Inverse Elasticity Rule in a Production Efficiency Problem

Anthony Hannagan and Hideo Konishi
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Anthony Hannagan: Boston College

No 778, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: Diamond and Mirrlees (1971) and Dasgupta and Stiglitz (1972) show that production efficiency is achieved under the optimal commodity tax when profit income is zero. Here, we consider the simplest possible model to analyze production efficiency in the presence of profit income: a tax reform problem in an economy with a representative consumer, two goods, and two firms with decreasing returns to scale technologies. We show that differentiating a uniform producer tax according to the inverse elasticity rule, while keeping government revenue constant, reduces additional distortions caused by the presence of profit income and improves social welfare.

Keywords: production efficiency; inverse elasticity; profit income (search for similar items in EconPapers)
JEL-codes: H21 (search for similar items in EconPapers)
Date: 2011-06-30
New Economics Papers: this item is included in nep-eff, nep-mic and nep-pub
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