October 21, 2022

Foundations of Public Policy Homework Assignment #4

Question 1.
An influential argument makes the following claim: A well-functioning democracy requires that
voters actually know what policies would be in their interests so that they can vote for politicians
who implement such policies. However, the argument continues, in a democratic system there is
a “public goods problem” with respect to information leading to systematically bad vote decisions
and, thus, policy choices in democracies.
Consider the following model. There are three voters a, b, and c and two candidates advocating
two different policies 1 and 2. None of the voters know which policy would be better off for
her. Moreover, the voters believe it is equally likely that they each prefer either policy. Each voter,
individually, can either invest in becoming an informed voter (at cost C) or not (at cost 0). If a voter
invests, she learns the policy she prefers, but she does not have the opportunity to communicate
it to the other voters. Moreover, let’s assume (for simplicity) that, were they all informed, all the
voters would prefer the same policy (i.e., there is a correct policy). The payoff of having the correct
policy chosen is B > C. The payoff of having the wrong policy chosen is 0. Assume all voters vote
and that if a voter is uninformed she flips a coin to choose between 1 and 2.
(a) Suppose a voter expects the other two voters not to become informed. What has to be true
about the relationship between B and C for her to become informed?
(b) Suppose a voter expects one of the other voters to become informed and one of the other voters
not to become informed. Under what conditions on B and C will she become informed?
(c) Suppose a voter expects both other voters to become informed. Under what conditions on B
and C will she become informed?
(d) Given the answers above, there are two things that can happen in equilibrium. What happens
in equilibrium if C ≤ B4 ?
B
(e) What happens in equilibrium if C > 4?

(f) Compare this to a model where there is only one voter. Under what conditions does this
single voter become informed?
(g) What does the comparison of the results from the three-voter model and the one-voter model
illustrate the public goods problem in democracy?

(h) What do you think would happen as we increase the number of voters in the model? Why?

Question 2.
A medical researcher is trying to cure a disease. For each unit of effort she puts into her work,
she generates a utility benefit of 10 for each member of society. There are 1,000 people in society
besides the medical researcher.
The medical researcher does not care about other people. She is in it for the glory. For each unit
of effort she puts into her work, she gets a utility benefit of 1000 (which is inclusive of the 10 that
she gets for being a member of society, plus a payoff of 990 in glory). If she exerts effort e, she also
suffers costs e2 .
Suppose a policymaker who was a committed utilitarian (including caring about the medical re-
searcher’s glory, since the medical researcher cares about it) was to choose the level of effort the

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medical researcher exerts. That policymaker would add up the total utility in society (including
the medical researcher’s utility) from any given level of effort and choose the level of effort that
maximizes that aggregate utility.

(a) The medical researcher’s payoff from exerting effort e is 1000e − e2 . What level of effort will
she exert in the equilibrium?
(b) What (social) utility function would the policymaker maximize?
(c) Would the policymaker like the medical researcher to exert more or less effort than your
answer to the first question (a)? (Use words, not math, to answer this). Why?
(d) What level of effort, eFB , would the policymaker demand of the medical researcher?
(e) Suppose that the policymaker wanted to implement this first-best policy eFB by paying the
medical researcher a subsidy σ for each unit of effort. What level of subsidy, σ FB , must the
policymaker offer to get the researcher to choose the first-best level of effort?
(f) Suppose, now, that the policymaker can only pay for the subsidy through inefficient taxation.
In particular, assume that if a total subsidy of eσ must be paid to the researcher, then a
total amount of revenues 2eσ must be collected. The tax burden will be shared equally by
everyone except the medical researcher (who pays no taxes). Assume taxes come linearly
out of the payoffs of each member of society. Suppose the policymaker chooses the subsidy
that maximizes the utilitarian payoff, taking account of these taxes and the level of medical
research. What (social) utility function would the policymaker maximize?
(g) Will the subsidy she chooses (σ SB ) be higher or lower than the first-best subsidy? Why?
(h) Calculate the second-best subsidy that the policymaker will implement.

Question 3.
As we saw in Section 4.3 of Political Economy for Public Policy, the first-best number of boats in
the tragedy of commons game is 45. But, if taxes are distortionary, then the socially optimal (i.e.,
second-best) number of boats is not equal to the first best.
Let’s assume we tax each boat at a rate of t dollars and then redistribute the revenues–giving
the revenues collected from firm 1 to firm 2 and the revenues collected from firm 2 to firm 1. As
in Section 4.4, there is some inefficiency associated with taxation–for each dollar distributed, the
government must collect τ > 1 dollars. That is, if the two firms run b1 and b2 boats, total taxes
collected are t(b1 + b2 ), but firm 1 gets back only tbτ2 and firm 2 gets back only tbτ1 . We can explore
the second-best number of boats in this setting.

(a) Given the tax policy t, what are firm i’s expected payoffs, if it believes the other firm will run
bi boats?
(b) Calculate firm i’s best response to the tax rate t and bi boats by the other firm–i.e., BRi (b−i , t).
(c) By substituting one firm’s best response into the other’s, what is the equilibrium number of
boats each firm will run, given a tax rate t?
(d) Given equilibrium behavior, for any tax rate t, what is each firm’s total payoff?

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(e) Use your answer to the previous question to write down the utilitarian social welfare as a
function of the tax rate t.
(f) Use your answer to the previous question to compute the second-best tax rate and the implied
second-best number of boats run by each firm.

(g) Show that the second-best number of boats is larger than the first-best number of boats run
by each firm.