Consider a good x1 in a model where a consumer chooses between x1 and a composite good x2.
A: Explain why the following either cannot happen or, if you think it can happen, how:
(a) Own price demand for a good is perfectly vertical but taxing the good produces a dead weight loss.
(b) Own price demand is downward sloping (not vertical) and there is no deadweight loss from taxing the good.
B: Now suppose that the consumer’s tastes can be summarized by the CES utility function u(x1, x2) = (0.5x1−ρ + 0.5x2−ρ) −1/ρ.
(a) Are there values for ρ that would result in the scenario described in A (a)?
(b) Are there values for ρ that would result in the scenario described in A (b)?
(c) Would either of the scenarios work with tastes that are quasilinear in x1?