EXERCISES

Textbook: Public Finance, 9th Edition (Harvey Rosen, Ted Gayer)

Chapter Tools of positive analysis

 Problem 1
 Problem 3
 Problem 6
Chapter Tools of normative analysis
 Problem 1
 Problem 4
 Problem 6
 Problem 10
 Problem 11
Chapter Public Goods
 Problem 1
 Problem 2
 Problem 11
 Problem 13
Chapter Externalities
 Problem 4
 Problem 6
 Problem 8
 Problem 10
 Problem 11
Chapter 2 – Positive analysis
1. In 2008, presidential candidate John McCain proposed extending the cut in
marginal income tax rates passed during the Bush administration.
 Explain why theory alone cannot predict how labor supply would be affected
if this proposal were implemented.
 If there were no political or legal impediments to doing so, how could you
design an experimental study to estimate the impact of lower marginal tax
rates on labor supply?

3. A researcher conducts a cross-sectional analysis of workers and finds a positive

correlation between time spent on a computer at work and wages.

The researcher concludes that computer use increases wages and advocates a policy
of computer training for all children. What is a possible problem with this analysis?

6. Suppose that five states reduce income taxes in a given year. You are interested in
estimating whether the tax cut has increased saving, and you find that the saving
rate for residents of these five states increased by 2 percent in the year after it was
introduced.

 Can you reasonably conclude that the tax cut caused the increase in saving?
 How would you conduct a difference-in-difference analysis to estimate the
impact on saving?
 What assumption must hold for the difference-in-difference analysis to be
valid?

Chapter Tools of normative analysis

1. In which of the following markets do you expect efficient outcomes? Why?
a. Hurricane insurance for beach houses
b. Medical care
c. Stock market
d. MP3 players
e. Loans for students who wish to attend college
f. Housing
4. According to Princeton University’s student newspaper, the Daily Princetonian (April
16, 2007), there was “a flourishing market of graduation ticket buyers and sellers on [the
Internet].” However, the dean of students shut down the market, arguing that “selling
tickets undermines that spirit of community, and undermines the sense of class unity that
seniors have worked hard to create.”
To analyze this policy, assume that a typical senior’s utility depends only on two
commodities, graduation tickets and a composite of all other goods. Assume there are
two students, Angelo and Bahn, each of whom starts out with three tickets. However,
Angelo is “rich” and has twice the amount of all other goods as Bahn. For simplicity, you
may assume that graduation tickets are infinitely divisible.
a. Draw an Edgeworth Box showing the initial allocation, assuming conventionally
shaped indifference curves for both students.
b. Using the Edgeworth Box, explain how the ban on selling tickets can lead to an
inefficient outcome.
c. Using the Edgeworth Box, represent a situation in which the ban on selling tickets does
not reduce efficiency for these two students.

6. Imagine a simple economy with only two people, Augustus and Livia.
a. Let the social welfare function be W= UL+UA where UL and UA are the utilities of Livia
and Augustus, respectively. Graph the social indifference curves. How would you
describe the relative importance assigned to their respective well-being?
b. Repeat part a when W= UL + 2UA
c. Assume that the utility possibilities curve is as follows:

Graphically show how the optimal solution differs between the welfare functions given in
parts a and b.
Chapter Public Goods
Problem 1
Problem 2
Problem 11
Problem 13
1. Which of the following do you consider pure public goods? Private goods? Why?
a. Wilderness areas
b. Satellite television
c. Medical school education
d. Public television programs
e. Automated teller machine (ATM)

2. Indicate whether each of the following statements is true, false, or uncertain, and
justify your answer.
a. Efficient provision of a public good occurs at the level at which each member of
society places the same value on the last unit.
b. If a good is nonrival and excludable, it will never be produced by the private sector.
c. A road is nonrival because one person’s use of it does not reduce another person’s use
of it.
d. Larger communities tend to consume greater quantities of a nonrival good than smaller
communities

11. Suppose that there are only two fishermen, Zach and Jacob, 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
Zach of each additional lighthouse is 90 - Q, and the marginal benefit to Jacob is 40 - Q,
where Q equals 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 Zach
and Jacob if the efficient number were provided?

12. Britney and Paris are neighbors. During the winter, it is impossible for a snowplow to
clear the street in front of Britney’s house without clearing the front of Paris’s. Britney’s
marginal benefit from snowplowing services is 12 - Z, where Z is the number of times the
street is plowed.
Paris’s marginal benefit is 8 - 2Z. The marginal cost of getting the street plowed is $16.
Sketch the two marginal benefit schedules and the aggregate marginal benefit schedule.
Draw in the marginal cost schedule, and find the efficient level of provision for
snowplowing services.
note that Paris gets zero marginal benefit for Z>4). Since
Chapter Externalities

6. For each of the following situations, is the Coase Theorem applicable? Why or why
not?
a. A farmer who grows organic corn is at risk of having his crop contaminated by
genetically modified corn grown by his neighbors.
b. In Brazil it is illegal to catch and sell certain tropical fish. Nevertheless, in some
remote parts of the Amazon River, hundreds of divers come to capture exotic fish for sale
on the international black market. The presence of so many divers is depleting the stock
of exotic fish.
c. In the state of Washington, many farmers burn their fields to clear the wheat stubble
and prepare for the next planting season. Nearby city dwellers complain about the
pollution.
d. Users of the Internet generally incur a zero incremental cost for transmitting
information. As a consequence, congestion occurs, and users are frustrated by delays.
8. In India, a drug used to treat sick cows is leading to the death of many vultures that feed off of
dead cattle. Before the decrease in the number of vultures, they sometimes used to smash into
the engines of jets taking off from New Delhi’s airports, posing a serious threat to air travelers.
However, the decline of the vulture population has led to a sharp increase in the populations
of rats and feral dogs, which are now the main scavengers of rotting meat [Gentleman, 2006,
p. A4]. There have been calls for a ban on the drug used to treat the cows.
Identify the externalities that are present in this situation. Comment on the efficiency of banning
the drug. How would you design an incentive-based regulation to attain an efficient outcome?

10. American suburbs are expanding to more rural areas at the same time as pig farms are
expanding in size [Economist, 2007d, p. 36]. The smells emanating from the massive
amounts of pig manure adversely affect property values.
Imagine that the Little Pigs (LP) hog farm is situated near 100 houses. The following
table shows, for each level of LP’s output, the marginal cost (MC) of a hog, the marginal
benefit (MB) to LP, and the marginal damage (MD) done to property values:

a. How many hogs does LP produce?

b. What is the efficient number of hogs?
c. Suppose the owner of LP can reduce the marginal damages of hog smells by twothirds
by modifying the hogs’ diet. The modified diet increases the marginal cost of each hog by
$100. What is the efficient number of hogs?

11. The private marginal benefit for commodity X is given by 10 - X, where X is the
number of units consumed. The private marginal cost of producing X is constant at $5.
For each unit of X produced, an external cost of $2 is imposed on members of society. In
the absence of any government intervention, how much X is produced? What is the
efficient level of production of X? What is the gain to society involved in moving from
the inefficient to the efficient level of production? Suggest a Pigouvian tax that would
lead to the efficient level. How much revenue would the tax raise?