A consumer purchases housing (H) and spends the remainder of income on

A consumer purchases housing (H) and spends the remainder of income on the composite good (C). The government is considering one of two policies. Policy A taxes housing by $50 per unit consumed.

With the tax in place, the consumer purchases 100 units of housing. Policy B collects a lump-sum tax of $5,000 from the consumer’s income. Compare the effects of the policies on the consumer’s utility/well-being and the amount of housing and composite goods purchased.

ANSWER

The lump-sum policy will allow him to reach the same bundle as with the tax while now leading to more preferable bundles with the change in slope of the budget constraint. Thus he will prefer the lump-sum tax and will purchase more housing and less of the composite good as compared to with a housing tax.