Unformatted text preview: 10.2) In the closed (autarky) economy, there is no different between a tax on the
producer and a tax on the consumer
Notice welfare loss: decisions based on distorted price signals. Figure 10.1 Figure 10.2 Ue X2 X2 T U*
E A mc1
X =D *
Dt A *
p2 T' X1 *
p2 X1 5
In the open economy, there is a great difference between taxing
consumption of a good versus taxing production.
Taxing consumption leads to a reduction in consumption, encouraging
Taxing production leads to a reduction in production, encouraging imports. Assume throughout that tax revenues are redistributed back to consumers
Then the value of consumption at consumer prices, equals the value of
production at producer prices plus (net) tax revenue.
Small Economy: fixed world prices = undistorted domestic autarky prices. Production Tax on X1 (subsidy on X2) (Figure 10.2) (10.4) Equilibrium requires:
(1) Trade balances at world prices, implying that the consumption and
production points are connected by the world price ratio.
(2) Producer prices do not equal world prices, implying that the world
price ratio cuts the production frontier. 7
(3) Consumers optimize with respect to the consumer price ratio, so that
the slope of an indifference curve is equal to the consumer price ratio
= world price ratio. Result: Bad trade. A subsidy c...
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- Winter '14
- tax revenues, price ratio