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Unformatted text preview: Economics 101 Marek Kapiˇ cka Intermediate Macroeconomic Theory Spring 2011 Problem Set 3 Solution Please write your name and your section on the top of your problem set. 1 Distortive Taxation 1. Solve Question 4.8 in Williamson. Suppose that we start with a proportional tax. Under the proportional tax the consumer’s budget line is EFH in figure 1. The consumer chooses consumption, C * , and leisure, l * at point A on indifference curve I 1 . A shift to a lump-sum tax steepens the budget line. The absolute value of the slope of the budget line is (1- t ) w and t has fallen to zero. The imposition of the lump-sum tax shifts the budget line downward in a parallel fashion. By construction, the lump-sum tax must raise the same amount of revenue as the proportional tax. The consumer must therefore be able to continue to consume C * of the consumption good and l * of leisure after the change in tax collection. Therefore, the new budget line must also pass through point A. The new budget line is labeled LGH in themust also pass through point A....
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This note was uploaded on 12/26/2011 for the course ECON 101 taught by Professor Dumbass during the Fall '08 term at UCSB.
- Fall '08