extraproblem2 - Extra problem for Chapter 2 of Notes...

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September 18, 2006 Extra problem for Chapter 2 of Notes. Consider a small country that produces both corn and umbrellas; this country imports umbrellas. The world relative price of corn is p w . (Umbrella is the numeraire good: its price is set to 1.) The country imposes a small tax on corn production. Using a graph, identify the production and consumption points under two scenarios: (i) the government returns the tax revenue to consumers in a lump sum, and (ii) the government throws the tax revenue into the sea. Identify the production point under free trade as A; the consumption point under free trade as B; the consumption point when the tax revenue is returned to consumers as G and the consumption point when the tax revenue is thrown into the sea as D. Identify other points as needed. Answer: First recognize that the production point depends only on rel- ative producer prices, not on what is done with the tax revenue. Therefore, the production point in both scenarios (with the tax) is on the PPF above A, where the tangent equals the negative of the relative producer price for corn.
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