Ramsey rule

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The formula that characterizes optimal commodity taxes in an economy with a single consumer. The Ramsey rule is derived by assuming that the government sets commodity taxes to maximize the utility of a single consumer subject to the chosen taxes generating a required level of tax revenue. This optimization determines the most efficient set of commodity taxes (they are efficient because the assumption of a single consumer implies there are no equity considerations). The Ramsey rule states (approximately) that the optimal taxes cause every good to have the same proportional reduction in compensated demand. See also inverse elasticity rule.

Subjects: Economics.

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