A person’s utility from goods A and B is U(A, B) = A⋅B. The marginal utilities of each good are MUA = B and MUB = A. The person has $120 income to spend on the two goods and the price of both goods equals $1.
e) A tax of $1 per-unit is placed on A (i.e.,
increases price of A to $2). Find the new utility maximizing
amounts of A and B. Show your answers graphically.
f) How much tax revenue is collected? Calculate and
show graphically.
g) A lump-sum tax (fixed $-amount income taken from the
person), set at the same dollar amount as the per-unit tax revenue
generated in part (e), replaces the per-unit tax. Show the new
budget constraint (i.e., with the lump-sum tax) on your
graph.
h) The taxes in (e) and (f) both collect the same
amount of tax revenue; which, if either, would the person prefer
(achieve higher level of utility)?
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