5. Consider an economy with two goods, A and B. Suppose the price of good A...

 

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5. Consider an economy with two goods, A and B. Suppose the price of good A is p and let the price of good B be 1. There is a large number of identical consumers. The indifference curves of consumers have the usual shape with diminishing marginal rate of substitution between the two goods. Suppose the government must raise a tax revenue of R, and can do this either by imposing a per-unit tax of t on good A, or by imposing a lump-sum tax T on each consumer. Which policy would the consumers prefer? Explain your reasoning carefully, using any appropriate diagram, and explain the intuition behind your result. 5. Consider an economy with two goods, A and B. Suppose the price of good A is p and let the price of good B be 1. There is a large number of identical consumers. The indifference curves of consumers have the usual shape with diminishing marginal rate of substitution between the two goods. Suppose the government must raise a tax revenue of R, and can do this either by imposing a per-unit tax of t on good A, or by imposing a lump-sum tax T on each consumer. Which policy would the consumers prefer? Explain your reasoning carefully, using any appropriate diagram, and explain the intuition behind your result.

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Assuming a perunit tax t is imposed on good A the new price of good A would be pt and the price of good B remains 1 Alternatively if a lumpsum tax T i... View the full answer