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Published July 7, 2022 | Submitted
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Taxes and Market Power: A Principal Components Approach


Suppliers of differentiated goods make simultaneous pricing decisions, which are strategically linked. Because of market power, the equilibrium is inefficient. We study how a policymaker should target a budget-balanced tax-and-subsidy policy to increase welfare. A key tool is a certain basis for the goods space, determined by the network of interactions among suppliers. It consists of eigenbundles -- orthogonal in the sense that a tax on any eigenbundle passes through only to its own price -- with pass-through coefficients determined by associated eigenvalues. Our basis permits a simple characterization of optimal interventions. A planner maximizing consumer surplus should tax eigenbundles with low pass-through and subsidize ones with high pass-through. The Pigouvian leverage of the system -- the gain in consumer surplus achievable by an optimal tax scheme -- depends only on the dispersion of the eigenvalues of the matrix of strategic interactions. We interpret these results in terms of the network structure of the market.

Additional Information

Attribution 4.0 International (CC BY 4.0). This work was supported by the ERC grant 724356 (Galeotti), the Pershing Square Fund for Research on the Foundations of Human Behavior (Golub), the National Science Foundation (SES-1658940, SES-1629446, Golub & DMS-1944153, Tamuz), the Sloan Foundation (Tamuz) and the US-Israel Binational Science Foundation (2018397, Tamuz).

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