PS 06 Key - ANSWERS TO PROBLEM SET 6 - Economics 335 J....

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ANSWERS TO PROBLEM SET 6 - Economics 335 J. Wissink - Cornell University 1. a. False. See graph on right. Notice that the tax generates no revenue since demand falls to zero at the post-tax demand price. However, there is still a fair bit of dead-weight-loss. Also note that the demand curve should be interpreted as the Hicksian demand curve at the after tax indifference curve. b. False. Such a tax would be efficient, however, it may not be desirable on equity or political grounds. c. False. Lump-sum taxes are truly lump-sum if they are independent of one's behavior, not if they are equal across all individuals. A random scheme that assesses different lump-sum taxes across individuals would be truly lump-sum, for example, even though tax liabilities across people would be different. However, some economists argue that there are no truly lump-sum taxes if income is private information, since there are bankruptcy constraints that will always have to be considered, which would render the taxes non-lump-sum. d. Not quite true. Commodity taxes on goods with completely inelastic Hicksian or compensated demand curves are efficient because they create no excess burden, but if we’re looking at Marshallian/market demand curves, then there is still an excess burden created by the substitution effect (that exists, but is masked by the income effect). e.
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PS 06 Key - ANSWERS TO PROBLEM SET 6 - Economics 335 J....

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