Lecture 12 - Announcements • MT1 is next Wednesday •...

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Unformatted text preview: Announcements • MT1 is next Wednesday. • Please e-mail me ASAP about conflicts. • HW4 (ch. 5) due tonight at 11:45pm. 1 of 40 Applications of the LDMU • LDMU can explain why soda machines only dispense one pack at a time, while newspaper stands expose all of the newspapers when you put your quarters in. Are newspapers readers more honest than soda drinkers? The economics explanation is that the MU of one more newspaper is pretty low while MU of one more soda is high. Vendors have probably never heard of the LDMU, but they behave 2 of 40 3 of 40 Applications of the LDMU • LDMU can also be used to explain why taxation is sometimes used to redistribute income from the relatively wealth to the relatively poor. • The taxation system in the U.S. is a progressive tax system. Definition of a pr ogr essive tax: as your income increases, the amount of taxes you pay ( as a percentage of your income ) increases. • Contrast this with a flat tax. Definition of a flat tax: you pay the same percentage of your income in taxes, regardless of your 4 of 40 The LDMU and Tax Policy • LDMU offers a rational foundation for a pr ogr essive tax system . • A progressive tax system is based on the belief that paying taxes should be equally “painful” for all, whether they are extremely wealthy or whether they are of more modest means. A progressive tax system assumes the MU of income is a decreasing function of income. Or, graphically: 5 of 40 MU Income/year LDMU and Tax Policy • A per fectly pr ogr essive tax system is one in which, after taxes and redistribution, all people receive the same income. 6 of 40 The LDMU and Tax Policy • A “perfectly” progressive tax system makes sense if these four assumptions hold true: 1.I ncome affects utility – the more income you have the “happier” you are. 2.Everyone has the same utility function for income. 3.The LDMU applies to income – you get less utility from the last dollar of income than from the first. 4.Total income in society is fixed. • I f these assumptions are true, you could make a strong case for having a progressive tax and redistribution system such that everyone’s 7 of 40 An illustration of the logic behind a progressive tax system. Suppose we have a society with two people, a 2005 student (you) and me. Assume there is a total income in society of $100,000 and that conditions 1-4 above hold. What tax policy should we use to maximize the total utility of society?...
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This note was uploaded on 06/21/2009 for the course ECON 2005 taught by Professor Zirkle during the Fall '07 term at Virginia Tech.

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Lecture 12 - Announcements • MT1 is next Wednesday •...

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