3. Lump-sum versus excise taxes Aa Aa Laura loves eating bananas and eating appl

Question

3. Lump-sum versus excise taxes Aa Aa Laura loves eating bananas and eating apples. Both cost $1 each, and she allocates $100 to spend on these two things alone each month. The following graph shows Laura's budget constraint for consumption of bananas and apples before any taxes are imposed (I1). The indifference curve, U1, lies tangent to I1 at point X QUANTITY OF APPLES 100 BC1 BC3 80 60 BC2 40 U1 U3 20 U2 20 40 60 80 100 QUANTITY OF BANANAS Hide excise tax budget line (BC2) Hide lump-sum tax budget line (BC3) Suppose the government introduces a 67% tax on apples. Click the link labeled "Show excise tax budget line (BC2)" to view Laura's budget constraint under the excise tax policy. After tax, Laura will choose to spend roughly will pay on apples, meaning that she in taxes Now, suppose instead that the government decides to levy a lump-sum tax equal to the revenue that would be collected by the excise tax. Click the link labeled "Show lump-sum tax budget line (BC3)" to view Laura's new budget constraint. The maximum amount she can now spend on either good is

Explanation / Answer

After 67% tax, budget line will be BC2 and Laura will consume at point X where 48 is roughly spent on apples and 52 on banana which means around $18 is paid as tax.

After $20 lumpsum tax, maximum amount to be spent is 80

Laura is better off under lumpsum tax policy. This is because advolrem taxes reduces utility through both effects.

Distortionary effecy will be larger because of no substitute availability.

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