Question

(9) (a) Derive an efficient commodity taxation rule (Ramsey taxation rule) (b) Now assume that there are two (unrelated) commodities x and y whose compensated price elasticities are n, 0.25 and n, 1. Suppose we know that 60%, what should be the tax rate on commodity y? (c) In addition to above information we know that before tax consumption of commodity y is 10 units at a pre-tax price $60. What is the excess burden associated with a commodity tax on y?

URGENT,SO IMPORTANT!!!

Answer 1

a. The goal of Ramsey rule is to minimize deadweight loss of a tax system while raising a fixed amount of revenue. It says

• Production prices are fixed and normalized to 1
• All commodities cannot be charged like leisure.
• Lump sum taxation is strictly prohibited.
• The ramsay rule is $MDWLi / MRi = \lambda \Rightarrow Tax Rate=\lambda / elasticity of demand$