Consider a country which taxes two goods, diamonds and bread. Each good has a supply elasticity of 1. The demand elasticity for diamonds is ηdd = −4; the demand elasticity for bread is ηbd = −0.25. In the market equilibrium, bread costs pb = $1 and a quantity of 100 is sold; diamonds cost $1000 and 10 are sold. Suppose a tax of τb = $0.50 is imposed on bread, and a tax of τd = $200 is imposed on diamonds. (a) What portion of the tax on bread is borne by consumers? What portion of the tax on diamonds is borne by consumers? (b) What is the deadweight loss from the tax on bread? What is the deadweight loss from the tax on diamonds? (c) Are these taxes optimal according to the Ramsey rule? If not, which tax should be increased and which should be decreased? (d) Are there any equity considerations which would argue against your answer for part (c)
Consider a country which taxes two goods, diamonds and bread. Each good has a supply elasticity of 1. The demand elasticity for diamonds is ηdd = −4; the demand elasticity for bread is ηbd = −0.25. In the market equilibrium, bread costs pb = $1 and a quantity of 100 is sold; diamonds cost $1000 and 10 are sold. Suppose a tax of τb = $0.50 is imposed on bread, and a tax of τd = $200 is imposed on diamonds. (a) What portion of the tax on bread is borne by consumers? What portion of the tax on diamonds is borne by consumers? (b) What is the deadweight loss from the tax on bread? What is the deadweight loss from the tax on diamonds? (c) Are these taxes optimal according to the Ramsey rule? If not, which tax should be increased and which should be decreased? (d) Are there any equity considerations which would argue against your answer for part (c)
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Consider a country which taxes two goods, diamonds and bread. Each good has a supply elasticity of 1. The demand elasticity for diamonds is ηdd = −4; the demand elasticity for bread is ηbd = −0.25. In the market equilibrium , bread costs pb = $1 and a quantity of 100 is sold; diamonds cost $1000 and 10 are sold. Suppose a tax of τb = $0.50 is imposed on bread, and a tax of τd = $200 is imposed on diamonds.
(a) What portion of the tax on bread is borne by consumers? What
portion of the tax on diamonds is borne by consumers?
(b) What is the deadweight loss from the tax on bread? What is the
deadweight loss from the tax on diamonds?
(c) Are these taxes optimal according to the Ramsey rule? If not,
which tax should be increased and which should be decreased?
(d) Are there any equity considerations which would argue against
your answer for part (c)
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