Let us consider two types of goods in an economy: demerit goods and all other goods. The government is concerned with the excessive consumption of demerit goods in an economy and therefore decides to levy a commodity tax such that the tax burden is fully borne by the consumers. Explain with the help a well-labelled diagram the distortions created by such commodity tax on demerit goods assuming the same effect on individual welfare. What determines the size of the distortions in this case?

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Step 1 Answer Tax distortion is described as the creation of distortions that violate the prerequisi... View the full answer