4.13 As in Harberger\'s classic example [JPE 1962], assume that there are two go

Question

4.13 As in Harberger's classic example [JPE 1962], assume that there are two goods produced: product X is produced by firms in the "corporate" sector and product Y by firms in the "non corporate" sector. Both products are produced using the two inputs labor and capital (quantities denoted by L and K). Production functions are All consumers have preferences described by the utility function u(X,Y) = XY. The consumers care only about consuming X and Y, and they supply labor and capital inelastically in the total amounts L = 600 and K-600. Let PX, py, PL, and PK denote the prices of the four goods in the economy: assume that L = 1 always. (a) What is the Walrasian equilibrium? (b) Suppose that a 50% tax is imposed on payments to capital in the corporate sector only, and that the government uses the tax proceeds to purchase equal amounts of the output of the two sectors. What will be the new Walrasian equilibrium? How is welfare affected by the tax - are people better off with or without the tax? 37

Explanation / Answer

(a) Walrasian equilibrium is also known as competitive equilibrium is the traditional concept of economic equilibrium, appropriate for the analysis of commodity markets with flexible prices and many traders and serving as the benchmark of efficiency in economic analysis.

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