4

True/False: (10 Questions, 2 Points Each, 20 Points Total)

1. The costs imposed by government regulations on business firms are included in
budget data on government expenditures. (

2. The government should abolish tariffs to achieve efficiency is a normative

statement. (

3. The marginal social cost of producing another unit of a pure public good will
always be positive. (

4. If the marginal external cost of pollution increases with the annual output of polluting goods,
then the total external cost will increase at a constant rate with annual output. (

5. If all voters have the identical most-preferred political outcome, given their tax shares, then
the political equilibrium under majority rule will be identical to the political equilibrium under
unanimous consent. (

6. A consumer currently pays $500 a year retail sales taxes. She would be better off
if she paid the same amount annually as a lump-sum tax. (

7. A payroll tax results in a difference between the gross wages paid by employers
and the net wages received by workers. (

8. If a $10 per unit tax is levied on the output of a monopolist, more of that tax will

be shifted to consumers than would be the case if the same good were produced by
a competitive industry. (

9. An income tax is an example of a price-distorting tax. (

10. If the compensated elasticity of supply of labor is zero, then a tax on labor
earnings will have zero excess burden. (

Concept: (10 Questions, 2 Points Each, 20 Points Total)

1. Public Sector Economics
2. Regulatory Budget
3. Observational Study
4. Pareto improvement
5. Commodity Egalitarianism
6. Command-And-Control Regulations
7. Agenda Manipulation
8. Regressive
9. Inverse Elasticity Rule
10. Horizontal Equity

Essay Questions: (3 Questions, 20 Points Each, 60 Points Total)

1. The US government spends about $1.5 billion for research on alternative

medicine, such as herb and energy field therapy. Is such research a public good? Is
it sensible for the government to pay for such research?
2. The private marginal benefit for commodity X is given by 10-X, where X is the
number of units consumed. The private marginal cost of producing X is constant at
$5. For each unit of X produced, an external cost of $2 is imposed on members of
society. In the absence of any government intervention, how much X is produced?
What is the efficient level of production of X? what is the gain to society involved in
moving from the inefficient to the efficient level of production? Suggest a Pigouvian
tax that would lead to the efficient level. How much revenue would the tax raise?
3. A New York Times editorialist recently advocated a cut in the payroll tax. Among
other advantages, he argued that it would stimulate hiring, since employers
shoulder half the burden of the tax. Sketch a model that is consistent with this
argument. Is it realistic?

__________ _________ __________ _______

20

20

60

100

Question
Number

True/False: (10 Questions, 2 Points Each, 20 Points Total)

10

Answer
Question
Number
Answer

Concept: (10 Questions, 2 Points Each, 20 Points Total)

10

Essay Questions: (3 Questions, 20 Points Each, 60 Points Total)

True/False: (10 Questions, 2 Points Each, 20 Points Total)

Question
Number

Answer

Question
Number

10

Answer

Concept: (10 Questions, 2 Points Each, 20 Points Total)

1. Public Sector Economics: The field of economics (1) that analyzes government
taxation and spending policies (1).
2. Regulatory Budget: An annual statement of the costs

(1) imposed on the

economy by government regulations (1).

3. Observational Study: An empirical study that relies on observed data (1) that are
not obtained from an experimental setting (1).
4. Pareto improvement: A reallocation of resources that makes at least one person

better off (1) without making anyone else worse off (1).

5. Commodity Egalitarianism: The idea that some commodities ought to be made

available (1) to everybody (1).

6. Command-And-Control Regulations: Policies that require a given amount of

pollution reduction (1) with limited or no flexibility with respect to how it may be
achieved (1).
7. Agenda Manipulation: The process of organizing the order (1) in which votes are
taken to ensure a favorable outcome (1).
8. Regressive: A tax system under which an individuals average tax rate decreases
(1) with income (1).
9. Inverse Elasticity Rule: For goods that are unrelated in consumption (1),
efficiency requires that tax rates be inversely proportional to elasticities (1).
10. Horizontal Equity: People in equal positions (1) should be treated equally (1).

Essay Questions: (3 Questions, 20 Points Each, 60 Points Total)

1. Answer: Research on alternative medicine is a public good if the research leads
to treatments or cures that are non-excludable, meaning that others besides those
who discovered the treatment may profit from the treatments. (8) This would
happen if discoveries cannot be patented. (4) Whether or not it is sensible for
government to pay for such research depends on the potential benefits of the
research, which could be substantial if alternative medicine provides effective
treatments, and whether or not the treatments can be patented. (8)

2. Answer: Private Marginal Benefit = 10 X. (2)

Private Marginal Cost = $5. (2)
External Cost = $2. (2)
Without government intervention, PMB = PMC; X = 5 units. . (2)
Social efficiency implies PMB = Social Marginal Costs = $5 + $2 = $7; X = 3 units.
(2)
Gain to society is the area of the triangle whose base is the distance between the
efficient and actual output levels, and whose height is the difference between private
and social marginal cost. Hence, the efficiency gain is (5 - 3)(7 - 5) = 2. (5)
A Pigouvian tax adds to the private marginal cost the amount of the external cost at
the socially optimal level of production. Here a simple tax of $2 per unit will lead to
efficient production. This tax would raise ($2) (3 units) = $6 in revenue. (5)
3. Answer: The imposition of a payroll tax has no effect on employment when the
supply of labor is perfectly inelastic, as shown below. (2) If, on the other hand, the
supply of labor is upward-sloping, the imposition of a payroll tax would cause
equilibrium employment to fall, and cutting the tax would then have a positive effect
on hiring, as suggested by the editorial. (2) It is realistic to assume that, although
labor supply is inelastic, it is not perfectly inelastic. (2)

Wage
Rate per
hour

SL

W1
W2
DL
DL

Hours per year

L1 = L2

(5)
The next graph shows an upward-sloping supply, and illustrates how the tax
reduces equilibrium employment. (2) Cutting the tax would cause the demand
curve to shift back to the right, toward the original demand curve, and cause
equilibrium employment to move back toward L1. (2)
Wage
Rate per
hour

SL

W1
W2
DL
D

L2 L1

Hours per year

(5)