Question 1:
Part
Good for you! You passed round two with flying colors. You negotiated a great employment contract and you are sitting at your desk waiting for a project to successfully complete. As it turns out, the Freedmanian Congress has decided to place a per unit tax on Medicine. Your supervisor needs you to provide an economic analysis. He provides you with the following information:
All consumers have the same incomes and preferences.
Utility for a typical consumer is given by: U(tequila, Medicine) = 1(tequila) + 1(medicine).
Income for a typical consumer is $200
Before the tax the price of both goods is $1 per unit.
Per unit tax on medicine is $1
After the tax, the price of tequila remains $1, but the price of medicine rises to $2.
Currently, a typical consumer purchases both goods.
You are quick to observe that tequila and medicine are perfect substitutes for each other.
How much tax revenue will the Freedmanian government collect from a typical consumer? Use a graph with medicine on the horizontal axis and tequila on the vertical axis to explain. Clearly label budget lines and indifference curves.
Question 2:
Hold the press! Congress is upset with your findings. They are demanding a re-evaluation. Your bonus depends on it. Congress is convinced that the utility function you are using is all wrong, but that the other information is correct. Congress insists that tequila and medicine are consumed in equal proportions. No choice, you must re-evaluate using Congresses fixed proportion utility function.
Task 2: Answer task 2 using the utility function provided to you by the Freedmanian Congress.