Suppose the government levies a per-unit tax on TVs, and this tax increases the price of TVs by $10.
a. On a graph with TVs on the horizontal axis and "$'s of other consumption" on the vertical, illustrate how the budget constraint for a consumer with exogenous income changes as a result of the tax.
b. Suppose you know the bundle on the after-tax budget that is chosen by the consumer. Illustrate on your graph how much in tax revenue the government is raising from this consumer.
c. If the government replaced the tax on TVs with a lump sum tax that does not alter any prices but raises the same amount of revenue from the consumer, how would this consumer's budget constraint change?
What will be an ideal response?
a. The graph should have two budget constraints with the same vertical intercept but different slopes --- with the steeper budget line representing the after tax case.
b. The tax revenue the government collects is the vertical distance between the after-tax bundle that is bought and the before-tax budget line.
c. The consumer's after-tax budget constraint would rotate through the previous after-tax bundle --- becoming shallower as the price distortion from the TV tax is lifted and ending up parallel to the before-tax budget.
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