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Price Distortion and Economic Welfare

Edward Foster
Hugo Sonnenschein

Abstract

We study a standard n-commodity model in which equilibrium positions are characterized by specified inequalities between society's marginal rates of transformation in production and a single consumer's marginal rates of substitution in consumption; these inequalities are exemplified by, but not limited to, excise taxes and subsidies. We explore circumstances under which certain increases in these "taxes" and "subsidies" can be said to decrease welfare. In order to do so, we look for conditions under which the equilibrium consumption vector is well defined by a specification of the taxes and subsidies, and find that the conditions required are stringent. Among our conclusions is the proposition that the validity of consumers' surplus measures for analyzing such problems may depend on assumptions that are more strict than their users have realized.