This Document Contains Chapters 1 to 5 Chapter 1 Introduction Multiple Choice 1. Public finance A) is not like public economics. B) develops principles for understanding the economic role of government. C) only works for local and state governments. D) is all of the above. Answer: B 2. A regulatory budget would A) provide an accounting of government regulation. B) be difficult to compute. C) have to be attempted unofficially. D) be all of the above. Answer: D 3. The federal government A) is the largest taxing entity in the country. B) is only concerned with international issues. C) spends heavily on net interest. D) is all of the above. Answer: A 4. State and local governments receive the largest amount of revenue from A) personal income taxes. B) property taxes. C) sales taxes. D) payroll taxes. Answer: C 5. The federal government gets most of its revenue from A) personal income taxes. B) property taxes. C) sales taxes. D) payroll taxes. Answer: A 6. In a pure market economy, A) there is no role for government. B) government intervention might be needed. C) large markets where people meet to buy and sell are required. D) all of the above. Answer: B 7. A government good or service includes A) bridges. B) parks. C) national defense. D) all of the above. Answer: D 8. Government output is hard to account for because government A) is so large. B) provides goods that have no resale value. C) keeps secrets about what it produces. D) goods are generally not sold or produced in easily measurable units. Answer: D 9. Economists who study the role of government in the market A) agree mostly on the role that the government should play. B) study for market problems that the government might help solve. C) find that supply and demand graphs never work for the government. D) do none of the above. Answer: B 10. Economics A) started as a business application B) can never be defined. C) is the study of unlimited wants but limited resources. D) has no “real world” relevance. Answer: C 11. Taxes A) are mandatory payments. B) are necessary for financing government expenditures. C) do not directly relate to the benefit of government goods and services received. D) are all of the above. Answer: D 12. For the government to provide goods and services, citizens A) have to come to an agreement about how much is needed. B) have to agree on a method of financing. C) need to be informed about the opportunity costs. D) must do all of the above. Answer: D 13. Education is A) generally financed at the state and local level. B) too expensive for the federal government. C) generally financed at the federal level. D) financed on a voluntary basis. Answer: A 14. Politics A) play no role in public finance. B) influence government decisions. C) have to be factored into economic decision making. D) do all of the above. Answer: D 15. Individuals A) are too small to matter in macroeconomic decision making. B) need to participate in a democracy. C) make up the government. D) a and b. E) b and c. Answer: E 16. The unified budget is A) a budget that includes all nations. B) a document which itemizes all the federal government’s expenditures and revenues. C) a document that accounts for all spending by states. D) none of the above. Answer: B 17. In 2009, the federal budget was almost A) 1 million pages long. B) 17 pages long. C) 1,300 pages long. D) 500 pages long. Answer: C True/False 18. Social insurance has become an increasingly large portion of federal taxes because of the “Baby Boomer” generation. A) True B) False C) Uncertain Answer: A 19. A very small portion of government expenditures is financed by taxes. A) True B) False C) Uncertain Answer: B 20. In 1965, national defense was just as large a general expenditure as Social Security. A) True B) False C) Uncertain Answer: B 21. The Constitution of the United States says nothing about state economic activity. A) True B) False C) Uncertain Answer: B 22. The taxes paid by citizens are directly related to the benefit of government goods and services received. A) True B) False C) Uncertain Answer: C 23. Interest on the national debt, as a percentage of federal expenditures, has increased significantly since 1965. A) True B) False C) Uncertain Answer: B 24. Local governments rely heavily on property taxes. A) True B) False C) Uncertain Answer: A 25. Government is designed to handle problems not addressed by the private sector. A) True B) False C) Uncertain Answer: C 26. Expenditures, as a percentage of GDP for the United States, are not very different than those of other industrialized nations. A) True B) False C) Uncertain Answer: A 27. Payroll taxes are a major financing tool at the federal level. A) True B) False C) Uncertain Answer: A 28. In 2005, the federal government spent 345.8 billion dollars on income security. A) True B) False C) Uncertain Answer: A 29. Personal income and Social Security payroll taxes are currently the largest sources of government revenue. A) True B) False C) Uncertain Answer: A Essay 30. Write an essay discussing some of the reasons that federal expenditures for Social Security have increased since 1965. Answer: Federal expenditures for Social Security have increased since 1965 for several reasons, including increases in the number of persons entitled to benefits and the introduction of Medicare and other programs. 31. Do you think it is correct policy that the federal government is not required to finance all of its expenditures with tax revenues and is allowed to borrow? What are the implications of this policy? Answer: Answers will vary, but financing out of current spending ensures that there are no deficits at the end of the fiscal year. However, in times of crisis, such as war, this type of financing would limit the government’s ability to accomplish its stated goals. Yes, it is generally accepted economic policy for governments to borrow to finance expenditures, not solely rely on tax revenues. This allows governments to smooth out spending over time, respond to economic downturns, and invest in infrastructure and public services. However, excessive borrowing can lead to concerns about debt sustainability, inflation, and future tax burdens. Balancing borrowing with prudent fiscal management is crucial for long-term economic stability. 32. Why do/should we care that federal expenditures are becoming an increasingly larger portion of GDP? Answer: We should care that federal expenditures are becoming an increasingly larger portion of GDP because of public sector crowding out. 33. Discuss your views on government intervention regarding tobacco consumption. Answer: As with many social issues, tobacco consumption will not only impact the health of the population but the ability of people to work and be productive members of society. Some will argue that this is a private issue and the government has no role in regulating people treat their own bodies but others will counter that the impacts are not just to the consumer but to third parties also. Chapter 2 Tools of Positive Analysis Multiple Choice 1. Positive economics A) does not depend on market interactions. B) only looks at the best parts of the economy. C) examines how the economy actually works (as opposed to how it should work). D) is very subjective. Answer: C 2. The Law of Demand states A) that there is an inverse relationship between price and quantity demanded. B) that the judicial branch of government sets demand schedules. C) that laws can have no effect on market economies. D) none of the above. Answer: A 3. The function Y = f (X, Z) means A) X multiplied by Y equals f. B) X + Y = Z. C) Y is a function of both X and Z. D) none of the above. Answer: C 4. If there is a function and one component is Y3, then there is a ____ in the function. A) square root B) cubic C) cosine D) circle Answer: B 5. Refer to Question 4 above. The equation containing Y3 would be A) linear. B) quadratic. C) a Nash equilibrium. D) inefficient. E) nonlinear. Answer: E 6. Marginal and average taxes are A) calculated using the same methodology. B) not used in modern tax analysis. C) not calculated using the same methodology. D) all of the above. Answer: D 7. The slope of a regression line is calculated by dividing A) the intercept by the change in horizontal distance. B) the change in horizontal distance by the change in vertical distance. C) the change in horizontal distance by the intercept term. D) the change in vertical distance by the change in horizontal distance. E) none of the above. Answer: D 8. Unobserved influences on a regression are captured in the A) error term. B) parameters. C) regression line. D) regression coefficient. Answer: A 9. The following can be analyzed using econometrics: A) labor supply. B) market demand. C) tax setting behavior. D) poverty. E) all of the above. Answer: E 10. Normative economics A) does not depend on market interactions. B) only looks at the best parts of the economy. C) examines how the economy actually works (as opposed to how it should work). D) embodies value judgments. Answer: D 11. The Latin phrase ceteris paribus means A) let the buyer beware. B) other things being the same. C) swim at your own risk. D) whatever will be will be. Answer: B 12. The substitution effect A) is when individuals consume more of one good and less of another. B) is associated with changes in relative prices. C) will have no effect if goods are unrelated. D) is all of the above. Answer: D 13. Self selection bias affects empirical estimation by A) leading to samples that are not representative of the entire population. B) making estimators improved. C) increasing the accuracy of test results. D) doing none of the above. Answer: A 14. When different bundles of commodities give the same level of satisfaction, you are A) said to be indifferent between the bundles. B) said to be confused. C) not able to make a decision. D) unhappy with any combination. E) none of the above. Answer: A 15. The marginal rate of substitution is A) the slope of the utility curve. B) the slope of the contract curve. C) the slope of the utility possibilities curve. D) none of the above. Answer: A 16. Panel data requires A) data on individual entities. B) time. C) neither a nor b. D) both a and b. Answer: D 17. A counterfactual is A) what happens when there are no facts. B) what would have happened if the treatment group had not received the treatment. C) a legal term describing the process of proving that a negative is the actual truth. D) none of the above. Answer: B True/False 18. Empirical analysis generally deals with theory and little data. A) True B) False C) Uncertain Answer: B 19. Economists attempt, with moderate success, to perform controlled experiments making policy analysis helpful. A) True B) False C) Uncertain Answer: A 20. Regression coefficients are indicators of the impact of independent variables on dependent variables. A) True B) False C) Uncertain Answer: A 21. Primary data sources include information gathered from interviews and experiments. A) True B) False C) Uncertain Answer: A 22. Multiple regression analysis typically requires several computers. A) True B) False C) Uncertain Answer: C 23. Econometrics is the statistical analysis of economic data. A) True B) False C) Uncertain Answer: A 24. Instrumental variables requires that the variable not be correlated with the outcome variable A) True B) False C) Uncertain Answer: A 25. The demand for a good is not affected by the demand for a related good. A) True B) False C) Uncertain Answer: C 26. Equilibrium in the market is where supply is equal to demand. A) True B) False C) Uncertain Answer: A 27. A model is a simplified description of some aspect of the economy. A) True B) False C) Uncertain Answer: A 28. Causation and Correlation are generally the same thing. A) True B) False C) Uncertain Answer: B 29. An experimental study is one which individuals are randomly assigned to the treatment and control groups. A) True B) False C) Uncertain Answer: A Essay 30. Suppose that a competitive firm’s marginal cost of producing output q is given by MC = 2 + 2q. Assume that the market price of the firm’s product is $13. A) What level of output will the firm produce? B) What is the firm’s producer surplus? Answer: q = 11/2. Producer surplus = ½ (11/2) 11 = 121/4. 31. Use the following function for elasticity: = - (1/s) (P/X), where s is the slope of the demand curve, P is the price, and X is the quantity demanded, to find elasticity when demand is Xd= 20- (1/5) P when the price of good X is 30. Answer: = - (1/-5) (30/24) = ¼ 32. Imagine that the demand for concert tickets can be characterized by the equation Xd = 14 – P/3. The supply of tickets can be written as Xs = P/4. Find the equilibrium price and quantity of concert tickets. Answer: X* = 6, P* = 24 33. “Since the social sciences are not like the natural sciences, experiments are a waste of time.” Comment on the above statement. Answer: It is true that social sciences are not the same as natural sciences. Experiments have been used successfully to tell us more about the world we live in. There are limits that social scientists should be aware of, but to dismiss the use of experimental analysis entirely would be incorrect. 34. Discuss the concept in econometrics that states, “garbage in . . . garbage out.” Answer: When the data used in an econometric analysis are not carefully screened for errors, there can be faulty and misleading results that occur. There has been some time expended to ensure that the data have been “cleaned” properly. 35. It is possible that two different economists can examine the same situation, such as school funding, and reach entirely different conclusions. Why is this so? Answer: Reasoning resulting in differing results includes the time period under examination, the data sources and proxies used, the econometric tools employed, and many other reasons. This is not to say that because different researchers come to different conclusions the analysis is confused. It just means further investigation is needed. 36. It has been suggested in the text that raising taxes on beer will reduce teen fatalities. Comment on this. Answer: As the text suggests, this is perfect use of experimental data for testing. Using certain states as “controls” would allow us to examine the difference in fatalities between those states that did not change the tax. Of course, we need to control for other differences that might affect outcomes. 37. Why might the consequences of imposing a tax on harmful fast foods not adhere to theory? Answer: Preferences of people with different desires could be altered in unintended ways. All variables could not be controlled for. Chapter 3 Tools of Normative Analysis Multiple Choice 1. The absolute value of the slope of the production possibilities curve is the A) marginal rate of substitution. B) contract curve. C) offer curve. D) Engel curve. E) marginal rate of transformation. Answer: E 2. The First Fundamental Theorem of Welfare Economics requires A) producers and consumers to be price takers. B) that there be a market for every commodity. C) that the economy operate at some point on the utility possibility curve. D) all of the above. Answer: D 3. Points outside the production possibility frontier are A) producible. B) endowment points. C) consumer equilibrium points. D) unattainable. Answer: D 4. General equilibrium refers to A) examining markets without specific information. B) finding equilibrium from general information. C) pricing goods at their shadow price. D) all of the above. E) none of the above. Answer: E 5. The marginal rate of substitution is A) the slope of the utility curve. B) the slope of the contract curve. C) the slope of the utility possibilities curve. D) none of the above. Answer: A 6. Market failure can occur when A) monopoly power exists in the market. B) markets are missing. C) consumers can influence prices. D) all of the above. Answer: D 7. Partial equilibrium is A) exactly like general equilibrium. B) studying only the supply side of the market. C) studying individual markets. D) examining the demand side of the market. Answer: C 8. A public good is A) a good that the public must pay for. B) nonexcludable in consumption. C) more costly than a private good. D) paid for by the government. Answer: B 9. Merit goods A) are provided for those who behave themselves and play nice. B) should be provided even if there is no demand for them. C) increase in costs along with demand. D) do none of the above. Answer: B 10. A social welfare function A) is a function made by the Department of Welfare. B) is a function that shows that the utilities of society are incorporated into society’s well being. C) can never be derived numerically. D) is all of the above. Answer: B 11. Movement from an inefficient allocation to an efficient allocation in the Edgeworth Box will A) increase the utility of all individuals. B) increase the utility of at least one individual, but may decrease the level of utility of another person. C) increase the utility of one individual, but cannot decrease the utility of any individual. D) decrease the utility of all individuals. Answer: B 12. Points on the utility possibility frontier are A) inefficient. B) points of incomplete preferences. C) not producible. D) Pareto. Answer: D 13. The Edgeworth Box should A) lie inside the PPF. B) lie partially inside the PPF. C) lie completely outside of the PPF. D) never touch the PPF. Answer: A 14. Pareto points in the Edgeworth Box are A) found when utility curves are tangent. B) found when MRS are equal. C) found when one person cannot be made better off without making another person worse off. D) all of the above. E) none of the above. Answer: D 15. The Second Fundamental Theorem of Welfare Economics requires A) that indifference curves be convex to the origin. B) that isoquants be concave to the origin. C) that there are no set prices for Pareto efficient allocations. D) that production be twice as large as consumption. E) all of the above. Answer: A True/False 16. Welfare economics is concerned with individual desirability of alternative economic states. A) True B) False C) Uncertain Answer: B 17. The contract curve is the collection of points where utility curves are tangent in the Edgeworth box. A) True B) False C) Uncertain Answer: A 18. The Utility Possibility Frontier is derived from utility curves. A) True B) False C) Uncertain Answer: A 19. When the First Fundamental Theorem of Welfare Economics doesn’t hold, there is a market failure. A) True B) False C) Uncertain Answer: A 20. Externalities can be difficult to detect in open economies. A) True B) False C) Uncertain Answer: C 21. Social indifference curves are the same as a Social Welfare Function. A) True B) False C) Uncertain Answer: A 22. A utility possibilities frontier need not incorporate the utility of every individual. A) True B) False C) Uncertain Answer: A 23. In equilibrium, the MRT should not equal the MRS of all individuals. A) True B) False C) Uncertain Answer: B 24. If the market does not allocate resources perfectly, the government can. A) True B) False C) Uncertain Answer: C 25. Normative economics is more important than positive economics. A) True B) False C) Uncertain Answer: C 26. Marginal cost of a product is the incremental cost of one additional unit of input. A) True B) False C) Uncertain Answer: A 27. Pareto improvement can be a reallocation of resources that makes more than one person better off. A) True B) False C) Uncertain Answer: A Essay 28. Consider an Edgeworth economy where there are two citizens, Mr. Cortopassi and Ms. Thomas. There are only two goods to be consumed in the economy, Beer and Pretzels. The total amount of Beer is 12 units. The total amount of Pretzels is 12 units. Answer the following: Suppose Mr. Cortopassi has utility for the two goods characterized as UC(B,P)=B+P. Ms. Thomas’s utility function is UT(B,P)=B+P. Identify the points that are Pareto efficient. Answer: Since the MRSs of the two are equal at every point in the Edgewood Box, every point is Pareto. 29. Imagine a simple economy with only two people, Leroy and Percy. If the Social Welfare Function is W = UL + UP, and the Utility Possibilities Frontier is UPF = UL + 2UP, what will be the societal optimum? Answer: The optimum would be a corner solution found the same way as if goods were perfect substitutes. Percy receives none, and all goes to Leroy. 30. If James has a utility curve characterized by the function of U = 2X3 Y2, what is his marginal rate of substitution between goods X and Y? Answer: To find the MRSs, take the partial derivative of the function with respect to X and divide it by the partial derivative with respect to Y, which yields (3/2)*(Y/X). 31. Consider a simple exchange economy where the marginal rate of transformation between two goods is greater than the marginal rate of substitution for the same goods. Can Pareto equilibrium be derived? Answer: It is possible to pick points along the PPF that have an MRT that matches equilibrium set of MRS. Mathematically, it can be very difficult and sometimes impossible to find. 32. Suppose that a competitive firm’s marginal cost of producing output q is given by MC = 5 + 2q. Assume that the market price of the firm’s product is $27. A) What level of output will the firm produce? B) What is the firm’s producer surplus? Answer: MC = P so 27 = 5 + 2q, then Q* = 11. Producer surplus is the triangular area above the MC line bounded with price. PS = 0.5* Base *Height = 0.5*11*(27-5) = 121. 33. Social welfare functions can be formed in many ways. They can be additive, meaning that the all utilities curves are added together. They incorporate the idea of least-best, meaning that the utility of the person with the least is maximized. If you were a central planner for an economy, what type of social welfare function would you create? Answer: Answers will vary, but generally you need a social welfare function that incorporates some collectively agreed upon notion of fairness. It must also be function that can be implemented without causing undue stress on citizens or the economy. As a central planner, I would likely favor a social welfare function that is utilitarian in nature, aiming to maximize the total sum of individual utilities across the population. This approach seeks to achieve the greatest overall happiness or well-being, taking into account the preferences and needs of all individuals in the society. 34. Merit goods have received considerable attention toward the end of this chapter. Can concerts and other publicly provided services be rationalized using these ideas? Answer: Yes, they fit the definition of a merit good, but no judgment should be made concerning the efficiency of such endeavors. 35. Why might asymmetric information contribute to the problem of a market failure? Answer: One of the underlying tenets of economics is complete and free flowing information. Without such information, one side of a transaction could gain an unfair advantage making free exchange impossible. Chapter 4 Public Goods Multiple Choice 1. Public goods are characterized by A) nonrivalness. B) excludability. C) the sum of the MRSs equaling MRT. D) all of the above. Answer: D 2. Market mechanisms are unlikely to provide A) prices. B) nonrival goods efficiently. C) supply and demand. D) none of the above. Answer: B 3. A pure private good is A) nonrival in consumption and subject to exclusion. B) rival in consumption and subject to exclusion. C) rival in consumption and not subject to exclusion. D) all of the above. Answer: B 4. Commodity egalitarianism refers to commodities that A) are important for most consumers. B) are too dangerous for most consumers. C) should be made available to all consumers. D) are good ideas but never produced. Answer: C 5. Charging individual prices that are based on consumers’ willingness to pay is A) government price supports. B) will pricing. C) second tier pricing. D) price discrimination. Answer: D 6. Equilibrium for public goods is characterized by A) MSB = MSB. B) MRS = MRT. C) MRS1 = MRS2 = MRS3=…= MRSn = MRT. D) MC = MB. E) MRS – MRT = MSB. Answer: C 7. Summing demand curves horizontally sends market ________ to individuals, while summing vertically sends market ________ to individuals. A) price; price B) quantity; quantity C) quantity; price D) price; quantity Answer: D 8. Public goods can be A) provided privately. B) provided publicly. C) subject to free rider problems. D) all of the above. Answer: D 9. A ________ is a person who wants to enjoy the benefits of a public good without contributing his or her marginal benefit to the cost of financing the amount made. A) free rider B) politician C) price maker D) price optimizer Answer: A 10. Congestible public goods A) are nonrival in consumption. B) cannot be priced in the market. C) are rival in consumption. D) are never provided by the private sector. Answer: C 11. A private good is A) nonrival in consumption. B) subject to free rider problems. C) not subject to exclusion. D) subject to exclusion. Answer: D 12. When those that do not contribute to the costs of a public good are denied use, this is a case of A) exclusion. B) being nonrival. C) price discrimination. D) infeasibility. Answer: A 13. Which of the following is a public good? A) public defense B) public television C) a library D) schools E) all of the above Answer: D 14. From Figure 4.3 in your text book, the market price of rockets is A) 10. B) 4. C) 6. D) 20. Answer: A 15. School vouchers are A) provided by the government. B) provided by private organizations. C) public funds to be used for private tuition. D) all of the above. Answer: D 16. When asked to reveal their true preferences people A) always tell the truth. B) never tell the truth. C) sometimes tell the truth. D) generally don’t know what preferences are. Answer: C 17. The MRT is A) the marginal ring tone. B) the minimal rate of time. C) the maximum rate of transformation. D) none of the above. Answer: D True/False 18. The free rider problem causes less than optimal production of a public good. A) True B) False C) Uncertain Answer: A 19. Pure private goods are nonrival in consumption. A) True B) False C) Uncertain Answer: A 20. Most goods that are nonexcludable are pure public goods. A) True B) False C) Uncertain Answer: C 21. Vertical summation of demand curves yield results equivalent to those of horizontal summation. A) True B) False C) Uncertain Answer: B 22. Increasing the quantity of a pure public good can be done at zero cost. A) True B) False C) Uncertain Answer: B 23. Demand curves for pure public goods satisfy the law of demand. A) True B) False C) Uncertain Answer: A 24. Pure public goods involve positive externalities. A) True B) False C) Uncertain Answer: A 25. Increases in spending on education will lead to an increase in student performance. A) True B) False C) Uncertain Answer: C 26. Airport security is best provided by public entities over private. A) True B) False C) Uncertain Answer: C 27. Private goods are always provided by the private sector. A) True B) False C) Uncertain Answer: B 28. The Global Positioning System (GPS) is an example of a good that is both non-rival and excludable good. A) True B) False C) Uncertain Answer: A 29. Choosing between public or private provision of a good always lead to market efficiencies. A) True B) False C) Uncertain Answer: C Essay 30. Suppose there are two individuals with identical demand curves characterized by the equation P = 2 – Q. What is market demand if these demand curves are added horizontally? Vertically? Answer: Horizontal adding yields Q = 4 – 2P. Vertical adding yields Q = 2 – 1/2P. 31. Use the answer you found when adding market demand curves vertically in Question 18 above to find the market equilibrium quantity if the market supply is constant at 4 units. Answer: Q* = 2 – 1/2P and 4 = 2 – 1/2P, then P* = 2. 32. Refer to “Discussion Questions” number 11 in your text. How does your answer change if the marginal cost of building each additional lighthouse increases to $150? Answer: Part a) stays the same. Part b) now becomes 0 for the cost is too high for any number of lighthouses to be built. 33. Suppose you are given the following demand curves: Q = 32 – P and Q = 16 – (P/2). Add these two demand curves vertically and find the market demand curve. Answer: The demand curve has two portions. When Q is between 0 and 16, the demand curve is Q = (64/3) – (P/3). When Q is between 16 and 32, the demand curve is Q = 32 – P. 34. Suppose there is a public good that has market supply characterized by the equation X = (P/3) – (32/3). Suppose further that market demand for this good can be characterized by the equation X = 25 –P. Find the equilibrium quantity of the public good that will be supplied. Answer: The two curves never intersect at a positive quantity; therefore, the amount of the public good provided will be zero. 35. You have read that the free rider problem affects equilibrium in a public good context. Explain how this situation can be modeled as a prisoner’s dilemma game. Answer: Each individual will say before construction that he will tell the truth about his preferences. It would be in each person’s interest to lie about his true preferences, which would allow him to enjoy a higher level of public good without paying for it completely. 36. Discuss and contrast the advantages and disadvantages of public highways versus toll roads. Answer: There would be less uniformity in roads and no assurances about quality. Toll roads might exist in key areas if no one decides to build one or the costs are prohibitive. 37. Some economists believe that public schools would improve if they were subjected to competition. Discuss the pros and cons of this idea. Answer: Competition would cause weaker schools to try harder to retain the students that they have. Competition could lead to teaching being concentrated at getting students’ test scores to rise without regard to subject matter. 38. Some people do not engage in free riding, even when there is no cost or chance or reprisal. Discuss why? Answer: Answers will vary but many people find it immoral to benefit without fully contributing. Others find the process of engagement fulfilling as they strive to find optimal outcomes for public goods. Some individuals refrain from free riding even when there is no risk of reprisal because of intrinsic motivations such as personal integrity, a sense of fairness, or a desire to contribute positively to their community or society. These individuals prioritize ethical considerations or long-term benefits over immediate gains, demonstrating their commitment to social norms and values. Chapter 5 Externalities Multiple Choice 1. Reducing output from the privately optimal level to the socially optimal level will A) cause a loss of consumption to consumers. B) reduce marginal damages. C) reduce the production costs. D) cause all of the above. Answer: D 2. Marginal damages are hard to measure because A) they can be generated from multiple sources. B) they are hard to graph. C) they happen over time. D) no one cares about them. Answer: A 3. In Figure 5.4, if the marginal damages line did not originate at 0, A) it would mean that marginal damages did not exist. B) there is no way to find MSC. C) MSC would not originate at the same intercept as MPC. D) all of the above. Answer: C 4. Externalities can be positive because A) marginal damages do not last over time. B) utility can be impacted positively as well as negatively. C) there is no concept for marginal benefit. D) positive externalities are subsidies. Answer: B 5. Refer to the following graphs. Which graph(s) represent(s) an externality? A) graph A B) graphs A and B C) graph B D) neither graph A nor graph B Answer: C 6. Refer to Figure 5.9 in the textbook. What is the total amount of tax paid by Bart? A) 0 B) 50 C) 15 D) 750 Answer: D 7. Congestion pricing A) is a tax. B) keeps nasal passages clear. C) is never efficient. D) all of the above. Answer: A 8. Pollution rights may be traded if A) polluters try to hide pollution. B) administrators are uncertain about Pigouvian taxes. C) there is no market for pollution. D) pollution is harmless. Answer: B 9. Externalities can be produced by ____________, as well as ____________. A) individuals; firms B) market prices; market incomes C) oceans; streams D) none of the above Answer: A 10. A Pigouvian tax corrects for A) market congestion. B) market losses. C) inefficient sales. D) low market prices. Answer: D 11. Which of the following is correct? A) SMC = PMC - MD B) MPB = MSB + MEB C) SMC = PMC + MD D) MSC = MPB E) MSB =MSC + MPB Answer: C 12. Marginal benefits are downward sloping when A) there are no total benefits. B) the slope of the marginal benefits curve is negative. C) total benefits are increasing at a decreasing rate. D) marginal costs are upward sloping. Answer: B 13. A Pigouvian subsidy A) cannot exist with externalities. B) is the same thing as a Pigouvian tax. C) is measured in terms of Pigouvian dollars. D) moves production to the socially optimal level of output. Answer: D 14. As a general rule, zero pollution is not socially desirable because A) there would be no production. B) the Environmental Protection Agency (EPA) needs to have something to do. C) no pollution would lead to global warming. D) all of the above. Answer: A 15. Externalities require government intervention when A) violence will result between disputing parties. B) there are only a few sellers in the market. C) property rights are not clearly established. D) the government imposes sales taxes. E) all of the above. Answer: C 16. Which method helps in obtaining the socially optimal level of output? A) Pigouvian taxes B) regulation C) property rights and bargaining D) all of the above Answer: D 17. Marginal damages A) must always be considered in social marginal costs. B) must not be considered in social marginal costs. C) must sometimes be considered in social marginal costs. D) have nothing to do with social marginal costs. Answer: A 18. A tax levied on each unit of pollution is A) an income tax. B) a emissions fee. C) a flat tax. D) an international tax. Answer: B 19. A cap-and-trade policy A) has a set number of permits. B) allows polluters to trade permits. C) caps the total level of pollution allowed. D) all of the above. Answer: D 20. Command-and-control regulations A) are less flexible than incentive based regulations. B) come from the private sector. C) have technology standards a type of control. D) a & c. E) a & b. Answer: D True/False 21. Technology standards work in reducing externalities of all kinds. A) True B) False C) Uncertain Answer: C 22. Negative externalities cause loss of welfare not transmitted by market factors. A) True B) False C) Uncertain Answer: A 23. Externalities can be positive, as well as negative. A) True B) False C) Uncertain Answer: A 24. A subsidy for pollution not produced can induce producers to pollute at the efficient level. A) True B) False C) Uncertain Answer: A 25. Pollution rights can be traded and are always efficient. A) True B) False C) Uncertain Answer: C 26. In the 1970s, the US relied on Command-and-Control models of pollution regulation. A) True B) False C) Uncertain Answer: A 27. The desire in the US for owner-occupied housing led to subsidies that contributed to the recession which started in 2007. A) True B) False C) Uncertain Answer: A 28. Market oriented solutions to externalities rarely work. A) True B) False C) Uncertain Answer: B 29. For market efficiency, MSC must be equated to MSB. A) True B) False C) Uncertain Answer: A 30. College education is an example of a positive externality. A) True B) False C) Uncertain Answer: C 31. An emissions fee is preferable to a cap-and-trade when MSB are elastic and costs are uncertain. A) True B) False C) Uncertain Answer: A 32. Incentive-based regulations provide polluters no incentive to reduce pollution and are thus not used often. A) True B) False C) Uncertain Answer: B Essay 33. Suppose the factory Afro-Puffs Inc. produces wigs. As a by-product of this wig production, they also produce dangerous emissions of toxic gases (as a result of the strong glue used to hold the hair in place). The De-Lite car factory, down the road, experiences a negative externality from this production process. Suppose that the supply curve (private marginal costs) for the wig factory is X = (2/5)P- 2, and it faces a market demand of Xd = 15 - P/2. The marginal damages caused by the production of wigs can be written as X = P – 1/2. (a) Find the equilibrium price and quantity in the market for wigs. (b) Find the socially optimal level of wigs and the corresponding price. (c) How much should the wig factory be taxed per wig? Answer: (a) Set PMC equal to demand and solve for P and X. X = 50/9, P = 170/9. (b) Find SMC by adding PMC to MD. Set SMC equal to demand and solve for P and X. X = 49/11, P = 232/11. (c) At X = 49/11, subtract PMC from SMC. Tax = 109/22. 34. A steel factory has the right to discharge waste into a river. The waste reduces the number of fish, causing damage for fisheries. Let X denotes the quantity of waste dumped. The marginal damage, denoted MD, is given by the equation MD = 2 + 5Q. The marginal benefit (MB) of dumping waste is given by the equation MB = 34 – 3Q. (a) Calculate the efficient quantity of waste. (b) What is the efficient fee, in dollars per unit of waste, which would cause the firm to dump only an efficient quantity of waste? (c) What would be the quantity dumped if the firm did not care about the fishery? Answer: (a) Set MD = MB and solve for Q*. Q* = 4. (b) Insert 4 units into either MD or MB. Fee = 22. (c) If the firm did not care about the fisheries, then they will discharge was as long as its marginal benefit is greater than 0. Therefore, set MB equal to zero and solve for X. X = 34/3. 35. The private marginal benefit for commodity X is given by 15 – X, where X is the number of units consumed. The private marginal cost of producing X is constant at 10. In the absence of any government intervention, how much X is produced? What is the gain to society involved in moving from the inefficient to the efficient level of production? Answer: Without intervention, optimal will be where PMB = 0. X = 15. The efficient level is X = 5. The area beneath the PMB is gained. Gain = 25. 36. Consider the case of two farmers, Tony and Hakim, depicted in the following figure. Both use DDT (a chemical pesticide) for their crops. The use of DDT causes an externality for swimmers down river from the farms. (a) Show the amount of pesticides used if each uses the privately optimal level of pesticides. (b) Show the amount of pesticides used if they are socially concerned. (c) Why is a reduction back to XH = HT not socially desired? Answer: (a) (b) (c) Not socially optimal. 37. Refer to Figure 5.11 and Figure 5.12 of your textbook to answer this question: (a) In case of an inelastic marginal social benefit curve, what type of pollution reduction system should the government employ? Why? (b) If the social benefit curve is elastic, do you answer change? (c) What are advantages and disadvantages of Cap-and-Trade systems over Emission Fee systems when the inflation and change in marginal costs are considered? Answer: (a) When the social marginal benefit curve is inelastic then the government should employ a cap-and-trade system because it is more efficient than the emission fee system. Emission fee system allows too little pollution compared to fairly higher pollution than efficient quantity of cap-and-trade system. (b) When the social marginal benefit curve is elastic then the government should employ an emission fee system because it is more efficient. Cap-and-trade system allows too much pollution reduction compared to fairly close pollution reduction of emission fee system. (c) Cap-and-Trade systems are superior in high inflation environments since it requires no legislative or regulatory action in response to inflation. Moreover, emission fee systems are not appropriate when the marginal cost of pollution reduction is not constant. With emission fee systems, pollution reduction decreases as marginal costs increase. However with cap-and-trade systems, pollution reduction is constant as marginal costs increase. Finally if the government is uncertain about the marginal cost of pollution reduction, then the effective reduction system depends on the elasticity of marginal social benefits. 38. Why are command- and -control regulations less flexible than incentive based systems? Answer: Although answers will vary, the main reason is monitoring costs and the costs involved in punishment strategies for offenders. Incentive systems induce firms to act in their own best interests which are less time consuming. Command-and-control regulations are less flexible than incentive-based systems because they prescribe specific rules and standards that must be followed uniformly by all entities. They often lack adaptability to changing circumstances or individual variations in costs and capabilities. In contrast, incentive-based systems offer flexibility by allowing entities to choose how to comply, encouraging innovation and cost-effective solutions tailored to their unique circumstances. 39. Which policy is more effective when handling externalities: Cap-and-trade or emissions fee? Answer: Although answers may vary, the reader should take into account how responsive each policy is to inflation. In addition, there should be some mention of the responsiveness to cost changes and uncertainty. Therefore when marginal social benefits are inelastic and costs are higher than expected, cap-and-trade achieves too much reduction and an emissions fee achieves too little reduction. Emissions fees are generally more effective for handling externalities compared to cap-and-trade systems. 40. List and discuss three problems that might arise when using the Coase theorem. Answer: Bargaining costs are generally not zero. Identifying damages is difficult. There is generally some amount of asymmetric information. Test Bank for Public Finance Harvey Rosen, Ted Gayer 9780078021688
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