Part I. Consider two goods X and Y, which are neither substitutes nor complements each other....

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Part I. Consider two goods X and Y, which are neither substitutes nor complements each other. The two good's compensated elasticities of demand are -1 and -2, respectively. Denote tx and ty as the ad valorem commodity tax rates on X and Y. 1. What does the principle of optimal taxation say about the ratio of X's ad valorem commodity tax rate to Y's (=tx/ty)? 2. If we set tx and ty following the rule in Q1, how much would be the relative percentage change in the compensated demands for X and Y (=)? Now suppose there are three taxpayers, A, B, and C. The government imposes tax on X and Y at the rates tx and ty, as determined above. (in million wons) Income per year Consumption of X (after-tax quantity) Consumption of Y (after-tax quantity) A 50 0.1 0.2 B 50 0.2 0.1 C 100 0.2 0.2 3. Does the tax satisfy the principle of horizontal equity? 4. Does the tax satisfy the principle of vertical equity? 5. If the government imposes a lump-sum tax instead of the optimal commodity tax, how would the excess burden change? Part I. Consider two goods X and Y, which are neither substitutes nor complements each other. The two good's compensated elasticities of demand are -1 and -2, respectively. Denote tx and ty as the ad valorem commodity tax rates on X and Y. 1. What does the principle of optimal taxation say about the ratio of X's ad valorem commodity tax rate to Y's (=tx/ty)? 2. If we set tx and ty following the rule in Q1, how much would be the relative percentage change in the compensated demands for X and Y (=)? Now suppose there are three taxpayers, A, B, and C. The government imposes tax on X and Y at the rates tx and ty, as determined above. (in million wons) Income per year Consumption of X (after-tax quantity) Consumption of Y (after-tax quantity) A 50 0.1 0.2 B 50 0.2 0.1 C 100 0.2 0.2 3. Does the tax satisfy the principle of horizontal equity? 4. Does the tax satisfy the principle of vertical equity? 5. If the government imposes a lump-sum tax instead of the optimal commodity tax, how would the excess burden change?

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1 The advelorem tax of any commodity is levied as a percentage of the market value of the com... View the full answer