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4 102 in the closed autarky economy there is no

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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 Figure 10.1 Notice welfare loss: decisions based on distorted price signals. Figure 10.1 Figure 10.2 Ue X2 X2 T U* Xt Ua E A mc1 mc2 q1 q2 Ut X =D * Dt A * p1 * p2 T' X1 * p1 * 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 exports. Taxing production leads to a reduction in production, encouraging imports. Assume throughout that tax revenues are redistributed back to consumers lump sum. Then the value of consumption at consumer prices, equals the value of production at producer prices plus (net) tax revenue. (10.3) 6 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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