FSU ECO4504 Final Exam

6. Explain Niskanen's theory of bureaucracy. Include in your discussion the incentives facing bureaucrats and the compare the characteristics of bureaucratic output to output in the private sector.

His theory is that bureaucrats are budget maximizers, because they have a bargaining advantage in negotiating their budgets with legislature. Tend to produce too much Competitive market tend to produce at equilibrium, while private parties that are monopolists will produce too little.

9. What is a value added tax? Explain how the amount a taxpayer owes is calculated under a value added tax. Compare a value added tax to a sales tax. Be sure that your comparison includes both the burden of the tax in each case and the administrative aspects of each tax.

A VAT is calculated by placing a tax on the value added at each stage of production. For instance, a VAT may be collected multiple times in the process of turning a tree onto a chair. In each stage of production, the value added to the good will be taxed. A sales tax is a one-time tax collected at the point of purchase by the producer. Essentially, the VAT is charged to the suppliers while the sales tax is taxed on the demanders. In each case, the burden of the tax is shared by both the suppliers and the demanders. Administrative aspects to consider include: a sales tax is easier to collect than the VAT, the VAT created problems on how to tax investments and whether the investments can be included in the costs of selling the good, the VAT has an advantage in that the gov doesn't have to distinguish between retail and wholesale purchases and is also more difficult to evade in general. A value added tax is a tax places on the value added by each producer in the economy. For example, a logger sells wood to a saw for $4, if the VAT is 10%, the logger pays 40 cents in for $7, then sawmill would pay .30 cents in VAT (74)x.10 ect. With a VAT, each producer pays the tax, and with a sales tax, demanders pay the tax. The economic effect of the taxes is the same; both suppliers bear the same burden of the tax. Despite similar economic effects, the sales tax is preferable, because its easier to collect. With a VAT, bureaucrats aim to collect and audit all suppliers in the production process. With a sales tax, bureaucrats just have to collect from retail sellers.

Discuss the way that saving is taxed under an income tax and a consumption tax. Which is more efficient? Why? Which is more equitable? Why? In your explanation, be sure to discuss how some tax systems place a double tax on saving.

A consumption tax is levied on a goods and services that are consumed. While an income tax is based upon income earned from labor or capital, a consumption tax is solely based upon consumption. The difference between a consumption tax and an income tax is that an income tax taxes income going towards saving in addition to taxing income going towards consumption while a consumption tax only taxes consumption. For this reason, economists argue that the income tax provides an incentive to consume more and save less when compared to a consumption tax. For this reason, economists argue that the income tax provides an incentive to consume more and save less when compared to a consumption tax. This makes the consumption tax more efficient. However, because lower earners spend more of their income on consumption than higher earners, the consumption tax is less equitable than the income tax because the income tax allows the gov to tax higher earners at a higher rate. With the income tax it can sometimes result in a double tax on savings. First the possible savings are taxed when the income is earned and secondly the gains made from investment n the stock market are taxed when the stock is sold. Under an income tax, savings is taxed when interest is earned on the saved amount. Under consumption tax, savings are not taxed until the money is spent on a taxable good in the economy. A consumption tax is more efficient because the income tax double tax rates and causes consumers to consume rather than invest. The decrease in investments decreases the capital stock and productivity of labor in the economy, which is inefficient. The income tax can be argued is more equitable because the double tax on savings typically falls on the wealthy.

What is a collective consumption good? Explain how the efficient level of production for a collective consumption good is determined, and why the market will not produce the efficient level. Relate the concept of the collective consumption good to Lindahl pricing, and explain the advantages of Lindahl pricing for collective consumption goods. Use graphs to assist in your explanation

A good is termed a "collective consumption good" if each unit produced can be consumed by all members of society. Efficiency is achieved when the marginal cost of production is equal to the SUM of the prices that ALL individuals are willing to pay. The market will not produce the efficient level of collective consumption goods because the marginal cost of provision is zero meaning that the production of these goods will be financed through tax revenue, and these taxes are not related to consumption or for the use of public goods. Lindahl pricing is a system where individuals report their willingness-to-pay for each quantity of the public good, and the government aggregates preferences to form a measure of the social benefit which means collective consumption goods are determined by arriving at Lindahl equilibrium or in other words the tax price everyone is willing to bear to produce the good. Advantages: The Lindahl solution involves both the level of public good provision, and the method by which it is financed. • Benefit taxation: The method of finance where each person's tax bill equals the quantity of public goods consumed, times the price per unit, since each person's Lindahl price is the marginal benefit she derives from the good being financed. • The Lindahl solution covers the cost of the public sector; It yields an efficient allocation.

What is a collective consumption good? Explain how the efficient level of production for a collective consumption good is determined, and why the market will not produce the efficient level. Relate the concept of the collective consumption good to Lindahl pricing, and explain the advantages of Lindahl pricing for collective consumption goods. You may use graphs to assist in your explanation

A good is termed a "collective consumption good" if each unit produced can be consumed by all members of society. Efficiency is achieved when the marginal cost of production is equal to the SUM of the prices that ALL individuals are willing to pay. The market will not produce the efficient level of collective consumption goods because the marginal cost of provision is zero meaning that the production of these goods will be financed through tax revenue, and these taxes are not related to consumption or for the use of public goods. Lindahl pricing is a system where individuals report their willingness-to-pay for each quantity of the public good, and the government aggregates preferences to form a measure of the social benefit which means collective consumption goods are determined by arriving at Lindahl equilibrium or in other words the tax price everyone is willing to bear to produce the good. Advantages: The Lindahl solution involves both the level of public good provision, and the method by which it is financed. • Benefit taxation: The method of finance where each person's tax bill equals the quantity of public goods consumed, times the price per unit, since each person's Lindahl price is the marginal benefit she derives from the good being financed. • The Lindahl solution covers the cost of the public sector; It yields an efficient allocation.

What is a natural monopoly? Explain, using a graph to assist, the theory behind regulating a natural monopoly for the public benefit. Are there many examples of natural monopolies in the real world? How did most monopolized industries come to be monopolized?

A natural monopoly is a condition on the cost-technology of an industry whereby it is more efficient for production to be concentrated in a single firm. Theoretically, natural monopoly arises when there are very large "economies of scale" relative to the existing demand for the industry's product, so that the larger the Q of goods a single factory produces, the cheaper the average costs per unit get, right up to production at a level more than sufficient to supply the entire demand in the relevant market area. This might occur when the production of the good requires extremely large initial capital investments to even enter the market in a modest way but then producing additional output requires only very modest additional outlays beyond the fixed initial investment. Natural monopoly is when LRAC are lowest when a single firm controls the market, thus making a natural market the most efficient way to distribute that resource. Natural monopolies exist in the real world, with utility companies holding a regional natural monopoly. Even with a natural monopoly there is an incentive to abuse the market and charge high prices so gov is often called to intervene. This is why we often see a utility company being run by the municipality.

What is the prisoners' dilemma game? Explain what outcome you would expect to see in a prisoners' dilemma game if (a) the game is played only once, or (b) if the game is played repeatedly with the same players. Both the prisoners' dilemma game and the Coase theorem consider the way that individuals interact when there are possibilities for mutual benefit. Relate your discussion of the prisoners' dilemma game to the Coase theorem

A paradox in decision analysis in which two individuals acting their own best interest pursue a course of action that does not result in the idea outcome one player has a strategy that yields the highest payoff regardless of the other player's choices. If you play the PD game once, you will likely defect because you don't know what the other will do. If you play the PD game more than once, you are likely to cooperate. If you play once, you have an incentive to defect. If you play more than once, you know that if you cooperate (in the LR) than you'll get a higher payoff. Coase: when property rights are involved, people tend to gravitate towards the more efficient and optimal outcome.

Explain the differences between fixed quantity subsidies and excise subsidies, using graphs to help illustrate the differences. Which of these two types of subsidies is likely to have the greatest effect on the allocation of resources? Why? Would the recipient be better off with an excise subsidy or a fixed quantity subsidy of the same amount? Explain, using a diagram to help your explanation

An excise subsidy involves the Gov. (taxpayers) paying a fixed number of dollars per unit of the good. With an ad valorem (a type of excise subsidy) subsidy, the Gov. pays a fraction of the good's cost. An excise subsidy is a fundamentally different form of subsidy - the Gov. pays part of the per unit price of a good but allows the quantity of the good to be determined by consumer purchases. An example of this: suppose the Gov. decided to pay the consumer $5 for each until of housing consumed. The Q and, hence the cost to the Gov. depend on the level of consumer purchases and so are not fixed by the nature of the policy. A fixed-quantity subsidy provides the consumer with a specified amount of the good in question. Food stamps and Gov.- operated schools are two important examples. Ex: 2,000 subsidy per hybrid car is an excise subsidy. Another example would be a housing subsidy voucher for each unit of housing a poor person owns. In contrast, a fixed-q subsidy provides the person with a fixed amount of the good, for instance food stamps or public schools. Fixed-Q subsidies are more likely to have a greater effect on the allocation of resources. With an excise subsidy the consumer is still free to determine the Q of goods demanded. For ex: if food was subsidized by an excise subsidy instead of food stamps, a poor person may be able to purchase greater Q of food than if controlled by food stamps, which limits the Q of subsidized food available to the poor consumer.

Explain the differences between inframarginal externalities and externalities that are relevant at the margin. Use graphs to help assist with your explanation. Some people have argued that education should be subsidized because it creates a positive externality, while others have argued that there is no efficiency reason for subsidizing education. Use the concept of inframarginal externalities to explain the arguments on both sides of this issue.

An externality is an economic cost/benefit that is the by-product of economic activity. They are allocated outside of market system. There are both negative and positive externalities. In Inframarginal externalities there are no marginal benefits/costs. Individuals account for benefits/costs of actions at the margin. Do not necessarily imply inefficient allocation of resources and do not require policy action. Some people have argued that education should be subsidized because it creates a positive externality. People who support this argument say that a more educated society is a better society, so we should subsidize education, as it's fixing a positive externality. However, those against the externality state that education is an inframarginal activity because subsidizing it only benefits the individuals getting the education, not society at large. Those against subsidizing education wouldn't change anything as people already have a private incentive to get an education, as they get more money and increase their job prospects. Because of this, a subsidy may be inefficient.

Redistribution programs might be pursued to promote greater equality, or might be pursued to help alleviate the problems of poverty. Discuss the merits of these two different goals. Do you think that one goal would be favored over the other from behind a Rawlsian veil of ignorance? Redistribution might take place through cash transfers, or might take place through in-kind redistribution. Discuss these two methods of redistribution as ways of addressing the goals of greater equality and alleviation of the problems of poverty

Cash Transfers: redistribution of cash from rich to poor. In-Kind transfers: food stamps, housing vouchers, Medicaid. To promote equality, one would assume that this would involve a heavy tax on the richest in order to bring them down to equal, while trying to subsidize the poorest so they are closer to equal. In contrast, alleviating the problems of poverty only leads to ensuring that the poorest do not exist in a stare of dire poverty. Under a Rawlsian veil of ignorance, the goal of promoting great equality would be favored as a person behind the veil would prefer to ensure that he or she has a greater chance of receiving respectable wage.

Give a thorough explanation of the condition for economic efficiency in the production of a non-rival consumption good. Assuming that majority rule chooses the outcome most preferred by the median voter, what condition would have to exist for the outcome selected by majority rule to be efficient? What is the relationship of this condition to Lindahl equilibrium? Use graphs to help your explanation.

Economic efficiency in the production of a non-rival consumption good is determined by the summation of demand curves as seen in the calculation of the Lindahl equilibrium. This level of production for the non-rival good is in theory determines by the median voter. Therefore, the median voter's preference for the level of production must equal the lindahl equilibrium's level if production in order for outcome selected by majority rule to be efficient. Show graph of Lindahl Equilibrium. Under Lindahl equilibrium, the marginal tax price must meet the marginal demand for all consumers. This condition must be true for the median voter as well for the Lindahl equilibrium to be instituted as policy and therefore for the policy to be considered efficient.

Compare the Haig-Simons definition of income to the Fisher definition. Give an example that illustrates the difference between the two definitions and explain how much income in your example would be taxable under each of the definitions.

Haig-Simons definition of income: one's income is the maximum one can consume without reducing wealth. (appreciation of assets is included) [argues that total value of bond should be paid off in first year] • Fisher definition of income: income is the sustainable flow of purchasing power you have. (includes: interest earned on assets [says i payments received yearly should be taxed yearly], o HS argues all $X should be taxed in the first year, while Fisher argues that each payment of $X should be taxed each given year

Explain the cyclical majority, as it applies to democratic politics. What condition must be present for a cyclical majority to occur? Is a cyclical majority more likely to occur in large groups of voters (electing a president, for example) or small groups (congressional voting)? What difference does the size of the group make to the likelihood of a cyclical majority?

If preference assumptions are violated, median voter's preferred outcome might not be selected by majority rule creating a cyclical majority. Cyclical majority occurs when voters are faced with multiple voting options but cannot choose the option they most prefer, since it is not available. Voters must consider whether the alternative option is closer to their original preference. Cyclical majority is more likely to occur in small groups of voters because legislative decisions will be characterized by unique and stable equilibrium that produces the outcome most highly valued by the legislative body while in large group of voters there is indeterminacy, where exchange among voters is not feasible in general elections, thus they can't produce political decisions and reducing the likelihood of a cyclical majority to occur.

Discuss how the federal government budget has evolved since 1960. (a) What percentage of national income is expended by the federal government? How has this changed over the years? (b) What are the major components of federal expenditures? How have they changed over the years? (c) What are the major components of revenues? How have they changed over the years? (d) What, if anything, would you like to see changed in the federal government's budget? Why?

In 1960, gov spending at all levels made up 28% of GDP, by 1980 it had risen to 1/3 of GDP, and by 2000 gov spending was 33.8% of GDP. National Defense, Human Resources, and interest. In 1960, defense expenditures made up slightly more than half the deferral budget, and declined to 41.8% of the federal budget by 1970 despite the Vietnam War in late 60s-early 70s. Within the next decade (80s) defense spending dropped to 22.7%. Slight raise in 80s, sharp decline in 90s. Human resource expenditures increased steadily from 1/3 to 66%. Interest expenditures stayed pretty steady through the years up until 2000s, start to increase slightly. Personal income tax, social insurance revenues, corp income taxes. 1960, personal income tax collections made up about 44%. Income tax rose to about about 47.2% in 80s and 70s and up to 49.6% by 2000s. Social Insurance revenues (almost entirely SS payroll taxes) have grown significantly over the decades. From just under 16% of federal revenues in 1960, they had almost doubled to more than 30% of fed revenues by 80s, and 36.8% in 90s as a result of substantial increases in SS tax rates. Social insurance revenues fell to 32.2% by 2000 as rates remained constant during 90s. When looking at fed expenditures, we see substantial increase in expenditures devoted to human resources. SS is the largest program in that category, and the increase in social insurance revenues mirrors the growth in human resource expenditures. Corp Income tax collections fell to 12.5% of revenues in 1980 and made up 7.4% of revenues in 2000. I would like to see an increase in revenue from corporate income taxes, but this would be difficult to achieve, because corporations would just keep their capital elsewhere, away from American tax jurisdiction.

Explain how a subsidy can eliminate the inefficiency caused by a positive externality. Use a graph to assist your explanation. Why does the optimal subsidy promote the efficient use of resources? Does the existence of a positive externality necessarily imply that a subsidy is needed for the efficient allocation of resources? Distinguish between marginal and inframarginal externalities in giving your answer

In a free market, people ignore the positive externalities of consumption, e.g. when cycling to work, you don't consider the reduction in pollution your decision creates. In a free market, there is under-consumption of goods with positive externalities because people usually ignore the 'external benefits' their decisions make. Subsidies are negative taxes that correct for positive used externalities, the optimal subsidy promotes the efficient use of the resources because is set equal to amount of the external benefit. A subsidy is not needed, but it enables a greater social efficiency. diagram showing a possitive externality

3. What is the median voter model? Explain three ways in which the conclusion of the model can be reached. Use graphs to assist your explanation. What condition must be satisfied in order for the median voter model's outcome to be economically efficient?

It is a model that candidates select platform (R1 , L1 ) and compete for median voter by moving closer to M. Outcome most preferred by median voter is determined by majority rule. Median Voter model is simple yet a very descriptive of majority rule elections. The model concludes that in a representative democracy majority rule decision-making tends to select the outcome most preferred by the median voter. It illustrates why candidates tend to have similar views, while extreme candidates cannot win elections. Impediments to majority rule elections: possibility of cyclical majority. Committee type process Referendum Representative democracy

Some reasons why resources could be allocated inefficiently by the market are negative externalities, positive externalities, and collective consumption goods. Explain, using graphs, what the problem is in each case, and explain possible solutions to each problem. All of these problems might be described as arising due to poorly defined property rights. Explain the relationship of property rights to these instances where the market fails to allocate resources efficiently.

Negative externalities: cost imposed on others as by-product of productive activity. Allocated outside of market system. Market price understates true opportunity cost of production. Example: pollution. A corporation may decide to cut costs and increase profits by implementing new operations that are more harmful for the environment. The corporation realizes costs in the form of expanding its operations but also generate returns that are higher than the costs. However, the externality also increases the aggregate cost to the economy and society, making it a negative externality. Externalities are negative when the social costs outweigh the private costs. Solutions: Small numbers - private exchange may allow for internalization of externality. Example: Leaf burning neighbor. *INSERT GRAPH ABOUT NEGATIVE EXTERNALITIES* Positive externalities: benefit to others not allocated within market. Demand curve does not reflect true value of activity. Activity will be under-produced. Solutions: Subsidies - negative taxes that correct for positive used externalities. Optimal subsidy set equal to amount of external benefit. Positive externalities occur when there is a positive gain on both the private level and social level. Research and development (R&D) conducted by a company can be a positive externality. R&D increases the private profits of a company but also has the added benefit of increasing the general level of knowledge within a society. Positive externalities have public, or social, returns that are higher than the private returns. *INSERT GRAPH ABOUT POSITIVE EXTERNALITIES* Collective Consumption Goods: consumption by one consumer will not reduce the consumption of any other consumer. Example: radio broadcast signal. At efficient output level P=MC. MC = 0 for collective consumption good. For efficiency, P = 0. Private sector will not produce efficient level of output. Solution: Government production at zero price. *INSERT GRAPH ABOUT COLLECTIVE CONSUMPTION GOODS*

Two categories of public goods are non-rival consumption goods and nonexcludable goods. Discuss the similarities and differences between these two types of goods. If a good is non-rival in consumption, does that mean that it is also nonexcludable? If a good is nonexcludable, does that mean it is non-rival in consumption? Why might the market produce non-rival goods inefficiently? Why might the market produce nonexcludable goods inefficiently?

Nonexcludability means that it is difficult to keep people from consuming the good once it has been produced, and jointness in consumption means that once it is produced for one person, additional consumers can consume at no additional cost. Goods that are joint in consumption are also called collective-consumption goods or nonrival consumption goods, and the terms are used interchangeably here. The market may produce it inefficiently because collective goods are financed by tax revenues.

Two characteristics of publicness in goods are nonexcludability and jointness in consumption. Define each characteristic, making sure to clearly differentiate them. For each characteristic, explain why in theory markets may fail to allocate good efficiently. Explain what type of government intervention might be called for in each case, and why. Then explain the inefficiencies inherent in government intervention in each case

Nonexcludability means that it is difficult to keep people from consuming the good once it has been produced. The problem with nonexcludable goods is that if consumers cannot be excluded from consuming them, they will free ride and consume without paying, again resulting in underproduction of the good. Jointness in consumption means that once it is produced for one person, additional consumers can consume at no additional cost. this characteristic of jointness in consumption is often referred to as Samuelsonian publicness. In the face of Samuelsonian publicness, markets fail to allocate resources Paretoefficiently. there are numerous ways in which markets fail to be efficient, which points toward a policy of government intervention to correct the market failure. But there are two logical problems in that. First, there is no guarantee that government production will be any more efficient than private production and second, the problem of revealed preference, If the market fails to get a true measure of revealed preference for public goods, can the government expect to do any better?

Income taxes and property (or wealth) taxes tax two different elements of the same tax base. Explain why this is so, giving a simple example to illustrate your explanation. Within this framework, explain the logic of taxing imputed rental income on owner-occupied housing, and explain how the tax system currently deals with this issue of imputed rental income

One taxes the Capital Gains and one taxes the whole asset. One is taxing the flow of income and the other is taxing the actual asset. Imputed rental income is the benefit you get from living in your own home. The current tax system does not make one pay for the benefit of living in their own owner occupied housing.

Education produces a positive externality, and this has been used as a justification for having the government subsidize education to internalize the externality. Explain the argument for the subsidy. Just because a positive externality exists does not mean that a subsidy will be efficient, even in theory, however. Explain the theoretical arguments that a subsidy may be inefficient, even when a positive externality exists, using graphs to illustrate your arguments. After examining the arguments on both sides, which side is more plausible to you? Should education be subsidized?

People for the subsidy say that a more educated society is a better society, so we should subsidize education, as it's fixing a positive externality. Those against the externality state that education is an inframarginal activity. Inframarginal externalities are externalities in which people neither gain nor lose anything at the margin, but benefits and costs do exist for those consumers within the given inframarginal range. So those against subsidizing education wouldn't change anything as people already have a private incentive to get an education, as they get more money and increase their job prospects. Because of this, a subsidy may be inefficient. To me, it's more reasonable that education is an inframarginal activity, and should not be subsidized. The government's role is to protect people's rights, and a subsidy isn't protecting anyone's rights. And that tax would create inefficiency somewhere else, so it's probably not worth it.

Explain the relationship between quotas and tariffs as methods of restricting imports. Use a graph to assist your explanation. If either a tariff or a quota is going to be used to restrict imports by a certain amount, explain what groups would favor tariffs and what group would favor quotas, and why

Quota: (limit on imported good) max amount of a type of goods that can be imported legally into a country. Tarriff: tax on imports, a duty that is applied in monetary terms to imported goods. Generate income for the gov.

Explain the Ramsey rule. What are the arguments in favor of using the Ramsey rule to determine tax rates? What are the arguments against it? Considering the political environment within which tax laws are determined would you favor or oppose trying to make more use of the Ramsey rule to set tax rates?

Ramsey Rule: • Assumes the gov sets commodity taxes to maximize the utility of a single consumer subject to the chosen taxes generating a required level of tax revenue. • Optimization determines the most efficient set of commodity taxes • The optimal taxes cause every good to have the same proportional reduction in compensated demand • The more inelastic the demand, the less DWL • Revenues are raised through commodity tax only • As tax rates are increased, welfare loss (DWL) goes up in proportion while tax revenue decrease in proportion The Ramsey rule explains how the excess burden of taxation can be minimized for a given amount of tax revenue to be raised. This implies that taxes should be placed on goods with inelastic demands, assuming that supply elasticity is the same. The RR is a theoretical proposition explaining how the excess burden of taxation can be minimized for a given amount of tax revenue to be raised. It states that to minimize the excess burden of commodity taxation, taxed should be placed on goods in inverse proportion to the elasticity of demand for the goods. Argument in favor: when a tax is placed on any given market, the excess burden of the tax increase more than proportionally with the tax. So, to minimize the excess burden of taxation, goods with relatively inelastic demands should be taxed more heavily than those with relatively elastic demands. Argument against: many simplifying assumptions: neglecting to consider the elasticity of supply, and assuming that goods are unrelated in consumption, there are costs to taxation over and above the $ amount of taxes paid. The excess burden is one example, but there are other costs as well including compliance costs, administrative costs, and political costs.

Philosopher John Rawls has argued that a fair society is one that would be approved of from behind a veil of ignorance. Explain what Rawls means, and more generally, explain the contractarian idea of fairness. Next, explain Pareto's concepts of social welfare and compare Rawls' vision of the social welfare with Pareto's

Rawls has a vision in which a person was asked to make decisions on governmental policies without regard to his or her own personal situation. The person is supposed to imagine that he or she is being born into the world and has an equal chance of being born into any segment of society. Then that person is asked to agree upon rules of society, such as whether a gov should run a welfare program or whether taxes for the rich should be high or low. This is similar to the contractarian view of fairness. In this theory, one imagines a nation coming together to negotiate the new contract under which the gov will operate. They would create the contract and vote on it to decide if this new gov is better than no gov. this relates to pareto in that the majority of the people would only vote for a new contract if the majority would be better off with the gov than without. Pareto would argue that something is only superior if one person gains and nobody is worse off. This would be applicable to the contractarian view of fairness because under a gov that protects property right everyone would be better off. Rawls forces a person to consider every person's preferences in an effort to find a Pareto optimal outcome. Bother versions of social welfare take into account everyone's preferences. Rawls might argue that the decrease in utility for one person is ok if the increase for another person is greater, while Pareto would argue that this outcome would be worse that the status quo. Rawls attempts to dispel a person's individual preferences for the good of society as a whole.

Income transfer programs provide income to individuals with low incomes, but the benefits are reduced or eliminated as individuals' incomes rise. For simplicity, assume that individuals receive a certain guaranteed level of income if they have no earned income, but as their earned income rises, the amount of transfer income falls, and the transfer eventually is eliminated at a certain level of earned income. (a) Will recipients be better off participating in the transfer program as compared to not participating? (b) Will recipients have a higher level of dollar income if they participate in the program? Use graphs to help illustrate your answer

Recipients will be better off because individuals are receiving certain guaranteed level of income with not producing any. However, if they start producing income the transferred money will be reduced and eventually eliminated as their income increases. This ensures that there will be an incentive for people to make money. Recipients will have a higher level of dollar income because the transfer program ensures that there will be an incentive to work and thus increasing the level of income.

5. What is the Ricardian equivalence theorem? Explain the arguments supporting and opposing the theorem. In your explanation, be sure to make clear who bears the burden of the debt according to both sides, and the implications (e.g., regarding interest rates, investment, etc.) of both sides of the equivalence theorem argument. Use graphs to help explain how each side views the burden of the debt.

Ricardian equivalence is an economic theory that suggests when a government tries to stimulate an economy by increasing debt-financed government spending, demand remains unchanged. This is due to the fact the public saves its excess money to pay for expected future tax increases that will be used to pay off the debt. Argument for: In its simplest terms: governments can raise money either through taxes or by issuing bonds. Since bonds are loans, they must eventually be repaid, presumably by raising taxes in the future. The choice is therefore "tax now or tax later." The consumers bear the debt burden in this side. Arguments against: The creation of public debt through the sale of bonds is worse than taxing now because the creation of public debt depresses savings in a growing economy. The government bears the debt burden in this side.

With regard to efficiency in collective decision-making, the unanimous decision rule is analogous to market exchange in private sector decisions. Explain why this is so. Given this special status accorded to unanimity, can majority rule ever be efficient? Discuss the situations in which unanimity rule is required for efficiency and when less than unanimous approval in collective decision-making could be efficient. Use graphs to assist in your explanation

Show graph from 135. The unanimous decision rule states that all parties must unanimously agree to a voluntary transaction in order for the transaction to be considered Pareto superior. This is common sense, as in a voluntary transaction each side is made better off in a unanimous decision to do business together. This displays that the transaction was efficient. However, most public sector resources are not allocated efficiently because of majority rule. In this case a policy may be approved by the minority who expect it will make them better off while being disapproved by the minority who expect it will make them worse off. Under the unanimous decision rule therefore majority rule can only rarely be considered efficient because every member of congress would need to be in favor of a policy for it to be efficient. Less than unanimous approval could be efficient in decision making because actual decisions would be make under this type of rule. By reaching decisions that would make more people better off this would improve the overall interest of the group. The people in the group who would be made worse off will accept this decision in exchange for lowering the decision making costs involved with with an extended unanimous approval debate and vote.

Explain how the Social Security program is financed, making sure to distinguish between funded and pay-as-you-go systems in your discussion. What are the economic consequences on saving and investment from funding Social Security as we do today? Use a graph to assist your explanation

Social security is financed through dedicated payroll tax. Employers and employees each pay 6.2% while the self-employed pay the whole 12.4%. If social security were fully funded, that would mean each generation contributed enough to fully provide for their benefits on retirement, and there would be intergenerational transfers. A pure pay-as-you-go system, on the other hand, would have no trust fund at all, and all SS retirement benefits would be paid for by the current contributions of the working generations. Because SS is only partially funded, at some point in the future all benefits will be transfers from the working population to retires if no charges are made.

Assume that a good is taxed 25 cents per unit, and that the tax rate is doubled to 50 cents per unit. How will the revenues collected by the tax change as a result of a doubling of the tax rate? How will the excess burden of the tax change? Use a graph to help illustrate your answer

Tax revenues do not move proportionally when you double the tax rate, however the burden of the tax will double. The result of doubling tax rates will likely be a loss in revenues.

8. Compare the effects of placing a per unit tax on the demanders in a market as compared to placing a tax of the same magnitude on suppliers. Carefully compare who bears the burden of the tax in each case, using graphs to illustrate the comparison. In general, how can one determine what proportion of the burden of a tax will be borne by demanders and what proportion will be borne by suppliers?

Taxes on consumers shift the "after-tax" demand curve down, lower equilibrium quantity and price paid to suppliers but the price inclusive of the tax rises, making quantity demanded fall. Taxes on suppliers shift the supply curve up by the amount of the tax; This makes the supply curve shift to the left achieving a higher equilibrium price and a lower equilibrium quantity keeping demand constant. Taxes will typically constitute a greater burden for whichever party has a more inelastic curve if supply is inelastic and demand is elastic, the burden will be greater on the producers. If demand is more inelastic than supply, consumers will pay a higher percentage of the tax; if supply is more inelastic than demand, suppliers will pay a higher share. In order to calculate the fraction of tax paid by demanders is Elasticity of Supply/(Elasticity of Demand + Elasticity of Supply)and to calculate the fraction of tax paid by suppliers is Elasticity of Demand/(Elasticity of Demand + Elasticity of Supply)

Explain how a corrective tax can eliminate the inefficiency caused by a negative externality. Use a graph to assist your explanation. Why does the optimal tax promote the efficient use of resources? After the tax is collected, should the money be paid in compensation to those who are harmed by the externality? Explain the pros and cons of compensating those harmed by an externality

Taxes on negative externalities are intended to make consumers / producers pay the full social cost of the good. This reduces consumption and creates a more socially efficient outcome. If a good has a negative externality, without a tax, there will be over-consumption (Q1 where D=S) because people ignore the external costs. After the tax is implemented, the output of the good will fall from Q1 to Q2. Q2 is socially efficient because at this level the social marginal benefit (SMB) = Social marginal cost (SMC). Because of the reciprocal nature of externalities, compensation would lead to too many people living in harm's way.

Explain the difference between technological and pecuniary externalities. To efficiently allocate resources, how should public policy deal with technological externalities? To efficiently allocate resources, how should public policy deal with pecuniary externalities? When are pecuniary externalities most relevant to public policy, and why are they relevant?

Technological externalities directly affect firm's production function or individual's utility function and operate outside market system. In the other hand pecuniary externalities influence market supply and demand conditions, resources are not allocated outside market system and government involvement can cause resource misallocation. Efficiency requires the clear definition and protection of property rights over the ownership of resources, but no property rights over the value of those resources. In other words, technological externalities should be prevented but pecuniary externalities should be allowed. Pecuniary externalities are relevant for public policy because they allow new firms to enter the market and incur pecuniary losses to promote efficiency in competitive markets.

2. What is the Coase theorem? Under what conditions will the Coase theorem's conclusions hold? Be sure to explain the importance of the distinction between small groups and large groups in the application of the theorem. What did Coase mean when he referred to the reciprocal nature of the problem with regard to his theorem?

The Coase Theorem states that if property rights are well defined and transactions costs are low, private parties can internalize an externality. Let's define some of these terms: 1) Property rights establish the legal owner of a resource and specify the ways in which the resource may be used. 2) Transactions costs are the costs of "doing business", relating to: time, communication, etc. 3) Internalizing an externality is when the (marginal) social and private costs/benefits are brought together. Coase's main point: 1. Externalities are reciprocal in nature. ▪ Not only does the pollution cause an externality, but also the presence of the victims harms the polluter. ▪ If no one were harmed, there would be no problem. In small numbers: low transactions costs. Resources allocated with minimal government involvement. In large numbers: high transactions costs. Resource allocation depends on assignment of property rights

Explain the logic behind the Laffer curve, using graphs to help illustrate the concept. What are the implications of this idea for tax reform—both past reforms and potential reforms at the present time?

The Laffer curve is a theory to show the relationship between tax rates and tax revenue collected by governments. Laffer's argument is that sometimes cutting tax rates can increase total tax revenue. Reducing or increasing tax rates too much would decrease the tax revenue using this theory. One example of optimizing tax rates using the Laffer curve occurred in India, where in the 1970's the marginal tax rate was 97.5% and was reduced to 30% by 1997-1998. Over the years, tax collection from personal income tax has improved. The reduction in tax rates may have encouraged individuals to work more, generate more income and pay taxes rather than evade.

The Tiebout hypothesis suggests that producing public goods locally can be more efficient than producing them at a higher level of government. Explain why this is so. List and discuss some of the advantages of local public good provision compared to provision by higher level governments, and some of the disadvantages

The Tiebout hypothesis improves the allocation of resources by more closely matching the package of government activity with voter/consumer preferences. Consumers may also move to a location that has their preferred level of public services. One disadvantage is that towns typically finance their public goods instead through a property tax that is levied in proportion to the value of homes. The problem that this property taxation causes is that the poor chase the rich. Richer people pay a larger share of the public goods bill than do poorer people, so people who value those goods would like to live in a community with people richer than they are.

Consider an excise tax put on a good in a competitive market. What happens to the amount of tax revenues collected as the tax rate on the good is increased? Explain the relationship between tax rates and tax revenues, illustrating your points graphically.

The amount of tax revenue increases correlated with an increase on the tax rate because an excise tax focuses on reducing the amount of an undesirable good and thus compensating the government in the process. The relationship is that as the tax rate is higher then the tax revenue will tend to be higher, however, this may cause inefficiencies as the quantity demanded of a good decreases with an increase on its tax rate.

What is the common pool problem? Discuss how the problem can be solved, making sure to distinguish solutions that might apply to small groups from solutions that apply to large groups. Why would potential solutions to the common pool problem for small and large groups be different?

The common pool problem is the common ownership where all owners have the right to use the resources and have the incentive to overuse them. In result, common pool resources are subject to problems such as congestion overuse pollution and potential destruction unless use limits are enforced. Solutions for common pool problems are clearly defined property rights over the resources. Solutions for small groups solutions for large groups, why they differ.

What is the excess burden of taxation? Why is there an excess burden, and what factors affect the size of the excess burden for a specific tax? If several goods are to be taxed, how should the taxes be distributed to minimize the excess burden of taxation?

The excess burden of taxation is the efficiency cost, or deadweight loss, associated with taxation. There is an excess burden because of the presence of taxes and subsidies in the market. The area of the associated commonly measures the excess burden of taxation "Harberger triangle". The base of the Harberger triangle is the amount by which Economic behavior changes as a result of price distortions introduced by the tax, and the height of the Harberger triangle is the magnitude of the tax burden per unit of economic activity. Taxes should be distributed through tax commodities in inelastic supply and demand, so that the impact on the quantity is smaller.

4. What is the free rider problem? What is the prisoners' dilemma game? Explain the relationship between the free rider problem and the prisoners' dilemma game. What solutions are possible to the free rider problem, both inside and outside of government?

The free rider problem is a market failure that occurs when people take advantage of being able to use a common resource, or collective good, without paying for it, as is the case when citizens of a country utilize public goods without paying their fair share in taxes. The prisoner's dilemma is a paradox in decision analysis in which two individuals acting in their own self-interest pursue a course of action that does not result in the ideal outcome. The typical prisoner's dilemma is set up in such a way that both parties choose to protect themselves at the expense of the other participant.

Congressional decision-making tends to resemble a distributive game in that each member of congress tries to get special interest programs passed rather than those in the general public interest.a) Explain why this is so. b) Show how this type of situation could lead to a cyclical majority, using a numerical example if possible. c) Explain why such cycles are rarely observed in the real world. d) Explain how this situation could lead to a unanimous coalition in which each member would be better off outside the coalition. Why would someone vote for something that would make him worse off than the status quo?

The fundamental incentive steering political behavior is reelection. If members do not satisfy voters in their districts, they will not survive in Congress. Furthermore, the most powerful positions in the House and Senate go to the members who have been there the longest, so the quest for reelection drives much of what Congress does. B. This course of action will lead to a cyclical majority because congressman's will try to further national involvement between public purpose and private interests to expand the probability of retaining their power positions and fulfilling their personal interests. C. The cyclical theory is a tool to analyze political, social, and economic change with philosophy, identifying recurring trends and correlations. The cyclical majority theory will not be accurate predicting events in the future because historians lack the benefit of hindsight thus won't be able to provide crucial knowledge and understanding of trends D. A cyclical theory will often lead to a unanimous coalition because the distribution of resources is determined by the majority rule. A unanimous coalition doesn't pursue the benefits to every individual but does provide to a majority. That's why unanimous coalitions are only beneficial for majority groups rather than every single individual. E. Because the political entrepreneur does not need to provide benefits for every citizen but just to a majority, resources can be taken away from minorities to enrich a majority. That's why there are always entrepreneurial opportunities available in democracy

A market economy can operate only if the rights of individuals are protected. Explain why. What are the three institutions of government that protect individual rights? Briefly explain the function of each institution

The market system is able to allocate resources efficiently because all individuals have the right to exchange the output the produce for output produced by others. This presupposes that individuals have the right to the output they produce and have the right to freedom of exchange. These rights are protected by the police, national defense, and the court system. Police protection safeguards individuals from having their rights violated by other members of the society. National defense protects individuals from aggression by foreign countries. The court system settles legitimate disputes that arise among individuals. Without government protection of rights, people would have to find ways to protect their own rights, which would greatly reduce the efficiency of an economy. People would have no incentive to produce any more than they could individually protect if their rights were not safeguarded. Therefore, the productivity of a market economy rests on the foundation of a society that protects the rights of individuals. People have no incentive to produce goods that they expect would just be stolen from them.

Explain the capture theory of regulation. Give an example of regulatory capture to illustrate your explanation.

The notion that a government agency established to regulate an industry for the benefit of society acts instead for the benefit of the industry. In effect, the government agency is "captured" by the industry it is regulating. The capture theory of regulation indicates that government regulator acts as the decision-making "head" of a now monopolized industry. This is achieved by a "rotating door" between the government agency and the industry, with members of the regulating agency being former and future employees of the industry. Rather than promoting efficiency, the regulating agency creates an inefficient allocation of resources. With this in mind, when an issue comes before the agency, such as whether or not manufacturers should be required to use a more expensive material that doesn't tend to explode when the temperature reaches a certain point, they are likely to rule in favor of a less expensive (possibly exploding), but more profitable material.

Jet aircraft taking off and landing at commercial airports generate an externality because the noise they make disturbs those on the ground in close proximity to the airport. One way to deal with the externality would be to tax the airlines. Explain how the optimal tax would be designed, and why it would be effective at reducing the external cost. Use a graph to explain the design of the tax. Should the revenue collected from this tax be paid to those who own property below to compensate them for the harm they suffer? Discuss the advantages and disadvantages of using the revenue from the tax to compensate those on whom the aircraft noise is imposed

The optimal tax is equal to the negative externality. Optimal tax would be effective at reducing the external cost because when they have to pay the cost, the supply will shift down and they will produce less. Also, it shouldn't t be paid to the people living there because this will take away their incentive to move away. Both the airplanes and the people living there are causing the issue so if the people living there are being compensated then there is no incentive to leave. The advantage is that then there will be no one injured.

Explain the demand-revealing system of voting proposed by Clarke, including the way in which his "Clarke taxes" help to make the system work. In what respects would the Clarke system be better than simple majority rule? In what respects would it be worse?

The problem with voting for collective goods is that it does not measure the intensity of preference. Someone who mildly favors a project has the same voting rights as someone who has a great desire for it, which can lead to irrational outcomes. Ex: Suppose you have 2 housemates, three of whom consider to buy a television for the house. Two vote against the new TV and one greatly desires it. If he buys it himself, free rider problem, if they all buy evenly, not all benefit equally etc. The Clarke tax replaces voting system on social programs. Thus if an interest group wants to acquire more funds from social programs they would have to compensate for that program. It would be better than simple majority rule because it would allow for the true demand of each program to be measure more efficiently. However, it could add significant transaction costs, as the voting system is complex.

Two alternative ways of taxing real estate are site value taxation and taxation based on assessed value. Explain the differences between these two types of taxation. Which type of taxation will have the lower excess burden? Why?

The simplest type of land tax is a tax that is fixed per acre of land, which, is virtually impossible to avoid paying (except by abandoning the property). In this case, the owner bears the entire burden of the tax, because the supply of land is completely inelastic because it is fixed in supply. Even though the entire burden is still on the owner, taxing is based on assessed value and provides a disincentive to making capital improvements on the property. Therefore, site value taxation will have the lower excess burden because people are not trying to avoid the tax by not making capital improvements. Site value taxation is a tax paid by the buyer of the home on just the mount of land the buyer has purchased. Consider a per-acre tax on land that has nothing to do with the assessed value of the home or its improvements. This would be paid up front by the original purchaser of the land and the cost of that tax would be a part of the price of the home. A person would have to pay the peracre tax every year. Assessed value taxation taxes the overall value of a property. This provides a disincentive to improve land or property. Which in turn decreases the incentive to invest in property improvements. Therefore, site value taxation has the lower excess burden.

During the 19th century, buffalo were hunted almost to extinction in western America, while the population of cattle grew substantially. During this period, however, people were killing and consuming far more cattle than buffalo. Explain why the buffalo population was declining but the cattle population was growing under these circumstances. Next, explain why the principle that describes the decline in the buffalo population also explains why many contemporary American cities have so much air pollution. What are some possible solutions to problems such as pollution and the potential extinction of animal species

There are no clearly defined property rights for buffalo and likewise with clean air. This means that no one has an incentive to protect it. Unlike with cattle, where people had an incentive to breed the population and keep it alive. A possible solution is that companies could be given marketable pollution rights, basically a company is given the right to make whatever amount of pollution. They can make that much pollution, or if they don't use that much then they can sell the right to another company.

Some critics of the current tax structure in the United States argue that there is a double tax on saving and that the tax structure should be overhauled. Others argue that taxes on saving should be higher. Explain and evaluate the argument that there is a double tax on saving. As a result of your explanation, do you think that the current tax structure should be changed? Give an economic justification for your opinion

There is a double tax on the current income tax because income is salary, interest earned, dividends, and capital gains. Savings is taxed also, which discourages saving and working. People will be more inclined to invest in luxury goods they can get immediate gratification from rather than be taxed. Double tax on savings: taxed once income is taxed, and again when capital gain is taxed. Argue for reform because it would increase the incentive to invest which would push level of investment to the optimal level

With increasing awareness of long-term problems with petroleum supplies there has been some discussion of increasing the per-gallon tax on gasoline. One Senator, representing an oil-consuming state, advocates placing a per-gallon tax on the suppliers of gasoline, supporting the tax but saying that overburdened consumers deserve a break. Another Senator, representing an oil-producing state, says that energy suppliers are burdened enough already and that we do not want to create further disincentives for producers, so the tax should be placed on the demanders. Explain, using graphs to illustrate your answer, what difference it would make whether a per-gallon tax on gasoline was placed on the suppliers of gasoline or on the demanders.

There would not be a difference whether the per gallon tax was imposed on the supplier or the demander. It is imposed on the buyer if the buyer pays a price for the good and then also pays the tax on top of that. Similarly, if the tax is imposed on the seller, the price charged to the buyer includes the tax. Regardless, the buyer cares about the total price paid and will pay the same in both situations.

Assume that a redistribution program is instituted which guarantees a certain minimum income. The program pays people the guaranteed amount if they earn no income, and reduces the amount people are paid by $.50 for every $1.00 of income earned. How would this program affect the incentive to earn income? Will low-income people necessarily have higher incomes with this program than without it? Use a graph to illustrate the points in your answer

This would be the reverse income tax. Graph on pg 391. A payment amount is agreed upon and for each additional dollar a person earned, half that dollar is subtracted from the reverse income payment. Ex: Gov pays out direct benefit of $10k to someone who earns no income and payments stop at $20k, a person making $7K in income would make $13.5k in total income after the negative income tax is paid. That's $7k+($10k-.5($7k)) = $13,500. This ensures that there is still an inventive to work and increase overall income. Low-income people would actually have higher incomes with the program until they make $20,000, in which each additional dollar is taxed.

Governments should act to further the public interest. This statement would probably receive general agreement, but it is not always clear exactly what determines when something is in the public interest. Discuss various measures of the public interest, including utilitarianism, the Pareto criteria, potential compensation, and the social welfare function. Explain each concept and the advantages and disadvantages of each.

Utilitarianism is the doctrine that an action is right insofar as it promotes happiness, and that the greatest happiness of the greatest number should be the guiding principle of conduct. It has several advantages such as: 1. It presents a strong sense of purpose. By using a utilitarian view to look at every decision you will make, every choice would become very important to you. As a result, you will start thinking of the things you do in a broader picture, which will affect more than just yourself. 2. It promotes a world with more happiness. Generally, utilitarians would want everything and everyone to be happy in making decisions, which could be very advantageous because it helps individuals to truly think about the consequences of their actions. 3. It articulates the basic human nature of feelings. Since birth, human beings are already conditioned to like or fear things based on the feelings that they can cause. Hurting yourself physically can cause us pain, while funny things can make us happy. The theory of utilitarianism just articulates the basic human nature of feelings. 4. It helps with making tough decisions. People naturally face difficult choices, with desires and emotions taking over decisions most of the time. But with this theory of ethics, we will be able to think rationally and eventually make the right choices. List of Disadvantages of Utilitarianism 1. It is disputable on whether who can decide good or bad. No one exactly knows who has the absolute right to say what is good or bad, as every individual is wired differently with different beliefs on certain things. For example, while some people believe that drinking alcohol brings happiness, others would disagree and argue that it is toxic to the body. When so much judgment is left to morality, issues will definitely arise. 2. It prevents us to make speculations about the future. If you judge actions based on outcomes, then you can never make accurate judgments. After all, it is very difficult to accurately determine the exact consequences, making the ideals behind this theory irrelevant. 3. It promotes favoritism. It would be difficult for someone to make a utilitarian decision with their loved ones on the line, as his/her instincts would take over, making him/her favor those he/she loves. 4. It can lead to missed opportunities. For situations that require quick decisions, utilitarianism would not work effectively. Most of the time, the chance to make a truly correct decision would be lost during calculation. Pareto criteria is any criterion for allocating an economy's resources at "unity", where re-allocation of resources cannot improve conditions for one person or group, without worsening conditions for others. Pareto criteria is: Pareto superiority: change makes at least one person better off; no one worse off and compares two possible situations Pareto optimality: no one can be made better off without making one person worse off and it is applied to a single situation Disadvantages: Not possible to adhere strictly to Pareto criteria. Lends legitimacy to status quo. Does not rank all possible states of the world Advantages: Market Exchange and Pareto Criteria Satisfies utilitarian criterion. Satisfies Pareto superiority (in absence of negative externalities) Potential compensation: gainers value gains more than losers value losses. Social welfare function: indifference curves depicting welfare of entire society.

Critics of Walmart argue that when the company opens stores in small towns, it tends to harm small locally run businesses, creating an externality. Explain how this externality is created, and discuss the public policy options to deal with it. What is the appropriate public policy (you may discuss more than one policy if you want), and why is the policy (or policies) you suggest appropriate?

Walmart is creating a pecucionary externality for small businesses, it's internal to the marketplace. Public policy options would be to prevent Walmart from moving into the city with zoning regulations. You could tax Walmart. However, the best thing to do is to not tax them because that is the best thing for the market because products will become more expensive. Nonetheless, in reality that would be very unpopular with the public that is being harmed so it is likely to not happen.

Explain the rationale for zoning laws, and discuss both common law and contractual alternatives to zoning that can address the same issues. What are the advantages and disadvantages of each? How have these alternatives been applied in the twenty-first century?

Zoning laws regulate the use of land within a municipality. It controls the ways in which the land can be developed and what purposes the zoned land can serve. Zoning is what keeps a residential district residential, a commercial district commercial, an industrial district industrial, and so on. Houston uses an assortment of urban planning tools that are zoning in all but name, include population density restrictions in some parts of the city, building height and setback buffering ordinances, lot size limitations and historic building preservation rules. Other tools that parallel zoning laws include those found in many other cities, such as developer-initiated deed restrictions and homeowners association rules.[1] In some places, zoning laws apply for local development tax reinvestment purposes and there is federally-mandated zoning in the vicinity of the city's airports.[2]

Explain the difference between the concepts of Pareto optimality and Pareto superiority. If a policy change moves the economy from a non-Pareto optimal situation to a Pareto optimal situation, does this necessarily imply an improvement in social welfare? Explain your answer, and illustrate it in an Edgeworth box diagram.

n Pareto Optimality there is no superior move possible from the current point of distribution. All possible moves are inferior in nature. Thus, no move can be preferred or defended by policy makers.Pareto Optimality is used heavily in political economics as a means to distribute resources in a more efficient manner to increase overall social utility. As it is the stated goal to promote the general interest of the public, Pareto Improvements are desirable to government officials seeking to act in the name of the electorate. Another practical uses include managers seeking to make decisions for investors, the company and consumers that serves everyone's interests. Pareto Superiority is a move from one distribution point to another is said to be superior when at least one party is better off and no one else is worse off. (This includes moves that benefit all parties; the essential concern is that no one is worse off after the move compared to welfare before the move.) A to E: Pareto Superior improvement in social welfare. If we move from A to E, it is a Pareto Superior move, because at least one person is better off and no one worse off, this means improvement in social welfare. A to C: Pareto Optimal, efficient allocation of resources, however can't tell if improvement in social welfare. In this move we cannot tell if improvements in social welfare despite moving to Pareto Optimal. At this point no one can be made better off with making someone worse off. This is because we can't tell if the utility gain from Janice offsets the utility loss from Steve.

Explain the relationship between Lindahl equilibrium and efficiency in the production of a collective consumption good. Does Lindahl equilibrium necessarily imply that the good is being produced efficiently? Does efficiency in the production of the good necessarily imply Lindahl equilibrium? How is Lindahl equilibrium beneficial to the political process of agreeing on the quantity of public sector output? Use a graph to illustrate your answer.

n collective consumption goods the consumption by one consumer will not reduce the consumption of any other consumer. MC = 0. Example: radio broadcast signal. Lindahl Pricing is set so each individual pays a marginal price equal to the marginal benefit that individual receives. In the equilibrium state, all individuals consume the same quantity of public goods but may face different prices because some people may value a particular good more than others. The Lindahl equilibrium price is the resulting amount paid by an individual for his or her share of the public goods. The relationship between these two is that collective consumption goods are public goods that are available for the society without incurring marginal costs on consumers. The lindahl pricing theory will allow to determine the willingness of society members to obtain these public goods and thus enhance an efficient tax price that correlates their willingness to bear the production of the good. Lindahl equilibrium does not necessarily imply that the good is being produced efficiently. Lindahl pricing is not necessary for the efficient level of output because individuals cannot adjust individual quantity consumed. Price does not have to equal consumer's marginal valuation to be efficient.

What is the Coase theorem? The Coase theorem is often applied to externalities due to market activities. How does this idea apply to political decision-making and the design of public policy?

where there are complete competitive markets with no transaction costs and an efficient set of inputs and outputs, an optimal decision will be selected. It basically asserts that bargaining between individuals or groups related to property rights will lead to an optimal and efficient outcome, no matter what that outcome is.