This Document Contains Chapters 11 to 15 Chapter 11 Social Security Multiple Choice 1. A pay-as-you-go system means A) you pay for your dinner as you go to the table to eat. B) current working citizens pay for current retired citizens. C) there is no need for taxes since current workers’ pay for current retirees. D) retirees are paid from accounts that have accumulated with interest over their working lives. Answer: B 2. Asymmetric information generally implies A) information between parties is not equal. B) all parties are fully informed. C) information is costless. D) information is too costly to transmit. Answer: A 3. A fully funded plan requires A) you to pay for your dinner as you go to the table to eat. B) current working citizens to pay for current retired citizens. C) no taxes since current workers’ pay for current retirees. D) retirees to be paid from accounts that have accumulated with interest over their working lives. Answer: D 4. An actuarially fair return means A) returns on investments are indexed to the stock market. B) returns on investments have to be positive. C) benefits received, on average, would be equal to the premiums paid. D) premiums for insurance are generally paid by the government. Answer: C 5. When workers save less during their working lives due to the fact that they have been paying Social Security taxes, this is known as A) the Social Security effect. B) the wealth substitution effect. C) the bequest effect. D) the life cycle hypothesis. Answer: B 6. Carve-out accounts A) applies only to workers between 65 and 69 years of age. B) take funds away from the traditional social security system. C) has a tax rate of no more than 16.9 percent. D) does all of the above. Answer: B 7. Social Security pension benefits are A) subject to income taxes for those with certain income levels. B) non-taxable for all retirees. C) subject to state, but not federal, income taxes. D) subject to capital gains taxes. Answer: A 8. The Social Security Administration has which program(s) to administer? A) disability payments B) health benefits C) pensions D) survivors' benefits E) all of the above Answer: E 9. In 2007, the Social Security program had costs of A) $30 million. B) $20 trillion. C) $200 billion. D) none of the above. Answer: D 10. An earnings test as it relates to Social Security implies A) benefits are reduced by some predetermined amount for those who have not reached normal retirement age. B) the amount of money earned during the working life of an individual determines the amount of benefits received. C) family earnings determine the amount of benefits received. D) all of the above. Answer: A 11. Social security taxes are projected to fall short of benefits starting in A) 2005. B) 2010. C) 2017. D) 2020. Answer: C 12. Social insurance can be justified on the grounds of A) adverse selection. B) decision-making costs. C) income distribution. D) paternalism. E) all of the above. Answer: E 13. The retirement effect is A) when people retire later than they normally would have due to Social Security. B) when people decide not to retire at all because of problems with Social Security. C) when people retire earlier than they normally would have due to Social Security. D) when people save less for their retirement due to Social Security. Answer: C 14. In 1970 the Social Security tax rate was ______ and had increased to ______ by 2008. A) 0.84%; 0.124% B) 12.4%; 8.4% C) 8.4%; 12.4% D) 84%; 124% Answer: C 15. A current worker may save more towards retirement so that he or she will have more to leave his or her children later. This altruistic motive is known as the A) altruism effect. B) bequest effect. C) income effect. D) savings effect. Answer: B True/False 16. Broadly speaking, Social Security redistributes incomes from high- to low- income individuals, from men to women, and from young to old. A) True B) False C) Uncertain Answer: A 17. The percentage of retired older workers has increased dramatically since the introduction of Social Security. A) True B) False C) Uncertain Answer: A 18. Social Security benefits have played an important role in the improved economic status of the elderly over time. A) True B) False C) Uncertain Answer: A 19. Social Security was not designed to provide insurance against outliving one’s retirement. A) True B) False C) Uncertain Answer: B 20. A pay-as-you-go system of financing Social Security is not as good as a fully funded system. A) True B) False C) Uncertain Answer: C 21. A worker can begin receiving benefits as early as age 58. A) True B) False C) Uncertain Answer: B 22. Social Security is used to redistribute income. A) True B) False C) Uncertain Answer: A 23. Average indexed monthly earnings are derived from the worker’s earnings history and determine the primary insurance amount (PIA). A) True B) False C) Uncertain Answer: A 24. Having a Social Security program makes people less inclined to save for their own retirement. A) True B) False C) Uncertain Answer: C 25. Social Security wealth is the future value of the Social Security system. A) True B) False C) Uncertain Answer: B Essay 26. Suppose in the market for labor that the labor supply curve is perfectly inelastic. This would mean that the supply curve is vertical. Furthermore, suppose that demand is normal and downward sloping. Your textbook has explained that unemployment taxes are paid entirely by the employer (demanders). Who actually pays the tax in the scenario described above? Answer: The suppliers of labor (employees) would be totally responsible for paying the tax, despite the fact that the tax was levied on employees. 27. According to the Bureau of Labor Statistics, in the Federal Government, the starting salary for economists having a bachelor’s degree was $35,752 in 2007. Assume that our economist will get this government job that offers a 3 percent raise annually. After 5 years of working, she quits and never works again. How much will this worker have earned over her brief working career? How much will she have paid in Social Security and Medicare taxes if the tax rate is 7.45 percent? Answer: The worker will have earned a total of approximately $189,812. She will have paid approximately $14,141 in taxes. 28. Suppose that the ratio of retirees to working citizens is currently 1 to 5, meaning that there are 5 working people for every retiree. Suppose that in thirty years the ratio will change to 1 to 2. If benefits remain the same, what will happen to the tax rate assuming retirees are provided benefits in a pay-as-you-go system? How much would benefits decrease if the tax rate remained the same? Answer: Initially, a worker paid for 20 percent of a retiree’s benefits. In the future, the same worker would be responsible for paying for half of a current retiree’s benefits. If benefits remained the same, then each worker’s tax burden would increase by approximately 30 percent of the cost of benefits. If tax rates remain the same, then benefits would need to fall by approximately 60 percent. 29. A worker within the middle income class is preparing to retire. In the year before he retired, his gross monthly earnings are $2,500. His Social Security benefits will be $1,500 per month. Before he retired, his income was subject to a tax of 30 percent. Find his before-tax and after-tax replacement rates. Answer: His before-tax replacement rate would be 1,500/2,500 = 0.60. His after-tax replacement rate would be 1,500/1,750 = 0.86. 30. Work disincentives in the system of Social Security have seen the number of persons in the program increase dramatically. What incentives could be put in place to reverse, or at least slow, this trend? Answer: Increasing the retirement age would see fewer people in the program. Other solutions include removing the survivor’s benefits and introducing a more stringent wealth threshold that says that those persons with a certain wealth are not allowed to receive benefits. 31. The Social Security Trust fund actually has no money in it and is filled with IOUs. Does this information impact your thinking regarding Social Security? Answer: It should, if it had not before. The Trust Fund concept needs to be replaced with a system where the money is not available for any other purpose. If not, contributors should expect higher tax rates and probably lower levels of services. 32. Do you feel that when you retire there will still be Social Security? If so, do you feel that benefits will be at present levels or tax rates will have increased? Finally, has this discussion changed your plans regarding your own personal savings for your retirement? Answer: This is a personal question, but as recently as August 2004, the current chairman of the Federal Reserve, Alan Greenspan, has warned that benefits will need to be reduced for future recipients or that there will need to be increases in taxes. Many working adults today are changing their saving patterns because of this outlook. Chapter 12 Income Redistribution: Conceptual Issues Multiple Choice 1. An in-kind transfer is a A) transfer made by people to be kind to others. B) transfer of wealth. C) transfer of goods and services instead of cash. D) system of clearing checks by local banks. Answer: C 2. For the additive social welfare function to yield results, we must assume A) individuals have identical utility functions. B) individuals’ utility functions have diminishing marginal utility of income. C) the total amount of income available is fixed. D) all of the above. Answer: D 3. The poverty rate in the United States has __________ over the last 30 years. A) remained the same B) increased C) decreased D) not been accurately measured Answer: C 4. Generally, official poverty measures ignore A) the impact of taxes. B) the value of in-kind transfers. C) the value of medical expenses that are paid by the government. D) all of the above. Answer: D 5. Taking into account the utility of all persons in society is referred to as A) a utilitarian social welfare function. B) equalizing social welfare function. C) an in-kind transfer. D) a Pareto equilibrium. Answer: A 6. A notion that supports the idea that some items should be distributed equally to all is known as A) Pareto efficiency. B) the Hoover Principle. C) poverty gap closing. D) commodity egalitarianism. Answer: D 7. The middle class in the United States has _______ since the late 1960s. A) stayed the same B) decreased C) increased a great deal but then declined D) increased slightly Answer: B 8. The _________ of whites in poverty in the U.S. is greater than that of blacks and Hispanics. A) percentage B) total number C) fraction D) none of the above Answer: B 9. In a public goods context, it is difficult to measure its impact on real income because A) public goods are generally free to the public. B) they make up a small percentage of total GDP. C) people do not reveal how they value public goods. D) inflation decreases the value of the good. Answer: C 10. The poverty line in the United States A) last changed in 1980. B) never changes. C) changes with the level of inflation and family size. D) changes with the minimum wage. Answer: C 11. Maximizing the utility of the person with the minimum utility is known as A) the minimax criterion. B) the maximin criterion. C) the Hicks-Kaldor criterion. D) the Corlett-Hague Rule. Answer: B 12. An additive social welfare function would A) add the incomes of the lowest ten percent of income earners. B) subtract out the utility functions of all people who are unemployed. C) sum all individual utilities. D) maximize the utility of the person with the minimum utility. Answer: C 13. Changing the price of good Y will A) only affect the demand for that good. B) have effects across some markets. C) keep prices down in all markets. D) have no effect. Answer: B 14. Giving poor people food instead of cash for food A) is an in-kind transfer. B) will benefit some more than others, depending on their utility function. C) is politically popular. D) is all of the above. Answer: D 15. The scope of the EITC program changed dramatically in A) 1963. B) 1983. C) 1993. D) 1996. Answer: C 16. An imaginary situation in which people have no knowledge of what their place in society is to be is? A) first position B) start position C) original position D) pole position Answer: C True/False 17. Giving in-kind transfers will ensure that people get proper amounts of nutrition. A) True B) False C) Uncertain Answer: C 18. Ignoring taxes when making redistributive decisions has no impact on equity. A) True B) False C) Uncertain Answer: B 19. A redistribution is Pareto efficient if no one is made worse off afterward. A) True B) False C) Uncertain Answer: A 20. Social welfare functions require that a society has at least three people living in it. A) True B) False C) Uncertain Answer: B 21. Income is the only factor used to measure a person’s wealth. A) True B) False C) Uncertain Answer: B 22. Ethics play a key role in income redistribution. A) True B) False C) Uncertain Answer: A 23. Poverty is relative and not absolute. A) True B) False C) Uncertain Answer: A 24. The highest 20% of money earners should only have 20% of all income. A) True B) False C) Uncertain Answer: C 25. Refer to Table 12.1 in your textbook. Relative to their starting position, people in the fourth fifth of the income distribution have seen the greatest decrease in their share of income. A) True B) False C) Uncertain Answer: B 26. The poverty rate in the United States has decreased by more than 50% over the last 40 years. A) True B) False C) Uncertain Answer: A 27. Measures of income before intervention are calculated on an annual rather than a lifetime basis. A) True B) False C) Uncertain Answer: A Essay 28. Suppose there are only two people, Mr. Mullinax and Ms. Fleming, who must split a fixed income of $500. For Mr. Mullinax, the marginal utility of income is MUm = 600 - 2Im, while for Ms. Fleming, marginal utility is MUf = 600 - 3If , where Im and If are the amounts of income to Mr. Mullinax and Ms. Fleming, respectively. (A) What is the optimal distribution of income if the social welfare function is additive? (B) What is the optimal distribution if society values only the utility of Ms. Fleming? What if the reverse is true? Comment on your answer. (C) Finally, comment on how your answers change if the marginal utility of income for both Mr. Mullinax and Ms. Fleming is constant such that Mum = 250 = MUf. (This one is subtle.) Answer: The setup should be Im + If = 500 and 600-3If = 600 - 2Im. (A) Solving this system of two equations and two unknowns gives Im = 300 and If = 200. (B) Since these two lines intersect at 0, the optimal distributions would remain Im = 300 and If = 200. (C) Since they are constant horizontal lines at $250, any distribution of the $500 will be optimal. 29. Suppose that in a certain society $10,000 is the official cut-off of income for the poor. This means that any person making less than $10,000 is considered poor. Suppose further that there are three people in this society: Randy, Marlon, and Tito, with incomes of $9,900, $9,900, and $5,000, respectively. A) How many people are in poverty? B) How much income would it take, on average, to lift every poor person out of poverty? C) What if some policy caused $200 to be taken from Tito and given to Randy. How many people are in poverty now? How much income would it take, on average, to lift every poor person out of poverty? Answer: A) Three people are in poverty. B) It would take $1,733.33, on average, to lift them out. C) Two people are in poverty but it would now take $2,650.00, on average, to lift them out. 30. Suppose Lefty has utility characterized by the equation: Ul = 3I1/2, where I is income. In addition, Righty has utility characterized by the equation: Ur = 4I1/2, where I is income. (A) If each had $100,000, which one would have the higher level of utility? (B) Illustrate Lefty’s and Right’s utility functions. (C) What equal amount of income could we give to both that would also give them the same level of utility? Answer: (A) Lefty’s utility would be 300. Righty’s would be 400. (C) The only level that would work for both is 0. 31. How would poverty be affected in the United States if the measure were changed to a more comprehensive one that included the value of in-kind transfers, medical services, and taxes? Answer: Estimates have shown that poverty measures that are more comprehensive, yield results about the changing face of poverty in the United States that are dramatically different than the ones we are currently using. 32. State whether you agree with the following statement and why: “It doesn’t make sense to give poor people cash since they’ll spend it on cigarettes and lottery tickets instead of needed items.” Answer: It is difficult to predict what any individual will do without knowing his or her preferences. Cash for some will allow them to reach higher levels of utility, while for others, in-kind transfers may be more effective. Generalized statements are too broad. 33. How would you feel about a policy that would raise someone else’s income without lowering yours? Are you any worse off? Answer: If total income is fixed, it would be impossible to raise the income of some without lowering the income of others. If income is not fixed, those who do not experience an increase in income while others’ income increases, will be worse off in a relative sense. 34. If the least wealthy person in a society has millions of dollars, should we still consider that person poor? Answer: If we are using a relative measure of poverty and this person has the lowest income in society, then by certain measures he/she is poor. On the other hand, if we use an absolute measure and we have a cut off of say $30,000 then this person would not be considered poor. We also need to take into account the number of dependents that this person is responsible for. Chapter 13 Expenditure Programs for the Poor Multiple Choice 1. The Earned Income Tax Credit (EITC) A) provides more income to those people on welfare. B) is a tax on low income workers. C) provides additional tax credits to low income workers. D) is a tax break for the wealthiest Americans. Answer: C 2. The switch from AFDC to TANF took place in A) 1937. B) 1986. C) 1996. D) 1998. Answer: C 3. Social Security Income(SSI) is available for all, except A) aged. B) immigrants. C) blind. D) disabled. Answer: B 4. A dollar reduction in benefits as a result of a dollar income from working is a A) 50% tax rate. B) 75% tax rate. C) 22.5% tax rate. D) 100% tax rate. Answer: D 5. The average food stamp payment in 2007 was? A) $100 B) $300 C) $0 D) $215 Answer: D 6. Voucher programs for housing A) provide rent vouchers for existing housing stock. B) are underutilized with a surplus of housing stock. C) provide down payment assistance to purchase homes. D) are known as Section 8. Answer: A 7. The Head Start program A) has been successful in fostering better levels of school attainment. B) began in 1965. C) provides preschool activities for 4 and 5 year old disadvantaged students. D) does all of the above. Answer: D 8. Enrollment in the Medicaid program A) is designed for those persons 65 years of age and older. B) has increased due to expanded eligibility. C) covers all medical expenses that a poor person may incur. D) requires a substantial co-payment that has not been helpful to poor families. Answer: B 9. Federal job training programs A) help provide job market skills to those in poverty. B) have been overwhelmingly effective in helping those in poverty. C) cost very little money per person participating. D) do all of the above. Answer: A 10. The group comprising the highest percentage of the poor is A) the disabled. B) elderly. C) male heads of households. D) children. Answer: D 11. The United States’ official measure of poverty is measured by A) only cash income. B) cash income and capital gains. C) only in-kind income. D) the imputed value of rent payments. Answer: A 12. Which is the largest cash transfer program for the poor? A) TANF B) Medicare C) SSI D) Medicaid Answer: A 13. Under TANF, the time limit for receiving benefits during a lifetime is A) 12 years. B) 13 weeks. C) 60 months. D) 5 months. Answer: C 14. Which group is not provided aid by Medicaid? A) elderly B) blind C) disabled D) poor Answer: A 15. All of the following are in-kind benefit programs, except A) food stamps. B) Medicaid. C) energy assistance. D) SSI. Answer: D 16. Expenditures on major need-tested programs from the federal government for medical care amounted to _____ in 2004. A) $98.1 B) $28.8 C) $46.9 D) $20.0 E) none of the above Answer: E 17. How many elderly people are covered by Medicare? A) one third B) one half C) almost all D) almost none Answer: C 18. The maximum amount of EITC benefit in 2008 was? A) $6090 B) $2398 C) $104 D) $4824 Answer: D 19. The gross replacement rate is A) the proportion of pretax earnings replaced by unemployment insurance. B) a rate of employment in key sectors of the economy. C) the percentage of each pay check that is removed for unemployment insurance. D) the rate that tax receipts are used to cover tax expenditures. E) none of the above. Answer: A True/False 20. Under TANF, at least 50% of single mother recipients and 90% of two-parent families must be working or in work preparation programs. A) True B) False C) Uncertain Answer: A 21. Poor people who participate in job training programs are more successful in leaving poverty. A) True B) False C) Uncertain Answer: C 22. In 1890, 29% of the United States’ population was in poverty. A) True B) False C) Uncertain Answer: C 23. Increasing the wage rate will cause people to work more. A) True B) False C) Uncertain Answer: C 24. Crowding out can occur when public insurance crowds out private insurance. A) True B) False C) Uncertain Answer: A 25. Providing housing decreases the incentive for the poor to find their own. A) True B) False C) Uncertain Answer: C 26. Medicaid is the most expensive program that the government runs that provides benefits to the poor. A) True B) False C) Uncertain Answer: A 27. The majority of government programs designed to help poor families consists of direct cash payments. A) True B) False C) Uncertain Answer: B 28. Workfare requires able-bodied individuals to participate in work-related activities in order to receive transfer payments. A) True B) False C) Uncertain Answer: A 29. Only about a quarter of the population eligible for housing subsidies actually receives them. A) True B) False C) Uncertain Answer: A 30. Unemployment taxes are collected from both employees and employers. A) True B) False C) Uncertain Answer: B 31. The gross replacement rate is typically 95% of pretax earnings. A) True B) False C) Uncertain Answer: B Essay 32. Consider a negative income tax. As discussed in your textbook, under the negative income tax, each person is entitled to a grant of G dollars per month. For every dollar the person earns, the grant is reduced by t dollars. Suppose G = 200 and t = 0.40. Consider an individual whose hourly wage is $10. There are 30 days in a month (so T is 720). Sketch the budget constraint before and after the introduction of a negative income tax. Answer: 33. This question is similar to Discussion Question 1 of Chapter 13 in your textbook. In New York, a welfare recipient can earn $90 per month without having her benefits reduced. Beyond $90, benefits are reduced by 57 cents for every dollar of earnings. Consider Jackie, a resident of New York, who can earn $10 per hour. If she does not work at all, she is eligible for welfare benefits of $577. (A) If she works 10 hours, how much are her work earnings, how much is her welfare benefits, and how much is her total income? (B) After Jackie works a certain number of hours, she does not receive any benefits at all. What is that number of hours? enjoy Answer: (A) If Jackie works 10 hours at $10 per hour, she will have earned $100 from working. She gets to earn $90 before her benefits are reduced. She earned $10 over that limit, so her benefits will be reduced to 577 – (0.57 * 10) = 571.3. She will have received in total $671.3. (B) She would need to work 110.228 hours before benefits are completely eliminated. 34. Suppose in a certain city the demand for low-cost housing can be characterized by the equation P = 500 – 2Q, where Q is housing measured in square feet. Further, suppose that supply is characterized by the equation: P = 25 + 3Q. (A) How much consumer surplus is there? (B) Suppose that a grant is given so that the supply of housing is increased. This increase changes the supply curve to P = 3Q. How much does consumer surplus change because of the grant? Answer: (A) Setting supply equal to demand gives that Q* = 95 and P* = 310. Therefore, consumer surplus is (1/2) (95) (190) = 9,025. (B) Setting the new supply curve equal to the original demand curve gives Q* = 100 with P* = 300. Now consumer surplus is (1/2) (100) (200) = 10,000. 35. Return to Question 22 above. Suppose that the government feels that the grant is not enough and, in addition, imposes a price ceiling of $270. What will happen to consumer surplus? What are the drawbacks? Answer: Under the price ceiling scheme, new P* = 270 and therefore the Q* = 90 consumer surplus is now found by (1/2) (90) (180) = 8,100. The drawback is that there is a shortage now, as Q* supplied is only 90 instead of 100. 36. A needy family consisting of a mother and three children currently receives cash benefits that average $12 per day. The mother of this family is allowed to earn an average of $4 per day before her benefits begin to decline. After that, for each dollar earned, cash benefits decline by 67 cents for each dollar earned. Assume that she can find work at $4 per hour. How many hours will she have to work per day before her benefits are eliminated? Answer: Cash benefits decline by $0.67 per dollar earned after she earns $4. Benefits decline $.067 * $4 = $2.68 per hour worked after her first hour. Given that it would take 5.4776 hours, then her cash benefits will be eliminated. 37. Over the years, there have been many programs designed to help the poor. One of the more popular ones has been the Earned Income Tax Credit (EITC). What makes this program so popular? Answer: Unlike other programs, participants in EITC are working and contributing to society. The skills and contacts made through working, helps in the efforts to keep these people from slipping further into poverty. 38. What are some of the drawbacks, as you see them, to a program like Workfare? Answer: Workfare requires a good deal of monitoring to ensure that participants are gaining skills. In addition, there have to be jobs available, which may not be the case. Some participants do not have the necessary education required for certain jobs and first need to concentrate on increasing their human capital regarding education. 39. One of the changes in the welfare system of the United States that occurred in 1996 was a move to block grants for states. What advantage(s) might a block grant system allow? Answer: Since participation in different states face varying needs to help them escape poverty, a national program may be too restricting, and local control can design a program more suitable to their constituents. However, an incompetently run state could do more harm than good regarding use of the funds. Chapter 14 Taxation and Income Distribution Multiple Choice 1. Statutory incidence of a tax deals with A) the amount of revenue left over after taxes. B) the amount of taxes paid after accounting for inflation. C) the person(s) legally responsible for paying the tax. D) the amount of tax revenue generated after a tax is imposed. Answer: C 2. 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: A 3. 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 4. A demand curve that is perfectly inelastic is A) horizontal. B) vertical. C) at a 45 degree angle. D) parallel to the X-axis. Answer: B 5. In 2005, the top 1% of all income earners paid _________ percent of federal taxes. A) 1.0 B) 4.1 C) 20.6 D) 27.6 Answer: D 6. A tax on suppliers will cause the supply curve to shift A) up. B) down. C) right. D) left. Answer: D 7. A monopoly has ______ seller(s) in the market. A) 0 B) 1 C) 3 D) many Answer: B 8. An ad valorem tax is A) given as a proportion of the price. B) Latin for “buyer beware.” C) identical to a unit tax. D) computed using the “inverse taxation rule.” Answer: A 9. An industry where the capital-labor ratio is relatively high is characterized as A) capital intensive. B) labor intensive. C) income intensive. D) market intensive. Answer: A 10. Demand for cigarettes is A) relatively elastic. B) relatively inelastic. C) increasing in the US. D) greater among wealthier people. Answer: B 11. When marginal tax rates are constant, A) the change in taxes paid is the same as the change in income. B) the change in taxes paid is greater than the change in income. C) the change in taxes paid is less than the change in income. D) there are no taxes. E) none of the above. Answer: E 12. The tax-induced difference between the price paid by consumers and the price received by producers is A) the tax difference. B) the tax wedge. C) the statutory incidence. D) the supply side effect. Answer: B 13. An oligopoly has ______ sellers in the market. A) 0 B) 1 C) 3 D) many Answer: C 14. A tax on consumers will cause the demand curve to shift A) right. B) left. C) up. D) down. Answer: B 15. 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 16. Regardless of income level, when the ratio of taxes paid to income is constant then it is called A) lump sum tax B) marginal tax C) progressive tax D) proportional tax Answer: D True/False 17. A unit tax is a fixed amount per unit of a commodity sold. A) True B) False C) Uncertain Answer: A 18. Regressive tax systems are bad. A) True B) False C) Uncertain Answer: C 19. In a general equilibrium model, a tax on a single factor in its use only in a particular sector can affect returns to all factors in all sectors. A) True B) False C) Uncertain Answer: A 20. Due to capitalization, the burden of future taxes may be borne by current owners of an inelastically supplied, durable commodity such as land. A) True B) False C) Uncertain Answer: A 21. Even with a tax, the price that consumers pay will be higher than what producers receive. A) True B) False C) Uncertain Answer: B 22. Ad valorem taxes create tax wedges just like unit taxes. A) True B) False C) Uncertain Answer: A 23. After a price change, the substitution effect will be the same as the income effect. A) True B) False C) Uncertain Answer: C 24. Marginal tax rates supply reliable measures of tax progressiveness. A) True B) False C) Uncertain Answer: B 25. Unit taxes cause shifts, while ad valorem taxes cause pivots. A) True B) False C) Uncertain Answer: A 26. A lump sum tax is one for which the individual’s liability does not depend on behavior. A) True B) False C) Uncertain Answer: A 27. Tax wedge is the difference between tax induced price paid by customer and the tax amount A) True B) False C) Uncertain Answer: B 28. Partial factor taxes are levied on an input in only some of its uses. A) True B) False C) Uncertain Answer: A Essay 29. Consider a monopolist who has a total cost curve of: TC = 7X + (1/2) X2. The market demand equation is Xd = 386 - (1/2) P. A) What are the equilibrium quantity, equilibrium price, and profits in this market? B) Suppose that a unit tax of $1 is placed on the monopolist. What happens to the equilibrium quantity, equilibrium price, and profits? How much tax revenue does the government generate? C) Suppose that the same unit tax of $1 is placed on consumers. What happens to the equilibrium quantity, equilibrium price, and profits? How much tax revenue does the government generate? D) What can be said about the taxes? Answer: A) X* = 153, P* = $466, = $58522.5 B) X* = 152.8, P* = $466.4, = $58,369.6, Tax Rev. = $152.8 C) X* = 152.8, P* = $465.4, = $58,369.6, Tax Rev. = $152.8 D) The tax revenue generated is the same, whether it is levied on the buyers or sellers. 30. Refer to Figure 14.2 in your textbook. Suppose the original before-tax demand curve for CD players is P = 100 - 2Qd. Suppose further that supply is P = 5 + 3Qs. Now suppose a $5 unit tax is imposed on consumers. (A) What is the before tax equilibrium price and quantity? (B) What is the after tax equilibrium price and quantity? (C) How much tax revenue is raised? Answer: (A) Setting before tax demand equal to supply gives Q* = 19, with P* = $62. (B) The after tax demand curve is now P = 95 – 2Qd. Setting the after tax demand curve equal to supply gives Q* = 18, and P* = 59. (C) Tax revenue is the after-tax equilibrium quantity multiplied by the tax rate. Therefore, $5x(18) = $90. 31. From Question 18 above, calculate the economic incidence incurred by producers and the economic incidence incurred by consumers. Answer: The after-tax consumer price is now $64. The after-tax producer price is now $59. The before-tax price was $62. The economic incidence for consumers is $2x(18) = $36. For producers, it is $3x(18) = $54. 32. Suppose that demand is perfectly inelastic. Supply is normal and upward sloping. What is the economic incidence of a unit tax placed on suppliers? Answer: The economic incidence of the tax is paid entirely by the consumers. 33. Suppose there is a market that has market demand characterized as X = 30 – P/3. Suppose further that market supply can be written as X = P/2 – 2. (A) Find the equilibrium price and quantity in this market. (B) If a unit tax of $16 is imposed on good X, what are the equilibrium price, quantity, and tax revenue in the market? (C) Suppose an ad valorem tax of 30 percent is imposed on good X. The after-tax demand equation would be X = 30 – P/2. Now find the equilibrium price, quantity, and tax revenue in the market. (D) What can be said about the amount of tax revenue generated under each taxing scheme, and why? Answer: (A) Setting supply equal to demand and solving yields P* = $38.4 and X* = 17.2. (B) The after-tax demand curve is now P = 74 – 3X. Setting after-tax demand equal to supply yields X* = 14, P* = $32 for suppliers, and P* = $48 for consumers. Tax revenue is $224. (C) Setting the given after-tax demand equal to supply yields P* = $32 for suppliers and P* = $48 for consumers. Tax revenue is $224. (D) The tax revenue and prices are the same using either taxing scheme. 34. In the press, there has been a considerable amount of attention given to the notion of corporations being taxed. Explain how it is that a tax on a business could be borne entirely by consumers. Answer: Elasticity plays a key role in determining exactly how much tax is borne by consumers and producers. 35. Why is it the case that a commodity tax on goods like food and shelter is sometimes seen as being regressive? Answer: Items like food and shelter require a larger percentage of discretionary income for those in the lower income brackets, than for those in higher brackets. 36. Why is it the case that taxes in one market can have impacts on supply and demand in others and should policy makers take this into account when setting taxes? Answer: When goods are complements or substitutes, changes in the price can impact demand for other goods. Policy makers should care about the overall impacts to the economy from certain tax policies. This will be discussed in greater detail in later chapters. Chapter 15 Taxation and Efficiency Multiple Choice 1. An income effect A) is measured as the change in prices over time. B) is not possible when people are unemployed. C) requires interest rates to remain constant. D) is the change in the quantity demand, due to the fact that real income changes when prices change. Answer: A 2. Equivalent variation means A) finding an equivalent change in income that puts a person on the same utility as a change in price would. B) finding equal tax rates that insure quantity demanded does not change. C) equalizing excess burden across all markets. D) moving the same distance in either direction from a starting point on an indifference curve. Answer: A 3. The compensated demand curve A) shows how the quantity demanded changes when the price changes. B) shows how income is compensated, so that the individual’s commodity bundle stays on the same indifference curve. C) is sometimes referred to as the Hicksian demand curve. D) is all of the above. Answer: D 4. 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 5. The Double Dividend Effect requires A) double credit on airline miles. B) two different taxes. C) no taxes on stock dividends. D) Pigouvian taxes. Answer: D 6. 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 7. Points on the same utility curve are A) points where the person is indifferent between bundles on the line. B) points where utility is maximized. C) never possible. D) known as “points of light.” Answer: A 8. The tax interaction effect is the _________ in excess burden in the labor market stemming from the _______ in real wages caused by a Pigouvian tax. A) increase; increase B) reduce; reduction C) increase; reduction D) reduction; increase Answer: C 9. A tax that causes the price that producers receive for a commodity to deviate from the buyer’s price is A) a unit tax. B) a compensated tax. C) an income tax. D) a price-distorting tax. Answer: D 10. Which of the following would be an example of a lump-sum tax? A) a compensated tax B) a retail sales tax C) a head tax D) an admission fee Answer: C 11. Which of the following is a unit excise tax? A) a tax of 15% B) an admissions fee of $5.00 on each ticket purchased C) an ad valorem tax of $3.00 D) an income tax of $3.00 Answer: B 12. The economic incidence of a unit tax is A) generally borne by the buyers. B) generally borne by sellers. C) generally borne by the government. D) independent of the statutory incidence for the tax. Answer: D 13. Excess burden is largest with A) lump-sum taxes. B) unit taxes. C) no taxes. D) all of the above. Answer: B 14. When a demand curve is vertical, the elasticity of demand is equal to A) 0. B) 1. C) . D) -1. Answer: A 15. A tax wedge causes A) consumer prices to equal producer prices. B) producer prices to rise above consumer prices. C) consumer prices to separate from producer prices. D) all prices to fall. Answer: C 16. Which of the following should be expected if the tax for a certain good increases? A) price of the good increases. B) the composition of the commodity bundle is distorted. C) the budget line pivots out. D) only a and b. Answer: D True/False 17. When a single tax is imposed, the excess burden is proportional to the compensated elasticity of demand and to the square of the tax rate. A) True B) False C) Uncertain Answer: A 18. A lump sum tax can create an excess burden. A) True B) False C) Uncertain Answer: B 19. The logic of the double-dividend hypothesis may not hold because the Pigouvian tax exacerbates pre-existing distortions in the labor market. A) True B) False C) Uncertain Answer: A 20. Taxing in labor markets creates more excess burden than taxing in commodity markets. A) True B) False C) Uncertain Answer: C 21. The differential taxation of inputs does not create an excess burden. A) True B) False C) Uncertain Answer: B 22. The VMP is the Value of Marginal Product. A) True B) False C) Uncertain Answer: A 23. Taxes that create an excess burden are bad. A) True B) False C) Uncertain Answer: B 24. Excess burden calculations typically assume many other distortions. A) True B) False C) Uncertain Answer: B 25. Unit taxes vary along with the price of the taxed commodity. A) True B) False C) Uncertain Answer: B 26. All taxes impose an excess burden. A) True B) False C) Uncertain Answer: B 27. Lump sum taxation is an attractive policy tool. A) True B) False C) Uncertain Answer: B Essay 28. Refer to Figure 15.5 in your textbook. Suppose that the demand curve for barley can be characterized by the equation P = 100 - 2Qd. Suppose further that price was $10.00 and a $10.00 tax is imposed on the market. (A) How many barleys would be purchased at a price of $10.00? After tax? (B) What is the amount of tax revenue generated by the tax? (C) How much excess burden is generated by the tax? (D) What is the amount of consumer surplus before and after the tax? What is the difference in consumer surplus? Is it equal to excess burden plus the tax revenue? Answer: (A) Q* = 45, Q* after tax = 40 (B) Tax revenue generated is (10) (40) = 400. (C) Excess burden is (1/2) (10) (5) = 25. (D) CSbefore tax = (1/2) (45) (100 - 10) = 2025 CSafter tax = (1/2) (40) (100 - 20) = 1600 CSbefore tax - CSafter tax = 2025 – 1600 = 425 29. Refer to Figure 15.7 in your textbook. If the supply curve for labor can be written as L = w/2 – 3/2 and the initial wage was $10, how much excess burden is created if there is a tax on wages of $2? Answer: Excess burden is the area of the triangle idh, which is (1/2) (2) (1) = 1. 30. Suppose the inverse demand curve for good A is given by the equation PA = 10 – QA/10, and the supply curve is perfectly elastic (horizontal) at $1. Good A is presently taxed at $2 per unit. Good B (which is independent of good A) has an inverse demand curve, PB = 5 – QB/20, and is also perfectly elastic at $1. Good B is untaxed. (A) How much tax revenue is collected and what is the excess burden of the $2 tax on A? (B) How much revenue is collected if the tax on good A is reduced to $1 per unit and good B is taxed at $1 per unit? (C) What is the total excess burden of taxing both goods at $1 per unit? (D) Which tax system is preferable from the point of view of economic efficiency? Answer: (A) Tax revenue = (2) (70) = 140. Excess burden = (1/2) (2) (20) = 20. (B) Total tax revenue = (1) (80) + (1) (60) = 140. (C) Total excess burden = (1/2) (20) (1) + (1/2) (10) (1) = 15. (D) Both systems raise the same amount of tax revenue, 140, but the second system does it with less excess burden, 15 < 20. Therefore, the second system would be more efficient. 31. Suppose that demand is perfectly inelastic. Supply is normal and upward sloping. What is the economic incidence of a unit tax placed on suppliers? Illustrate this with an appropriate diagram. Answer: The economic incidence of the tax falls entirely on the consumers. 32. Refer to Figure 15.8 in your textbook. If VMPmkt can be characterized by the equation VMPmkt = 50 – 2Hmkt, where H is the number of hours worked, and VMPhome can be characterized by the equation VMPhome = 45 – 3Hhome, where H is the number of hours worked, what is H* if there are a total of 40 hours to be worked between work and home? Answer: Setting the two equations equal to each other gives 50 – 2Hmkt = 45 – 3Hhome and, keeping in mind the total time constraint, that Hmkt + Hhome = 40 yields that Hhome * = 25 and Hmkt* = 15. 33. Suppose you had to design an economic system for a country that had never existed before, like one of the former Soviet Union countries. What criteria would you consider to minimize the excess burden of the system of taxation? Answer: Reducing excess burden would be critical, but there has to be a great deal of care involved in ensuring that the tax system is fair. This would be important for a new country that has no institutional history to draw up. 34. Equivalent variation is a method employed to measure excess burden. Comment on why a method such as compensating variation would not be appropriate for this analysis. Answer: Compensation variation measures the change in income that would be required to return a person to his original utility curve after a commodity tax/subsidy had moved him from it. Equivalent variation measures the amount of income change that would be necessary to move a person to the same level of utility that a commodity tax/subsidy moved him to. 35. Is it possible to design a tax that does all of the following: i) leaves behavior unchanged so that the quantity demanded of goods and services does not change, ii) creates no excess burden, iii) is not regressive, and iv) is welfare enhancing? Answer: No. Currently, it would be difficult to design a tax system that can do all of these things. Although, economists are trying every day to get closer. Test Bank for Public Finance Harvey Rosen, Ted Gayer 9780078021688
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