Chương Cost – Benefit analysis

3) A project yields an annual benefit of $25 a year, starting next year and continuing forever. What
is the present value of the benefits if the interest rate is 10 percent?
[Hint: The infinite sum x + x2 + x3 . . . is equal to x/(1 - x), where x is a number less than 1.]
Generalize your answer to show that if the perpetual annual benefit is B and the interest rate is r,
then the present value is B/r.

The present value of the perpetual annual benefit = B/(1 + r) + B/(1 + r) 2 + … = B (r + 1 - r)/r =
B/r.

Áp dụng: The present value of $25/.10 = $250.

4) Suppose that you are planning to take a year vacation to bike across the United States. Someone
is willing to sell you a new bicycle for $500. At the end of the year, you expect to resell the bicycle
for $350. The benefit to you of using the bicycle is the equivalent of $170.
a. What is the internal rate of return?
b. If the discount rate is 5 percent, should you buy the bicycle?

a. The internal rate of return is the discount rate that would make the project’s net present value (NPV)
equal zero. To solve for the internal rate of return, , set the present value of benefits minus the
present value of costs equal to zero. If we assume the benefit of using the bicycle is immediate (and
worth $170), there is also the benefit of re-selling the bicycle for $350, but it can’t be re-sold until
next year, so must be discounted. Therefore, NPV is 170 + [350/(1+)] – 500 = 0. Solving this
expression for  yields  = 6 percent. If we assume that the benefits of the vacation will not be
 enjoyed for one year, then NPV is [(170+350)/(1+)] –500 and setting this expression equal to zero
and solving for  yields  = 4 percent.

b. If the discount rate is 5 percent, purchasing the bicycle is a good idea if  is 6 percent, but a bad idea
if  is 4 percent.

5. Bill rides the subway at a cost of 75 cents per trip, but would switch if the price were any higher.
His only alternative is a bus that takes five minutes longer, but costs only 50 cents. He makes 10
trips per year. The city is considering renovations of the subway system that would reduce the trip
by 10 minutes, but fares would rise by 40 cents per trip to cover the costs. The fare increase and
reduced travel time both take effect in one year and last forever. The interest rate is 25 percent.
a. As far as Bill is concerned, what are the present values of the project’s benefits and costs?

b. The city’s population consists of 55,000 middle-class people, all of whom are identical to Bill, and
5,000 poor people. Poor people are either unemployed or have jobs close to their homes, so they do not
use any form of public transportation. What are the total benefits and costs of the project for the city as a
whole? What is the net present value of the project?
c. Some members of the city council propose an alternative project that consists of an immediate tax of
$1.25 per middle-class person to provide “free” legal services for the poor in both of the following two
years. The legal services are valued by the poor at a total of $62,500 per year. (Assume this amount is
received at the end of each of the two years.) What is the present value of the project?
d. If the city must choose between the subway project and the legal services project , which should it
select?
e. What is the “distributional weight” of each dollar received by a poor person that would make the
present values of the two projects just equal? That is, how much must each dollar of income to a poor
person be weighted relative to that of a middle-class person? Interpret your answer.

a. Bill is willing to pay 25 cents to save 5 minutes, so he values time at 5 cents per minute. The subway
saves him 10 minutes per trip, or 50 cents. The value of 10 trips per year is $5. The cost of each trip is
40 cents, or $4 per year (10 trips per year). The annual net benefit to Bill is therefore $1. The present
value of the benefits = $5/.25 = $20; the present value of the costs is $4/.25 = $16.
b. Total benefits = $20x55,000=$1,100,000.
Total costs = $16x55,000 = $880,000.
 Net benefits = $220,000.
c. Costs = $1.25 x 55,000 = $68,750.
Benefits =($62,500/1.25) + ($62,500/1.252) = $90,000.
Net benefit = $21,250.
d. The subway project has a higher present value. If a dollar to the “poor” is valued the same as a dollar
to the “middle class,” choose the subway project.

e. Let  = distributional weight. Set:

220,000 = -68,750 + [(62,500/1.25) + (62,500/1.252)]

 = 3.21
This distribution weight means that $1 of income to a poor person must be viewed as more important
than $3.21 to the middle class for the legal services to be done.

6. Suppose that the government is debating whether to spend $100 billion today to address climate
change. It is estimated that $700 billion of damage will be averted, but these benefits will accrue 100
years from now. A critic of the proposal says that it would be far better to invest the $100 billion,
earning an average real return of 5 percent per year, and then use the proceeds in 100 years to
repair the damage from climate change. Is this critic correct?

$100 billion invested for 100 years at 5 percent per year would generate over $13 trillion, a lot more than
the $700 billion in damage caused by the climate change. There might be other considerations offered
when evaluating this proposal, but the critic is correct from a financial standpoint.

9. According to Viscusi and Gayer [2005], regulations in the United States vary greatly in the cost
per each life they save. For example, the regulation to install passive restraints in vehicles has a cost
per life saved of $600,000, whereas the regulation to remove asbestos in workplaces has a cost per
life saved of $180 million. What does this information imply about whether the regulations pass a
cost-benefit test? How might resources be shifted between these regulations in order to reduce cost
or save more lives?
Viscusi (2006) finds the value of a life between $4 and $10 million. Therefore, the passive restraints in
vehicles passes cost benefit analysis, but the asbestos removal does not. This implies that resources could
be shifted from asbestos removal to vehicle restraints to reduce costs or save lives.

Chương Income Redistribution

2. Suppose there are only two people, Simon and Charity, who must split a fixed income of $100.
For Simon, the marginal utility of income is MUs = 400 - 2Is while for Charity, marginal utility is
MUc = 400 - 6Ic where Ic, Is are the amounts of income to Charity and Simon, 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 Charity? What if the reverse
is true? Comment on your answers.
c. Finally, comment on how your answers change if the marginal utility of income for both Simon
and Charity is constant: MUc = 400 , MUs =400

a. To maximize W, set marginal utilities equal; the constraint is I s + Ic = 100. So, 400 - 2Is = 400 -
6Ic, substituting Ic = 100 - Is gives us 2Is = 6 (100 – Is). Therefore, Is = 75, Ic = 25.
b. If only Charity matters, then give money to Charity until MU c = 0 (unless all the money in the
economy is exhausted first). So, 400-6I c = 0; hence, Ic = 66.67. Giving any more money to Charity causes
her marginal utility to become negative, which is not optimal. Note that we don’t care if the remaining
money ($33.33) is given to Simon or not.
If only Simon matters, then, proceeding as above, MUs. =0 if Is = 200; hence, giving all the money to
Simon is optimal. (In fact, we would like to give him up to $200, nghĩa là nếu cho thêm được ngoài 100$
thì sẽ tiếp tục cho Simon.)
c. MUs = MUc for all levels of income. Hence, society is indifferent among all distributions of
income.
6. An economy consists of two individuals, Lynne and Jonathan, whose utility levels are given by U L
and UJ, respectively.
a. Suppose that the social welfare function is W = UL + UJ
True or false: Society is indifferent between giving a dollar to Lynne and a dollar to Jonathan.
b. Now suppose that, instead, the social welfare function is W = U L + 8UJ
True or false: Society values Jonathan’s happiness more than Lynne’s.
c. Now suppose that, instead, the social welfare function is W = min[U L, UJ]
True or false: In this society, the optimal distribution of income is complete equality

a. False. Society is indifferent between a util to each individual, not a dollar to each individual.
Imagine that UL=I and UJ=2I. Then each dollar given to Jonathan raises welfare more than the same
dollar given to Lynne.
b. True. The social welfare function assumes a cardinal interpretation of utility so that comparisons
across people are valid.
c. False. Departures from complete equality raise social welfare to the extent that they raise the
welfare of the person with the minimum level of utility. For example, with the utility functions U L=I and
UJ=2I, the social welfare function W=min[U L,UJ] would allocate twice as much income to Lynne than
Jonathan.

8. Sherry’s utility is US and her income is YS. Marsha’s utility is UM and her income is YM. Suppose
it is the case that:
Define the Pareto efficient redistribution, and explain why the concept is relevant in this
situation. Suppose that initially Sherry and Marsha both have incomes of $100. Assuming that the
social welfare function is additive, what happens to social welfare if $36 is taken away from Marsha
and given to Sherry?
Pareto efficient redistribution is a reallocation of income that increases (or does not decrease) the utility
of all consumers. With these two consumers, Marsha’s utility increases as Sherry’s utility increases.
Thus, it may be possible to reallocate income from Marsha to Sherry and raise both of their utility.
With Sherry’s initial utility function of U S=100YS1/2, her utility with $100 of income is U S=100($100)1/2,
or US=1,000. With Marsha’s initial utility function of U M=100YM1/2+0.8US, her utility with $100 of
income is UM=100($100)1/2+0.8(1,000), or UM=1,800. If the social welfare function is additive, then
initial welfare is W=US+UM=1,000+1,800=2,800.
If $36 is reallocated from Marsha to Sherry, then Sherry’s income is now $136 and Marsha’s is now $64.
With Sherry’s utility function, her utility with $136 of income is U S=100($136)1/2, or US=1,166.190. With
Marsha’s utility function, her utility with $64 of income is U M=100($64)1/2+0.8(1,166.190), or
UM=800+932.952=1,732.952. In this case, Sherry’s utility increases from 1,000 to 1,166.190, while
Marsha’s utility falls from 1,800 to 1,732.952. Social welfare increases with this redistribution, going
from 2,800 to 2,899.142. Thus, this redistribution increases social welfare, but is not Pareto efficient
redistribution.
Chương Taxation and Income distribution
1. In 2009, it was proposed that the state of Nevada create an entertainment tax that “would require
the state’s 25 legal brothels to give the state some money on a per-transaction basis” [Friess, 2009].
Discuss the likely incidence of such a tax. Use an appropriate diagram as the basis for your
discussion.

The market initially is at P1Q1. Adding a per-customer tax on strip clubs would be a tax on a
commodity. Because the producer would be paying the tax, the effective supply curve for
suppliers would be S1. The producers are happy and the market clears only when PS is paid by
the customers for quantity Q2. Of this price, PS-PC is the tax paid, where customers pay PS-P1 of
the tax and the suppliers pay P 1-PC. The incidence depends on the relative elasticities of supply
and demand. Here, the curves are drawn such that the consumers and suppliers face roughly the
same incidence. However, if one believed that the supply was relatively more inelastic, then the
strip clubs would face a higher incidence.
 S1
Price
S

PS

P1
PC

Q2 Brothel
Q1 Transactions

2. Consider a society with only two people—one rich and one poor—who have the same utility
functions. These utility functions exhibit diminishing marginal utility. Suppose that taxes are set
such that the total amount of utility that each person loses is the same. Does it follow that the tax
will be progressive? Explain.

No, it does not follow that the tax will be progressive. If both lose the same amount of utility, the rich
person will pay more because of diminishing marginal utility of income. But, a progressive tax requires
that a higher proportion of income (the average tax rate) be taken from the rich person . This tax plan only
requires that the absolute amount be higher, not the proportional amount. For instance, if the marginal
utility were decreasing, but very close to constant, then the rich and poor would pay very close to the
same amount in taxes. This amount would be a much larger share of the poor person’s income.
Cho hàm QD = 2000-200P, QS= 200P. CP áp mức thuế đơn vị $2 lên người bán. Tính sản lượng cân
bằng khi chưa có thuế, khi có thuế. Tính doanh thu thuế.
a. Set 2000 – 200P = 200P, so P = $5 and Q = 1000 packs
b. 2000-200P=200(Pcons – 2)
Producer receives $4 per pack; consumer pays $6 per pack.
Quantity sold = (200)(4) = 800 packs.
Tax revenue = (tax/pack)(no. of packs) = (2)(800) = $1600
7. Suppose that the income tax in a certain nation is computed as a flat rate of 5 percent, but no tax
is levied above $50,000 in taxable income. Taxable income, in turn, is computed as the individual’s
income minus $10,000; that is, everyone gets a $10,000 deduction. What are the marginal and
average tax rates for each of the following three workers? (Evaluate the marginal tax rate at each
person’s current income level.)
a. A part-time worker with annual income of $9,000.
b. A retail salesperson with annual income of $45,000.
c. An advertising executive with annual income of $600,000.

a. A part-time worker with annual income of $9,000 pays no taxes since everyone gets a $10,000
deduction. Her marginal tax rate is 0% and her average tax rate is 0%.
b. A retail salesperson with annual income of $45,000 has taxable income of $35,000 and pays $1750 in
taxes (5 percent of taxable income). As a percentage of income, the average tax rate is 3.89% ($1750 is
3.89% of $45,000). Her marginal tax rate is 5%.
c. An advertising executive with annual income of $600,000 pays $2,000 in taxes since no tax is levied
above $50,000 in taxable income (đánh thuế trên 40 ngàn, do khấu trừ thêm 10 ngàn trước khi bắt đầu
tính thuế). As a percentage of income, the average tax rate is 0.33%. Her marginal tax rate is 0%.
The tax is initially progressive, but because of the cap on taxable income, becomes regressive.

Chương Taxation and Efficiency

1. Which of the following is likely to impose a large excess burden?
a. A tax on land.
b. A tax of 24 percent on the use of cellular phones. (This is the approximate sum of federal and
state tax rates in California, New York, and Florida.)
c. A subsidy for investment in “high-tech” companies.
d. A tax on soda bought in a cup or glass but not bought in a bottle or can. (Such a tax exists in
Chicago.)
e. A 10-cent tax on a deck of cards that contains no more than 54 cards. (Such a tax exists in
Alabama.)
f. A tax on blueberries. (Such a tax exists in Maine.)

a. The supply of land is fixed, or perfectly inelastic, so there is no excess burden because the lower price
that sellers receive does not cause quantity supplied to fall.

b. The use of cell phones is probably fairly price-elastic, which implies that the excess burden could be
large.

c. It is possible that companies could identify themselves as high-tech in order to receive the subsidy.
Thus, the supply is quite elastic, and there will be substantial excess burden.

d. Consumers and sellers will likely agree to avoid cups and glasses in order to avoid the tax. A tax that
is easily avoided does not have much of an impact, except to create some inconvenience, and does not
raise revenue.

e. Card companies can easily increase or decrease the number of cards in a pack, avoiding the tax and
reducing the excess burden.

f. There are many good substitutes for blueberries. Therefore, their demand is quite elastic, and a tax on
them will have a substantial excess burden, relative to the size of revenues collected.

2. Suppose that your neighbor is willing to pay you $100 to do some home repairs for her. You
would
be willing to do the job for $80, so you strike a deal. Now suppose that the government levies a tax
of $25 on all home repair transactions. You pack up your gear and leave your neighbor’s home,
because it is no longer worthwhile for you to do the job. As a result of your leaving the job, you do
not have to pay the $25 tax. Relate this scenario to the concept of excess burden.
Prior to the tax, you and your neighbor are both made better off by the trade. After the introduction of the
tax, the work does not get done even though you would be willing to accept the wage that your neighbor
is willing to pay. This loss of a potentially beneficial trade that is not compensated by an increase in tax
revenue (in fact, no tax is collected) is exactly the idea of excess burden.

9. In the United Kingdom, each household that owns a television pays a compulsory levy that is
equivalent to $233 per year. The total revenue collected, which is over $7 billion annually, goes to
the British Broadcasting Corporation. Do you think that such a tax is likely to have a substantial
excess burden relative to the revenues collected?

It is likely that the demand for owning at least one television is quite inelastic. It follows that the excess
burden from a $233 per year television tax is small relative to the revenues that are collected.

Beard tax (đọc thêm)

The beard tax was progressive because it was a function of social position, which was probably a good
proxy for income. Because the tax attempted to treat people with the same income similarly, it satisfied
some level of horizontal equity, even though it penalized those with a preference for facial hair. It’s hard
to know about the efficiency consequences unless one knows more about the price elasticity of demand
for the privilege of having a beard. If the elasticity was small, then it would be an efficient tax.