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304 Midterm 1
Terms in this set (91)
First Fundamental Theorem of Welfare
The equilibrium outcome of competitive free market trading, production, and consumption is Pareto efficient if
1) no market power
2) no imperfect information
3) no transaction costs
4) no externalities
No one can be made better off without making someone else worse off.
Goods for which the investment of any one individual benefits everyone in a larger group.
The theory of how the political process produces decisions that affect individuals and the economy.
The Four Questions of Public Finance
1. When should the government intervene? ** Most important!
2. How might the government intervene?
3. What is the effect of those interventions on economic outcomes?
4. Why do governments choose to intervene in the way they do?
The study of the role of the government in the economy.
Arise whenever the actions of one party make another party worse off or better off, yet the first party neither bears the costs nor receives the benefits of doing so.
A problem that causes the market economy to deliver an outcome that does not maximize efficiency.
The shifting of resources from some groups in society to others.
When should government intervene in the economy?
1. Market failures - but just because the private market outcome is not efficiency maximizing does not imply that the government intervention will necessarily improve efficiency.
2. Redistribution - Resources allocations are unfair; typically produce efficiency losses.
How might the government intervene?
1. Tax or subsidize private sale or purchase - price mechanisms.
2. Restrict or mandate private sale or purchase, "thou shall", ex) mandating health care in Switzerland.
3. Public provision - government provides the good directly, ex) Canada provides health care.
4. Public financing of private provision - finance private entities to provide a desired level of a good, ex) Medicare prescription drug benefit, government reimburses insurers.
What are the effects of interventions?
1. Direct effects - the effects that would be predicted if individuals did not change their behavior in response to the interventions, ex) cost of providing free public health care in the US.
2. Indirect effects - the effects that arise only because individuals change their behavior in response to the intervention, ex) incentives that would arise for people paying for health care to get free government health care.
Why do governments choose to intervene the way they do?
Political economy, the theory of how governments make public policy decisions.
Government must aggregate the preferences of all Americans - but do they do this? There are government failures and market failures.
The externality is entirely confined to prices and hence does NOT cause market failure.
Private Marginal Cost (PMC) v. Social Marginal Cost (SMC)
PMC - the direct cost to producers of adding an additional unit of a good.
SMC - the PMC plus any costs associated with the production of the good that are imposed on others.
Internalizing the externality!
When there are well-defined property rights and costless bargaining, then negotiations between the party creating the externality and the party affected by the externality can bring about the socially optimal market quantity.
The efficient solution to an externality does not depend on which party is assigned the property rights, so long as someone is assigned those rights. (The welfare of the parties will change by changing the assignment of the rights and the outcome may change as well, but it is Pareto efficient either way.)
Problems with the Coase Theorem
1. Assignment problem
2. Holdout problem
3. Free-rider problem
4. Transaction costs and negotiating problems
When an investment has a personal cost but a common benefit, individuals will underinvest.
Tax the externality at a rate equal to marginal damages.
Government mandates the socially optimal quantity.
Rain that is unusually acidic due to contamination by emissions of sulfur dioxide and nitrogen oxide.
1970 Clean Air Act
Landmark federal legislation that first regulated acid rain-causing emissions by setting maximum standards for atmospheric concentrations of various substances in NEW plants, including sulfur dioxide.
Costs estimated at 600,000 jobs and $75 billion, but benefits are magnitudes greater.
SO2 Allowance System
The feature of the 1990 amendments to the Clean Air Act that granted plants permits to emit SO2 in limited quantities and allowed them to trade those permits.
International Emissions Trading
Under the Kyoto treaty, the industrialized signatories are allowed to trade emissions rights among themselves, as long as the total emissions goals are met.
Changes to insurance premiums that insurance companies make in order to compensate for expected expense differences.
The damage one does to oneself through adverse health (or other) behaviors.
In 1987, banned CFCs. Key was that there was a cost-competitive chemical that could replace CFCs.
Challenges Using Tradable Carbon Permits
1) Price volatility
2) Must allow "banking" - permits not usable past 2008
3) Took nearly 10 years to implement
4) Windfall profits for polluters
5) RGGI: Cap set too high (auction price very low)
Theory of the Median Voter Model
If politicians care about maximizing the number of votes that they get, then they will appeal to the median voters' preferences on specific issues
Pure Public Goods
Goods that are perfectly non-rival in consumption and are non-excludable.
Non-Rival in Consumption
One individual's consumption of a good does not affect another's opportunity to consume the good.
Assumptions of the Median Voter Theory
1) Single-dimensional voting - voters are basing their votes on a single issue
2) No money can influence the voters' decisions
3) No ideology/influence - ideology shouldn't play a role in how the politician wants to market his/her political preferences to voters
4) Full information - all voters are fully informed about the issues
5) No selective voting- assumes that all people affected by public goods will vote!
6) Only 2 candidates are competing!
Individuals cannot deny each other the opportunity to consume a good.
Impure Public Goods
Goods that satisfy the two public good conditions (non-rival in consumption and non-excludable) to some extent, but not fully.
cash-flow accounting and problems with it
accounting method that calculates costs solely by adding up what the government pays for inputs to a project, and calculates benefits solely by adding up income or gov. revenues generated by the project. Ignores:
1) Opportunity cost
2) non-market costs and benefits
3) discounting the future and treating risk
4) governments need to care about more than themselves i.e. their citizens
A good for which the price is set at $1 to model choice between goods, which depends on relative, not absolute, prices.
when individuals value the benefits and costs to others in making their consumption choices (donating anonymously would be altruistic
The value of altruistic and communal behavior in society
warm glow model
individuals care both about the total amount of public good and their contribution as well (donating publicly so that you not only get the altruistic feeling of others benefitting, but also warm glow that YOU are being recognized for benefitting them)
as the government provides more of a public good, the private sector will provide less
Estimating Preferences for Public Goods: 3 problems
1) Preference Revelation - people may understate their true valuation so that the government won't charge them a higher price
2) Preference Aggregation - how can we add up every single person's preferences
3) Preference knowledge - people may not have valuation on what their preferences actually are
Four Assumptions of First Fundamental Welfare Theorem
1) No market power
2) No imperfect information
3) No transaction costs
4) No externalities
If EPA's cost benefit analysis concludes that regulations under the Clean Air Act are cost-beneficial, then what must be true?
EPA's regulations are better than the do-nothing alternative
Suppose the government wishes to provide college tuition aid to one of the following groups of high school students. Which target group would most limit the possible extent of indirect effects?
Students whose father has died recently
The effects of government interventions that would be predicted if individuals did not change their behavior in response to the interventions.
The effects of government interventions that arise only because individuals change their behavior in response to the interventions.
Which of the following correctly depicts the changes in the sources of federal, state, and local receipts in the past 50 years?
Corporate and excise taxes are now a smaller share of federal receipts.
Defense spending currently makes up approximately _______ of the total federal discretionary budget in the United States.
How governments should intervene is a _________ question, and why governments intervene in the way they do is a __________ question.
Which of the following is the government agency that uses empirical economics to achieve its mission of providing Congress with objective, nonpartisan analyses necessary for economic and budget decisions?
Congressional Budget Office
The Medicare insurance program in the United States reimburses hospitals and doctors for providing health care services to the elderly. This is an example of:
public financing of private provision.
Veterans receive health benefits directly through hospitals owned and operated by the Veterans Health Administration. This is an example of:
The equity-efficiency trade-off means that the result of obtaining __________ in equality is also to obtain __________ in the so-called size of the pie.
an increase; a decrease
Suppose the government proposes a program that will transfer income from one group to another. The goal of this government intervention in the marketplace is best characterized as:
Suppose a consumer values a certain 19-inch television set at $150, and the seller is unwilling to sell the set for less than $200. What price will lead to an efficient transaction between the potential buyer and seller?
No price will lead to an efficient transaction.
Suppose government wants to get the amount of pollution right. Which instrument for intervention should the government choose?
When the social marginal benefit curve of reduction of pollution is locally flat and the costs of reduction are uncertain, which of the following generally makes sense?
price (tax) intervention
If the social marginal benefit curve of reducing pollution is locally flat, which of the following must be true?
There is little differential benefit to society from a small or a large reduction.
The marginal damage curve of pollution is flat.
In a free market with pollution and no government intervention, the market equilibrium quantity of pollution reduction is reached when:
pollution reduction is zero.
Suppose government instead subsidized the consumption of education. The subsidy would:
shift the private demand curve to the right.
Government subsidizes education in part because education is believed to produce a positive externality. The subsidy:
shifts the private supply curve to the right.
Suppose that factories in Chicago, Illinois, and Gary, Indiana, produce pollution that affects people living in western Michigan. Even though the polluting plants and affected individuals can be identified, the externality cannot be resolved privately because of the large number of polluters and affected individuals. This is an example of:
transaction costs and negotiating problems.
With respect to solving a problem of a negative externality, the assignment problem refers to difficulty in determining:
who is to blame for an externality and who bears the damage of the externality.
The ____________ is the direct benefit to consumers of consuming an additional unit of a good.
private marginal benefit
To maximize total welfare, one must equate ________ with ____________.
marginal social benefit; marginal social cost
To maximize social welfare when there are no externalities, __________ must be equal to __________.
private costs; social costs
marginal private costs; marginal private benefits
social benefits; private benefits
Suppose that a market is in equilibrium and there is no government intervention in the market. If the private marginal cost of producing an item is $4 and the social marginal cost of production is $6, what is the private marginal benefit of the item?
The fact that 80% of smokers wish to quit but fewer than 80% quit is evidence of:
a self-control problem.
Which of the following implies that smoking causes a negative externality?
Employers lower all wages to account for less productive workers.
The problem addressed by the Kyoto treaty was getting _________ in 1997; the problem addressed by the Montreal Protocol of 1987 was getting _________ in 1987.
worse slowly; worse quickly
Which of the following was an unintended consequence of the 1970 Clean Air Act?
Utilities ran plants built prior to 1970 longer than they would have otherwise.
Suppose the government can pursue up to three projects. The first has benefits of $300 and costs of $270; the second has benefits of $580 and costs of $460; the third has benefits of $90 and costs of $80. Suppose that it costs $0.15 for the government to raise $1 in revenues. Which project should the government pursue?
the second project
Suppose that the businesses in a small town get together and decide each of them will renovate their buildings to make the downtown area more attractive to shoppers. What problem may prevent this plan from going into action?
the free rider problem
Which of the following is true when there is optimal provision of a public good?
the sum of all consumers' marginal rates of substitution equals marginal cost
A good for which the price is set at $1 to model choice between goods is:
a numeraire good.
If one person is UNABLE to prevent another person from consuming or having access to a good, that good is:
A road, which can be considered as nonexcludable but rival in consumption, is an example of:
an impure public good.
Suppose that you estimate the value of life by comparing the earnings and probabilities of death from working on a fishing boat in Alaska with the earnings and probabilities of death from working in a fish processing plant in Alaska. You find that a year of life is valued at $6 million. If risk-loving people take the jobs on the boats and risk-averse people take jobs at the processing plants, then what will be true of your estimate?
It will understate by an unknown amount the value of a life for the average person.
The consensus value of a life based on the revealed preference approach is approximately equal to:
$9*** million. (or 7 million, pick the figure that's closest)
If the present discounted value of $110 next year is $100 this year, what is the implied annual rate of interest?
If an input is sold in a perfectly competitive market, its price is equal to:
The accounting method that calculates costs solely by adding up what the government pays for inputs to a project and calculates benefits solely by adding up government revenues generated by the project is:
The school of thought that emphasizes that government failures are too often minimized by public finance economists is:
Public choice theory
Suppose a state has two senators; one is Republican and the other is a Democrat. The median voter model predicts that:
each will vote the same way as the other, which is inconsistent with empirical voting records.
The property of the independence of irrelevant alternatives refers to which of the following?
Choices must satisfy the condition that if one choice is preferred to another, then the introduction of a third choice will not change that ranking.
Which acronym is most often revealed by hedonic regression?
VSL- value of a statistical life
Arrows Impossibility Theorem
I - independence of of irrelevant alternatives
N - non-dictatorship
P- Pareto Criterion
U - unrestricted domain
T - Transitivity
Arrows Impossibility is basically that with more than 2 options there is no method that satisfies INPUT (there is no social decision-making strategy that can prevent dictatorship/ restricts preferences while converting individual preferences into consistent aggregate decisions)
Command n Control. Must know MD and SMC curves
Challenges to CBA valuation of non-market goods
Various biases of stated preferences
Revealed preferences are limited in what they can detect
Conditions of Median Voter Theorem
Preferences are single-peaked or single crossing
May's Pairwise Majority Theorem
when chosing between only 2 options Majority rule voting is the only decision making process that satisfies 4 conditions
o Anonymity- All individuals count the same
o Neutrality- All options should receive equal consideration
o Decisiveness - some option will always be selected, no dead lock
o Positive Responsiveness- If an option were to be selected and then suddenly supported by more individuals it should still be selected.
THIS SET IS OFTEN IN FOLDERS WITH...
Public Finance Midterm Review
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