Question

15-13 Clarified question from 13-2, Rosen (1985), 1 edition; 14-6, Rosen (1988), 2"d ed Suppose there are two commodities, R and S. When a tax on R alone is imposed, the excess burden is R. When a tax on S alone is imposed, the excess burden is s. When the two taxes are imposed simultaneously, the overall excess burden is greater than AR+ Xs . In order to obtain this result, what must be true about the relationship amongst the two commodities, R and S? That they must be: i) substitutes, i complements, or ii) neither substitutes nor complements. (You may assume that there is a third commodity, call it T, although it is immaterial for the case of i) substitutes.) Explain how this might happen diagrammatically and intuitively in light of the theory of second best.

Answer 1

Loss OF

When the price of a good rises due to implementation of tax then automatically the consumer will buy less and the demand curve will shift to leftwards .

Why does loss of welfare when price of both goods have rose is more than loss of welfare in single commodity :-

1) They both are substitutes but there are availability of imperfect substitutes - In such case the consumer will start purchasing more of imperfect substitutes at prices lower than of the substitutes.

2) They are complementary goods but are luxury goods -

In such cases the consumer will tend to stop their consumption and focus more on buying necessities.