Solution Manual for Public Finance in Canada 5th Edition

Solution Manual for Public Finance in Canada 5th

Edition

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 Suggested Answers to Exercises

Chapter 7

1.
2. a. Below, the preferences for each person.

Person 4
1 Person 5 Person 3

2 Person 1

3
Person 2
4

A B C D

b. C wins in every pair wise vote. Thus, there is a stable majority outcome, despite the
fact that persons 1, 2, and 3 have double-peaked preferences. This demonstrates that
although multi-peaked preferences may lead to voting inconsistencies, this is not
necessarily the case.

3. a. The outcome of the first election (M vs. H) is M. The outcome of the second election (H vs.
L) is L. The outcome of the third election (L vs. M) is M. Majority rule leads to a stable
outcome since M defeats both H and L. Giving one person the ability to set the agenda
would not affect the outcome in this case.

b. With the change in Eleanor’s preference ordering, majority rule no longer generates a stable
outcome. In a vote between M and H, the outcome is H. In a vote between H and L, the
outcome is L. In a vote between L and M, the outcome is M. So, giving one person the
ability to set the agenda affects the outcome. For example, Abigail prefers H, so she might
pit L against M first in order to eliminate L and avoid having L defeat H.

4. a. When each actor pays $5, Moe’s preferred quantity is 4 hours, Larry’s is 7, and
Curly’s is 2. Their preferences are single-peaked and thus the median choice (4 hours)
prevails. This is close to the optimal level of 5, where MB = MC.
b. In this case, Moe’s preferred choice is 6, Curly’s is 6, and Larry’s is 3. Majority rule selects 6
as the winning choice, which exceeds the efficient quantity of 5.
5.
a. Neither issue would pass with majority voting as in both cases, two voters of the three
would vote against the each issue because they receive negative net benefits. This is not
efficient because issue X has a positive total net benefit and should be funded.

Rosen: Public Finance, 5Ce 7-1

© 2016 McGraw-Hill Ryerson Limited
 Suggested Answers to Exercises

b. With logrolling, voters A and B can trade votes. A will vote for issue Y if B votes for
issue X, but C will not vote for either project. Both issues will pass with two votes for
and one against. This is not efficient because issue Y has a negative total net benefit.
c. If side payments were allowed A could pay B to vote for issue X (A would not pay C
because C would require a higher payment than B), and B could pay A or C to vote for
issue Y. This would result in the same inefficient outcome as in b. (If side payments
were allowed A would have to pay B at least 1 to vote for issue X. A would only be
willing to pay less than 6. B would have to pay A or C at least 3, but no more than 4 to
entice him to vote for issue Y.)

6. a. Three percent a year.

b. Assuming that the public sector uses only labour as an input, the price of the public good
increases by 3 percent a year.
c. The size of government increases. For further discussion of this phenomenon see the paper by
W.J. Baumol, “Macroeconomics of Unbalanced Growth: The Anatomy of Urban Crisis,”
American Economic Review, 1967.
7. When there is a vote over five options, there is the chance that a potential majority vote is split
between four relatively preferred options, and the fifth option wins. The winning option may have
been voted down if it had been a two-way vote with any of the other options. Further, if preferences
are not single-peaked, cycling and inconsistent public decisions may emerge.
8. When the policy changed to allow and encourage female voting, female voters became the
majority, so it is sensible that the median voter is now a woman. Given this, the median voter
theorem suggests that politicians should shift their positions to more closely align with the
views of women.

9.

a. With the demand curve of Q=100-10P and a perfectly elastic supply curve at P=2, the
milk is sold at a price of $2, and a quantity of 80 units is sold.

b. The marginal revenue curve associated with the inverse demand curve P=10-(1/10)Q
is MR=10-(1/5)Q, while the marginal cost curve is MC=2. The cartel would ideally
produce a quantity where MR=MC, or 10-(1/5)Q=2, or Q=40. The price associated
with a cartel quantity of 40 units is P=10-(1/10)*40, or P=6.

c. The rent associated with the cartel is the product of the marginal profit per unit and
the number of units produced. The marginal profit per unit of milk is $4 (=$6 price -
$2 marginal cost), while 40 units are produced. Thus, the rents equal $160.

d. The most the cartel would be willing to contribute to politicians is the full economic
rent of $160. The cartel situation, the quantity of milk produced is too low from
society’s point of view. The deadweight loss triangle is computed using the
difference between the cartel output and competitive output as the “base” of the
triangle, and the difference between the cartel price and competitive price as the
“height.” Thus, the triangle is equal to (1/2)*(80-40)*($6-$2)=$40.

Rosen: Public Finance, 5Ce 7-2

© 2016 McGraw-Hill Ryerson Limited
Solution Manual for Public Finance in Canada 5th Edition

Suggested Answers to Exercises

e. As Figure 7.5 in the textbook shows, the deadweight loss could now go as high as the
sum of the conventional deadweight loss and the rents, or $160 rents + $80 DWL =
$240. This is because, as noted in the text, “rent-seeking can use up resources –
lobbyists spend their time influencing legislators, consultants testify before regulatory
panels, and advertisers conduct public relations campaigns. Such resources, which
could have been used to produce new goods and services, are instead consumed in a
struggle over the distribution of existing goods and services. Hence, the rents do not
represent a mere lump-sum transfer; it is a measure of real resources used up to
maintain a position of market power.”

10. When a cartel raises its price, any individual firm has an incentive to cheat, that is, to increase its
production beyond its agreed-upon quota. If the firms can get the government to enforce the
cartel, then they can maintain the high price without having to worry about cheating.

Rosen: Public Finance, 5Ce 7-3

© 2016 McGraw-Hill Ryerson Limited

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