Homework 1.

E4821 Public Economics Spring 2013 Due: February 7, before the lecture Problem 1 Suppose that a consumer wants to maximize his happiness as expressed by utility function u(c1 , c2 ). His/her income is M and the prices of goods 1 and 2 are p1 , p2 . (a) Write down the problem of the consumer. (b) Write down the Lagrangian for the problem
(c) Write down the rst order necessary condition for c 1 , c2 ,

FOC for c1 to get lamda=...

.

(d) Suppose that u(c1 , c2 ) = log c1 + A log c2 . Use FOC from part (c) to nd optimal c 1 , c2 as functions of p1 , p2 , M . Hint: Use FOC for c1 to solve for c1 in terms of and FOC for c2 to solve for c2 in terms of , plug these into the budget constraint, solve the resulting equation for and nally plug it back into the expressions for c1 , c2 . (e) Suppose that u(c1 , c2 ) = 1 11 + 2 12 . Use FOC from part (c) to nd optimal c 1 , c2 as 1 a functions of p1 , p2 , 1 , 2 , M . Hint: If y = x then x = y a . c1 c1

(f) Suppose that

= 1. How do c 1 , c2 from part (e) compare to c1 , c2 from part (d)?

Problem 2 Consider an endowment economy with two consumers - Tom Hanks and Wilson, and two goods coconuts and sh. Denote by cT H , cW , f T H , f W the consumption of coconuts and sh by Tom Hanks an Wilson respectively. Assume that their utility functions are U T H (cT H , f T H ) = log cT H + AT H log f T H U W (cW , f W ) = log cW + AW log f W Tom Hanks an Wilson dont have money, but they do have endowments of coconuts and sh which we H W TH W denote by eT c , ec , e f , ef . (a) Suppose that prices of sh pf and coconuts pc are determined by competitive markets. Write down the consumers problem for Tom Hanks and the consumers problem for Wilson. (b) Dene a competitive equilibrium for the economy. (c) Let M T H be the total value of endowments of Tom Hanks, and M W the total value of endowments H TH of Wilson. Write the formula for M HT using pc , pf , eT and the formula for M W using c , ef W W pc , pf , ec , ef . Use the solution for Problem 1(d) to write the expressions for optimal choices c T H , cW , f T H , f W . (d) Suppose now that there is a government that needs to spend Gf sh and Gc coconuts on defense H W TH W of the island, and is thus using taxes tT c , tc , tf , tf to collect enough coconuts and sh from H Tom Hanks and Wilson. (So for example tT is how many coconuts government takes from Tom c Hanks.) (e) Dene a competitive equilibrium for the economy with government.

Problem 3 Go to the webpage of Economic Report of the President www.gpoaccess.gov/eop/download.html and click on the link for year 2012. Obtain Population from Table B34. Obtain Federal government receipts, outlays, surplus/decit, debt and GDP from Table B78. Construct the following time series 1. federal receipts as % of GDP, 2. outlays as % of GDP 3. decit as % of GDP 4. debt as % of GDP 5. debt in per capita term (by dividing them with population). Then create the following charts 1. A line chart with receipts and with outlays as % of GDP (both time series plotted together) 2. A line chart with decit as % of GDP. 3. A line chart with debt as % of GDP 4. A line with debt per capita. Find who was president in US in which years since 1945, whether he was Republican or Democrat, and add this information to both graphs (draw vertical lines separating presidents). Here is an example to give you the idea what your charts should look like (this chart however shows dierent time series than those you should plot).

Comment briey the four charts that you have obtained. Submit only charts and comments, do not print out tables!