6. Consider two goods, x and y. Using budget lines and indifference curves show that a...

6. Consider two goods, x and y. Using budget lines and indifference curves show that a sales tax on good x is inferior to an income tax that yields the same amount of revenue

I need graphs too not just explanations of words please.

Thank you :)

Expert Solution

GIVEN THAT;-

A person can consume different types of goods;

They are of two types. Most of the goods are normal goods. But some goods are inferior. Here inferior will be poor in quanity. So a person will buy less units of inferior goods, when his moves up. This smaller quantity of inferior goods is substituted by consuming more of normal goods. Just opposite will happen,
when income of the person is decrased. In that case consumer will not be able to buy required quantity of normal goods. So he will take less normal units and will substitute it by taking more of inferior goods. Thus demand of inferor goods will rise with the fall in income.
Inferior goods can be explained further by a diagram which is shown above.In the diagram, consumer is taking two commodities X and Y. quantity of x has been measured on horizontal axis and quantity of y on vertical axis
AB is the budget line. It shows all possible combinations of these two commodities that he can buy with his income.

A point on the budget line;

where he can maximize his satisfaction. It is possible with the help of indifference curve. It is a diagram, which shows different possible combinations of two commodities which will give him a specific level of satisfaction.

Each level of satisfaction is represented by a separate indifference curve. So attainment of higher indifference curve will mean he has improved his satisfaction level.

so in the diagram, consumer will try to select a point on the budget line AB which will help him to attain highest possible indifference curve. It is possible where budget line is tangent with an indifference curve. In the diagram above, e1 is the point of tangency of budget line AB and indifference curve IC1. Thus initially consumer is taking X1 units of commodity X and Y1 units of commodity Y.

Now income has decreased. As a result he will now buy lesser units of commodities. So budget line will shift downward. It is CD. Due to downward shift, new tangent point is e2. Now he is talking more of commodity X (i.e. X2 units) and less of commodity Y (i.e. Y2).

As consumption of commodity X is going up, due to decrease in income, it is an inferior goods.

As consumption of commodity X is going up, due to decrease in income, it is an inferior goods.

Rahul Sunny answered 1 year ago

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