues. Like most economists, he believed that at tax rates above a certain level, tax revenue would fall (because high taxes would discourage some people from working) and that people would refuse to work at all if they received no income after paying taxes. This relationship between tax rates and tax revenue is graphically summarized in what is widely known as the Laffer curve. Plot the Laffer curve relationship, assuming that it has the shape of a nonlinear curve. The following questions will help you construct the graph.

    1. Which is the independent variable? Which is the dependent variable? On which axis do you therefore measure the income tax rate? On which axis do you measure income tax revenue?

    2. What would tax revenue be at a 0% income tax rate?

    3. The maximum possible income tax rate is 100%. What would tax revenue be at a 100% income tax rate?

    4. Estimates now show that the maximum point on the Laffer curve is (approximately) at a tax rate of 80%. For tax rates less than 80%, how would you describe the relationship between the tax rate and tax revenue, and how is this relationship reflected in the slope? For tax rates higher than 80%, how would you describe the relationship between the tax rate and tax revenue, and how is this relationship reflected in the slope?