Public Economics: Advanced Topics

Tutorial 10 SOLUTIONS
Prepared by S. Grassi

Q1 E-ZTAX: Tax Salience and Tax Rates

True/False Explain.
For each statement 1), 2) and 3), indicate if they are true or false, and provide a short
explanation for your answer. (Do not exceed 150 words or half page with average size
handwritten style.)

The analysis in this paper suggests that:

1) introducing an Electronic Toll Collection (ETC) increases the salience of toll collection
2) Under ETC driving becomes more elastic with respect to the toll
3) Toll rates increase after the adoption of ETC.

SOLQ1
1)FALSE. Salience proxies the awareness of the toll, and the analysis shows that when the
ETC is introduced people are less aware of the amount paid in toll by those who pay
electronically relative to those who pay using cash.
2) FALSE. As expected, when salience is low because facilities use ETC, driving become less
elastic in absolute value with respect to the toll.
3) TRUE. This is explained by lower elasticity of driving and toll setting becoming less
sensitive to the local election calendar.

Q2 “Intergenerational Mobility and Preferences for Redistribution” by Alesina et al.

What is the main takeway from the table below? How does it relate to the paper by Bénabou
and Tirole (Beliefs in a Juast World) studied in class?

SOL
See section II. Mobility (Mis)Perceptions A. Actual and Perceived Mobility in the paper.
The misperceptions of mobility found in this article are perfectly in line with Bénabou and
Tirole’s (2006) model of “ideology,” where people need and demand “just world” beliefs to
summon willpower and effort. In their “Belief in a Just World Equilibrium,’’ there is
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overestimation of mobility and rewards for effort and low redistribution; the opposite holds
true for the “European or Realistic Pessimism equilibrium.’’

Question 3
Figure 1 shows that it is easier for a child born from poor parents to become richer than his
parents in the USA rather than in Denmark. True/False? To justify your answer, refer to
Figure 1 and describe the measure of intergenerational income mobility used by Chetty et al
(2014)

Figure 1

Sol: for the solutions you must refer to lecture slides Inequality. You must also look at the
article by Chetty (in Keats: chetty-friedman-kline-saezQJE14mobility.pdf) and learn what the
Rank-Rank Slope is. See pages 1575-76-77 and earlier pages 1555.

Q4 “Intergenerational Mobility and Preferences for Redistribution”

The following paragraph is excerpted from Intergenerational Mobility and Preferences for
Redistribution. Some words are missing and replaced by a number. For each missing word,
select the appropriate option from the choice offered below at the corresponding number.
Example: for missing word (1), choose between options indicated by (1) (LESS/ MORE).
Then indicate how, among the most pessimistic respondents about intergenerational mobility,
those who are left-wing differ from those who are right-wing in terms of support for
government intervention (in no more than 100 words).

“Views on mobility are highly correlated with policy preferences

across all countries: respondents who are ____(1)_____ pessimistic about mobility tend to
favour more generous redistributive policies and ____(2)____ levels of government

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involvement. Interestingly, the correlation is stronger for _____(3)_____ policies than for
_____(4)_______policies.”

1) LESS / MORE
2) HIGHER / LOWER
3) EQUALITY OF OUTCOME / EQUALITY OF OPPORTUNITY
4) EQUALITY OF OUTCOME / EQUALITY OF OPPORTUNITY

SOL
1) MORE
2) HIGHER
3) EQUALITY OF OPPORTUNITY
4) EQUALITY OF OUTCOME

Left-wing respondents: those who are more pessimistic about the level of intergenerational
mobility tend to support more aggressive government intervention and more redistribution.
Among right-wing respondents, those who are more pessimistic do not, presumably because
they have very negative views of government.

Q5 E-ZTAX: Tax Salience and Tax Rates

The following table is taken from the paper by A. Finkelstein on the effect of electronic toll
collection on tax rates.

Focus on column (2). How do you interpret the coefficient -0.016 for AnyElecYears,t and the
sign of the coefficient for AnyElecYears,t*ETCi,t?

Sol:

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-0.016 indicates that for manual collection toll, there is a reduction of 1.6percentage points in
the annual growth of tolls. The positive coefficient for the interaction term
AnyElecYears,t*ETCi,t indicates that for ETC, the political calendar has a much reduced impact
on the growth of toll. The sum of AnyElecYears,t*ETCi,t+ AnyElecYears,t=0.01>0: toll growth
rate is unaffected by the political calendar.

Q6
Show that with the following utility function for consumption and leisure, there is no income
effect.

u=c+ √ L
Assume that the budget is:
c=w(T −L).
SOL3.
MRS=slope of budget.
1
=w
2 √L
¿ 1
L=
4 w2
¿ 1
c =wT −
4w

Note that the MRS is independent on c. For a given L, the slope of the indifference curve
remains constant. Indifference curves are parallel vertical shifts of the same curve.

Find Income effect.

1
We change the wage to w’. Final choice of L is: L∗¿= 2
4w'
Now we find the level of L that gives the old utility at the new price.
'
MINc +w L
st :U∗¿ c + √ L
U* is U*=
1
4w √
+ wT +
1
4 w2
.
Use Lagrangean: L=c +w ' L+ λ {U ¿ −c−√ L}.
∂L
=0:1=λ
∂c
∂L 1
=0: w ' =λ
∂L 2√L
∂L
=0: U =c+ √ L
¿
∂λ
c 1
Find : L = 2
4w'
Substitution effect is: SE=Lc −L¿ ;
c
Income effect is: IE=L¿∗¿−L ¿.
1 1
SE= 2
− 2
4w' 4w
IE=0.

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There are different ways of finding this result.

MORE Practice: find optimal labour supply for

1 /2 1/ 2
1) max
c,L
c L subject ¿ c=wT −wL

α 1−α
2) max
c,L
c L subject ¿ c=wT −wL

3) max
c,L
lnc+lnL subject ¿ c=wT −wL