3 Lumpsum versus excise taxes Aa Aa Sunita loves eating donu

3. Lump-sum versus excise taxes Aa Aa Sunita loves eating donuts and eating bagels. Both cost $1 each, and she allocates $150 to spend on these two things alone each month. The following graph shows Sunita\'s budget constraint for consumption of donuts and bagels before any taxes are imposed (I1). The indifference curve, U1, lies tangent to1 at point X. QUANTITY OF BAGELS 150 , BCI 120 BC3 90 BC2 60 U1 U3 30 U2 30 60 90 120 150 QUANTITY OF DONUTS Hide excise tax budget line (BC2) Hide lump-sum tax budget line (BC3)

Solution

1. Now, she is consuming around 80 bagels, thus amount spent in bagels = 1.67 * 80 = 133.60

2. Amount paid in taxes = .67 * 80 = $53.60

3. The new budget constraint is BC3, thus maximum amount spent on either good = $120.

4. Better off as she lies on higher indifference curve in case of lump sum taxes.

5. Excise taxes

6. Smaller

7. Easy availability of close substitutes