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ECON411 Public Sector Economics Exam 1 complete solutions correct answers key
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University of Illinois at Urbana-Champaign
ECON411 Public Sector Economics Exam 1 complete solutions correct answers key
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PART I: Multiple Choice Questions (45 points)
1. Suppose the government taxes the rich to distribute money to the poor. Which of the
following is an example of an efficiency loss?
A) Rich people take home less of the money from their jobs because of the tax.
B) Rich people don't work as hard because of the tax.
C) Poor people are better off because of the redistribution.
D) Both A and B are correct.
E) None of the answers is correct.
2. Suppose the government wishes to provide college tuition aid to one of the following
groups of high school students. Which target group would most limit the possible extent
of indirect effects?
A) students whose father has died recently
B) students who drive inexpensive cars
C) students who live in low-income neighborhoods
D) students with relatively low Scholastic Aptitude Test scores
E) students who earn less than $2,000 per year
3. How governments should intervene is a _________ question, and why governments
intervene in the way they do is a __________ question.
A) normative; normative
B) positive; normative
C) negative; normative
D) positive; negative
E) normative; positive

4. Suppose Tim spends his entire income on hot dogs and hamburgers and consumes at
least some of both. Now suppose that the price of hot dogs increases while the price of
hamburgers remains the same. If Tim's utility is held constant, which of the following
must be true?
A) Tim is better off than he was.
B) None of the answers is correct.
C) Tim consumes more hamburgers and fewer hot dogs.
D) Tim is worse off than he was.
E) Tim consumes more hot dogs and fewer hamburgers.
5. The First Fundamental Theorem of Welfare Economics states that:
A) social efficiency can be achieved if and only if government intervenes in the
economy.
B) the competitive equilibrium, where supply equals demand, can always be achieved
through government intervention.
C) government intervention always reduces social efficiency.
D) social efficiency cannot be achieved in any competitive equilibrium.
E) the competitive equilibrium, where supply equals demand, maximizes social
efficiency.
6. A Rawlsian social welfare function implies which of the following?
A) The well-being of the worst-off member is maximized.
B) The sum of individual utilities is maximized.
C) The marginal utility of everyone in society is equal.
D) No redistribution should occur.
E) Both B and C are correct.
7. Suppose you wish to determine whether exercising increases academic achievement.
What would be the best approach to take?
A) Compare the achievement of athletes with that of nonathletes.
B) None of the answers would be effective approaches.
C) Compare the achievement of baseball players with that of track and field athletes.
D) Compare yourself with a friend who exercises less.
E) Compare the treatment and control groups in a randomized trial.

8. Suppose that job training is randomly assigned among applicants. The people who
receive the training form the _______ group; the people who do not receive training
form the _______ group.
A) randomized; observational
B) treatment; treatment
C) control; control
D) treatment; control
E) control; treatment
9. Suppose that you find the owner of the dog who has been using your lawn in an
unwanted way and that the owner compensates you for the use of your yard. This
solution to an externality is:
A) a tax.
B) a subsidy.
C) Coasian bargaining.
D) quantity restriction.
E) Both A and B are correct.
10. Which of the following results when shared ownership of property rights gives each
owner power over all the others?
A) the problem of internalizing an externality
B) the holdout problem
C) transaction costs and negotiating problems
D) the free-rider problem
E) the assignment problem
11. Suppose that factories in Chicago, Illinois, and Gary, Indiana, produce pollution that
affects people living in western Michigan. Even though the polluting plants and affected
individuals can be identified, the externality cannot be resolved privately because of the
large number of polluters and affected individuals. This is an example of:
A) the free-rider problem.
B) the problem of internalizing an externality.
C) transaction costs and negotiating problems.
D) the holdout problem.
E) the assignment problem.

12. Which of the following is (are) NEVER true?
A) Quantity restrictions are equivalent to using a corrective tax.
B) Quantity restrictions with tradable permits are equivalent to using a corrective tax.
C) Mandating equal pollution reductions from all firms is equivalent to using a
corrective tax.
D) Both A and C are correct.
E) None of the answers is correct.
13. If one person is UNABLE to prevent another person from consuming or having access
to a good, that good is:
A) excludable.
B) nonexcludable.
C) purely rival.
D) partially rival.
E) Both A and C are correct.
14. Suppose that the businesses in a small town get together and decide each of them will
renovate their buildings to make the downtown area more attractive to shoppers. What
problem may prevent this plan from going into action?
A) transaction costs and negotiating problems
B) the holdout problem
C) the free rider problem
D) the assignment problem
E) the irrationality problem
15. Suppose that the local public radio station, which is supported partly by voluntary
contributions, reaches eight towns. Suppose also that the radio station vowed not to
report on the local news events of any town unless it received a certain level of
contributions from the residents of that town. This could be best characterized as:
A) a private provider method of providing a public good.
B) a private provider method of providing a private good.
C) a private provider solution to the free rider problem.
D) a public sector provider method of providing a public good.
E) Both A and C are correct.

PART II: Essay Questions (55 points)
1. (12 points) Your state introduced a tax cut in the year 1999. You are interested in seeing whether this tax cut has led to increases in personal consumption within the state. You observe the following information:

a. (5) Your friend argues that the best estimate of the effect of the tax cut is an increase in consumption of 30 units, but you think that the true effect is smaller, because consumption was trending upward prior to the tax cut. What do you think is a better estimate?

b. (7) Suppose that you find information on a neighboring state that did not change its tax policy during this time period. You observe the following information in that state:

2. (12 points) The marginal damage averted from pollution cleanup is MD = 200 – 5Q. The marginal cost associated with pollution cleanup is MC = 10 + Q.
a. (6) What is the optimal level of pollution reduction?

b. (6) Show that this level of pollution reduction could be accomplished through taxation. What tax per unit would generate the optimal amount of pollution reduction?

3. (15 points) 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. (6) Explain why we might not expect to find the efficient number of lighthouses along this coast if each person were to act alone.

b. (9) What is the efficient number of lighthouses? What would be the net benefit to Zach and Jacob if the efficient number were provided?

4. (16 points) Emma’s wage rate is $6 per hour and she has a maximum of 100 hours per week to allocate between
leisure and work. In the absence of any welfare assistance, Emma optimally chooses to work 37.5 hours per
week.
a. (7) Suppose Emma is eligible for welfare benefits of $225 per week, but benefits are reduced $1 for every $1
she earns. Draw the budget line (carefully label all relevant values) and add an indifference curve that
represents Emma’s maximum utility under these circumstances.
b. (9) Suppose Emma moves to another state, where welfare benefits are structured differently. Now, her welfare benefit is $120 per week if she does not work and this benefit is reduced 50 cents for each $1 she earns. Draw a budget line consistent with this new system and add an indifference curve that represents Emma’s maximum utility given the new welfare system.
Both graphs show income on the vertical axis and leisure hours on the horizontal axis.

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ECON411 Public Sector Economics Exam 1 complete solutions correct answers key
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University of Illinois at Urbana-Champaign ECON411 Public Sector Economics Exam 1 complete solutions correct answers key Form B Solutions PART I: Multiple Choice Questions (45 points) 1. Suppose the government taxes the rich to distribute money to the poor. Which of the following is an example of an efficiency loss? A) Rich people take home less of the money from their jobs because of the tax. B) Rich people don't work as hard because of the tax. C) Poor people are better off because of the redistribution. D) Both A and B are correct. E) None of the answers is correct. 2. Suppose the government wishes to provide college tuition aid to one of the following groups of high school students. Which target group would most limit the possible extent of indirect effects? A) students whose father has died recently B) students who drive inexpensive cars C) students who live in low-income neighborhoods D) students with relatively low Scholastic Aptitude Test scores E) students who earn less than $2,000 per year 3. How governments should intervene is a _________ question, and why governments intervene in the way they do is a __________ question. A) normative; normative B) positive; normative C) negative; normative D) positive; negative E) normative; positive 4. Suppose Tim spends his entire income on hot dogs and hamburgers and consumes at least some of both. Now suppose that the price of hot dogs increases while the price of hamburgers remains the same. If Tim's utility is held constant, which of the following must be true? A) Tim is better off than he was. B) None of the answers is correct. C) Tim consumes more hamburgers and fewer hot dogs. D) Tim is worse off than he was. E) Tim consumes more hot dogs and fewer hamburgers. 5. The First Fundamental Theorem of Welfare Economics states that: A) social efficiency can be achieved if and only if government intervenes in the economy. B) the competitive equilibrium, where supply equals demand, can always be achieved through government intervention. C) government intervention always reduces social efficiency. D) social efficiency cannot be achieved in any competitive equilibrium. E) the competitive eq...
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