Public Finance Midterm study guide Fall 2013

1. 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.
Ans: d
2. A Pigouvian subsidy
A) can not 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.
Ans: d
3. 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
Ans: c
4. Public goods are characterized by
A) nonrivalness.
B) excludability.
C) the sum of the MRSs equaling MRT.
D) all of the above.
Ans: d
5. Equilibrium for public goods is characterized by
A) MRS MRT = MSB
B) MRS1 + MRS2 + MRS3+....+ MRSn = MRT.
C) MRS1 = MRS2 = MRS3== MRSn = MRT.
D) MC = MB.

6. 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
Ans: a

7. Which of the following is a public good?

A) public defense
B) public television
C) a library
D) schools
E) all of the above
Ans: d

8. Points on the utility possibility frontier are

A) inefficient.
B) points of incomplete preferences.
C) not producible.
D) Pareto efficient
Ans: d

9. 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.
Ans: d

10. Pareto improvement can be a reallocation of resources that makes at least one person better
off without making anyone else worse off.
A) True
B) False
C) Uncertain
Ans: a

11. 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.
Ans: d
12. 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.
Ans: a
13. Causation and Correlation are generally the same thing.

A) True
B) False
C) Uncertain
Ans: b
14. A government good or service includes
A) bridges.
B) parks.
C) national defense.
D) all of the above.
Ans: d
15. Government is designed to handle problems not addressed by the private sector.
A) True
B) False
C) Uncertain
Ans: c
16. 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.
Ans: b
17. With multiple-peaked preferences,
A) a unique political equilibrium does not exist.
B) all individuals have a point that is most preferred.
C) the law of consistency is violated.
D) all of the above.
Ans: d

18. Logrolling is
A) a system used often at lumberjack contests.
B) a system that will always lead to worthy projects getting funded.
C) a system that involves the trading of votes.
I) a system that generally involves double-peaked preferences.
Ans: c
19. Lindahl prices
A) result in efficient levels of public goods provision.
B) require honest revelation of preferences.
C) result in different prices for the same amount of output.
I) cause all of the above.
Ans: d

20. 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.
(i) How much should the wig factory be taxed per wig?
21. Consider the following net benefits (measured in billions of dollars) that will result from the
passage of two legislative bills, X and Y:

(a) Identify the logrolling opportunity present in this situation.

(b) Identify the potential gains to voters.
(c) Explain why logrolling is efficiency enhancing.
Ans:
(a) On their own, neither issue X nor Y will pass. Both will be voted down by votes of 2-1. If
person A trades a vote with B, then both issues will pass by 2-1 votes.
(b) With both issues passed, overall utility for person A is 3. For person B, overall utility is 4.
For person C, overall utility is 5.
(c) With issue X passed, society is benefited because it had a total benefit to society of 3.
Logrolling also allowed issue Y to pass, though it shouldnt have since its total benefit to society
is 1.
Ans:
(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.

22. Suppose that there are only two fishermen, Ali and Ahmet, who fish along a
certain coast. They would each benefit if lighthouses were built along the coast
where they fish. The marginal cost of building each additional lighthouse is $100.
The marginal benefit to Ali of each additional lighthouse is 90-Q, and the marginal
benefit to Jacob is 40-Q, where Q is the number of lighthouses.
a)
Explain why we might not expect to find the efficient number of lighthouses
along this coast.
b)
What is the efficient number of lighthouses?
What would be the net benefits to Ali and Ahmet if efficient number were
provided?
Ans:

a) since the marginal cost (100) is greater than marginal benefit(when Q=0) for
each individual. When it is left to Ali and Ahmet, they wont demand any
lighthouse.
b) For public goods efficient quantity is found when market demand equals
market supply. To find market demand we add individual demands
vertically. (90-Q+40-Q=130-2Q) Then equalize this with MC=100
130-2Q=100
Q*=15
When Q=15 Net benefit to Ali is and Veli ia consumer surplus(area of the
triangle under market demand line and above MC. (130-100)*15/2 = 225