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Unformatted text preview: b) Assume that the government imposes a $1.50 tax on Pepsi. Again, using indifference curve analysis, show that Joel will now purchase only Coke. c) How much revenue does this tax raise? In dollars, what is the excess burden associated with this tax? Demonstrate this excess burden using graphical analysis. 4) Ramsey Rule Janet has income m and receives Cobb-Douglas utility from consumption of two goods (X and Y): U = log(X) + (1- ) log(Y) Pre-tax prices are given by P X and P Y and ad-valerom tax rates are given by T X and T Y . a) Show that, with Cobb-Douglas utility, demand functions are given as follows: X = m / (P X (1+ T X )) Y = (1- )m / (P Y (1+ T Y )) b) Show that the Ramsey rule requires T X = T Y . Hint: X = dX/dT X . c) Relate your answer in part b) to the inverse elasticity rule. Hint: First calculate the price elasticity of demand for good X [(dX / dP X ) / ( X / P X )] and good Y....
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