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Suppose that u(x1,x2) = x1x2, w = 90, p1 = 0.9, and p2 = 2.

(a) Consider a tax t = 0.10 on the consumption of good 1 (a tax of $0.10 per unit of good 1 purchased). Graph the consumer's budget line before and after the implementation of the tax. Find the consumer's optimal bundle after the implementation of the consumption tax. Call that bundle A.

(b) Find the tax on the consumer's general purchasing power that will collect the same revenue as t = 0.10. Graph the consumer's budget line under this income tax. Find the consumer's optimal bundle under the income tax. Call that bundle B. Does the consumer prefer B over A?

(c) Now consider a tax τ on the consumption of both goods, a tax that collects $τ per dollar spent on either good. What should τ be to collect the same as the above tax policies? Would the consumer prefer this consumption tax on both goods over the above tax polices?

Microeconomics, Economics

  • Category:- Microeconomics
  • Reference No.:- M948337

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