Chapter_14_v2

# Chapter_14_v2 - Part 4 A Framework for Tax Analysis Chapter...

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Part 4 – A Framework for Tax Analysis Chapter 14 – Taxation and Income Distribution 1. The market initially is at P 1 Q 1 . Adding a per-transaction tax on brothels would be a tax on a commodity. Because the producer would be paying the tax, the effective supply curve for suppliers would be S 1 . The producers are happy and the market clears only when P S is paid by the customers for quantity Q 2 . Of this price, P S -P C is the tax paid, where customers pay P S -P 1 of the tax and the suppliers pay P 1 -P C . The incidence depends on the relative elasticities of supply and demand. Here, the curves are drawn such that the consumers and suppliers face roughly the same incidence. However, if one believed that the supply was relatively more inelastic, then the brothels would face a higher incidence. 2. No, it does not follow that the tax will be progressive. If both lose the same amount of utility, the rich person will pay more because of diminishing marginal utility of income. But, a progressive tax requires that a higher proportion of income (the average tax rate) be taken from the rich person. This tax plan only requires that the absolute amount be higher, not the proportional amount. For instance, if the marginal utility were decreasing, but very close to constant, then the rich and poor would pay very close to the same amount in taxes. This amount would be a much larger share of the poor person’s income. S D S 1 Price Brothel Transactions P S P 1 P C Q 2 Q 1

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Chapter 14 – Taxation and Income Distribution 3. In the competitive case, the full tax is paid by the consumer because the supply curve, given by MC, is perfectly elastic. With a monopoly, the tax is shared between the consumer and the producer depending on the elasticity of demand. (If the tax is imposed on the consumer, the demand curve falls by \$u, and the result is the same in both cases). Q 1 Q D MC+u=AC+u MC= AC Price Quantity P+u P Q 1 Q D MC+u=AC+u MC= AC Price Quantity Perfectly Competitive Market Monopoly Market MR P 1 P P 1 -u
Part 4 – A Framework for Tax Analysis 4. If a tax is placed on cigarettes, markets other than the cigarette market will be affected. A tax on cigarettes is effectively a tax on the resources used to make them. The tax will

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Chapter_14_v2 - Part 4 A Framework for Tax Analysis Chapter...

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