Submitted by: Submitted by hope3096
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Category: Business and Industry
Date Submitted: 09/20/2016 07:09 AM
1. Definition
1) Ramsey’s rule
The Ramsey rule is the formula that characterizes optimal commodity taxes in an economy with a single consumer. The Ramsey rule is derived by assuming that the government sets commodity taxes to maximize the utility of a single consumer subject to the chosen taxes generating a required level of tax revenue. This optimization determines the most efficient set of commodity taxes (they are efficient because the assumption of a single consumer implies there are no equity considerations). The Ramsey rule states that the optimal taxes cause every good to have the same proportional reduction in compensated demand.
F.P. Ramsey used this model as a starting point for considering what sort of taxes might have the least distortionary, welfare-reducing effect on society. For simplicity’s sake, Ramsey assumed a case of perfectly elastic supply, where a supplier will provide an infinite amount at a given price. In this model, the more inelastic the demand, the less the dead weight loss. Thus, when demand is less responsive to changes in prices, then the imposition of a tax results in a smaller dead weight loss. According to this argument, politicians will generate a smaller cost to society if they tax necessities such as milk, which people will continue to buy in the face of an increase in prices. A simplified version of the Ramsey rule is the “inverse-elasticity rule.” This rules states that tax rates on goods should be inversely related to their elasticity of demand.
2) Two-Part Pricing
This is to set a two-part price, charging different prices for different quantities of services and it is one possible and often practical solution to the difficulty that it is difficult to set an efficient price because there are increasing returns to scale. For example, if price is set equal to marginal cost, at P2, in the below figure, then price is less than average cost and a firm or authority cannot cover all its cost. If price is set...