Commodity taxation with price-dependent preferences

Abstract

This study focuses on price-dependent preferences and their taxation. They have been subject to research in the field of economics since the beginning of the twentieth century. In general, the researchers classified these goods as either status goods or quality-indicators. This thesis searches for other possible perceptions of price-dependent preferences and brings a new approach to them, showing that they may be necessities in the virtue of income elasticity. Even though there are many pieces of research about the price-dependent preferences, the situation is not the same for their taxation. The second motivation of this thesis is prompted by this inadequacy. How would the optimal taxes behave when the utility functions were to include prices? The methodology is a constraint optimization with excise taxes in a static and deterministic world. In particular, I solved an optimal commodity tax problem of a representative agent who derives utility from two goods, and one of its prices enters the utility function. The first result is that price-dependency is not a synonym for luxury items, in fact, they may be necessities according to their income elasticities. In other words, a consumer may derive utility from the good’s low price in addition to the good itself. Another important finding of this research supports that on the contrary to the classical approach, levying a higher tax on the more elastic good might yield an efficient outcome for some cases.