Review for second exam.
Public Economics
1. The following refer to cash transfer programs for the poor.
a. What does EITC stand for? The EITC program has three different “phases.” What are the three phases? If you
do not recall the names, discuss what is happening in each of the three phases. Would any of the three phases lead to
an efficient allocation of resources? Briefly explain.
b. In a properly labeled graph, show the budget constraint between consumption and leisure for a household with
and without the EITC. Assume the following information; hours that can be divided between work and leisure =
160, wage = $10 per hour, the EITC would be fully phased out at an earned income of $1,500.
- Discuss the effects this program would have on hours worked at each phase using the tools of economics.
c. A wage subsidy and a negative income tax are ways to redistribute income to the poor. Edgar Browning in
“Alternative Programs for Income Redistribution: The NIT and the NWT,” discusses the relative merits of the two
programs.
- Which of the two programs does he find superior? Discuss.
- Using graphs of the labor market discuss the different outcomes of the two programs.
- Show that, holding consumption of non-recipients constant, recipients are better off under a NWT.
- Show that, holding consumption of recipients constant, non-recipients are better off under a NWT.
-What are the distortions inherent in a NIT? In a NWT?
- What is the formula for deadweight loss? (Harberger's Triangle)
2. The following refer to the TANF program.
a. What does AFDC stand for? What does TANF stand for? What were the major changes in the move to TANF?
b. In a properly labeled graph, show the budget constraint between work and leisure for a household before and after
the TANF program.
- Describe the various parts of the budget constraint for the TANF program. In other words, tell me why it looks the
way it does.
- What would you predict would happen to hours of work for a household on TANF? Explain using the tools of
economics.
- Using the tools of economics, discuss the expected consumption level before and after the introduction of the
TANF program. Are there individuals we are certain will increase their consumption? Are there individuals we are
confident will decrease their consumption? Explain.
3. The following questions refer to our discussions on education.
a. What are some arguments that can be used to justify government intervention in the market for higher education?
Be specific. How are the arguments for the subsidization of elementary and secondary education different? Be
specific. Can we make a stronger case for the subsidization of one of levels of education over another? Briefly
explain.
b. Briefly discuss the major findings of Derek Neal.
c. Briefly discuss the major findings of Paul Peterson. Does he support the expansion of the voucher program? If
so why? If not, why not?
d. What are the problems with the research on the effects of the voucher program? What are the problems with the
research on the effects of private schooling?
4.
Given what you know about the food stamps program, briefly discuss the merits of the following statements:
i.
"The food stamps program is superior to a cash grant since it increases a participant’s consumption of food
more than a lump-sum cash payment of equal value."
ii.
"The dollar amount of all food stamps certificates is a good measure of the benefit to farmers of the
program."
5. Consider a household with income of $1,000 per month that spends their income on food (P food = 2)
and other goods (PX = 1).
a. In the space below, show a properly labeled graph of the budget constraint in the absence of any
government intervention. In the absence of any government intervention, assume this household spent
$240 on food.
b. Assume that the household is entitled to $200 worth of food stamps. Show the budget constraint
under the food stamps program. Clearly indicate the values at all intercepts and any kinks.
c. Can you make any predictions about the change in the level of food consumption under the food
stamps program? If so, what is your prediction. Using the tools of economics, explain your prediction.
d. We want to compare the current food stamps program with the “purchase requirement” program of
the 1970s. Under the purchase requirement the above household would be sold $300 worth of food
stamps for $100. Show the budget constraint under the purchase agreement in the space above.
e. What types of households would be indifferent between the current program and the purchase
requirement program?
f. What types of households would be affected by a purchase requirement?
g. Why might we find the purchase agreement a better system over the current food stamps program?
Think about what we are hoping to accomplish with this program.
6. Fairlie and London discuss the effects of incremental benefit levels on births to AFDC recipients. The
following questions are related to their article.
a. Discuss how an economist would attempt to model the behavior of a AFDC recipient and her decision to have
another child.
b. Discuss the general results of their paper. Would reducing the level of incremental AFDC benefits reduce the
birth rate of this population? Discuss.
c. You should be able to explain the meaning behind the output presented in table 3 of their paper.
d. They claim that omitted variable bias is behind the large role incremental AFDC benefits plays in the probability
of another birth. What evidence do they give in support of this contention? Explain.
e. They conclude that incremental AFDC payments make very little difference in the decision to have another child.
Explain why this may be true. Explain this in the context of the economic model of child birth.
7. Olsen in “Housing Policy and the Forgotten Taxpayer” gave several criteria he felt were necessary for
sound housing policy. We argued that these could be extended to most programs. Using your
understanding of the food stamps program, discuss two criteria Olsen gives and how well they apply to
the food stamps program.
8. Discuss the methodology and findings Early (1998) “The Role of Subsidized Housing in Reducing
Homelessness.” Would an expansion of subsidized housing be an effective way of reducing homelessness? Explain.
9. Does majority rule usually bring about an efficient allocation of resources? Explain. What is logrolling? Does
it guarantee an efficient allocation of resources? Discuss rational voter ignorance. Do we argue that everyone who
is a well-informed voter is irrational? Do we argue that everyone who votes is irrational?
10. Discuss the merits of the following comment.
“The market has failed; therefore, the government should intervene.”
11. Show that the food stamps program is identical to a cash grant if the household consumed more food than the
face value of the vouchers before they received food stamps. What can you determine about the consumption of
food under the food stamps program vs. the consumption of food before the household entered the food stamp
program? Explain using the income and substitution effect.
The following are relevant questions from past second exams.
1.a. The U.S. has several programs in aid of the poor. We mentioned the need to justify government intervention. In
the space below, justify such programs. Be sure to use justifications acceptable to a public economist.
b. The space below shows the budget constraint between leisure and consumption per month in the absence of any
programs in aid of the poor. Assume the following:
Wage = $10.00, maximum number of hours of available to work or take as leisure is 320 hours per month. Label
both axes and give values for both intercepts.
c. What is the slope of the above budget constraint? Interpret the meaning behind the slope. Be specific and clear.
d. Assume the government introduces a negative income tax program with the following characteristics: marginal
tax rate = 60%, breakeven income = $2,500. In the graph above, show the budget constraint with the negative
income tax. Be clear about all intercepts, kinks and discontinuous points on the budget constraint.
e. Consider a head of household, who before the negative income tax program, worked 160 hours a month. Using
the tools of economics, give a clear and concise prediction regarding the number of hours this individual will work
after the start of the negative income tax program.
2. The following questions refer to subsidies to education.
A. Argue against the subsidization of higher education. [Hint: Think about what must be true to justify government
intervention.]
The space below shows the budget constraint between higher education and spending on all other goods assuming no
subsidies to higher education, private or public.
B. Consider the following program. Texas students can only attend one of three Texas universities, A&M, UT or
UTEP. These universities are state assisted schools. [In other words, identical to the current system.] Show the
effect of this on the budget space above.
C. We argued that this system is inefficient. Replace the current state-assisted university program with another
program to subsidize higher education that would show the current system is inefficient. Show this program in the
graph above.
D. Clearly explain in words, why the program you show above leads us to conclude that the current system is
inefficient.
3. As a public economist, you should now be able to analyze programs we have never discussed. Below is the
description of a hypothetical programs. Answer the questions following each description.
Southwestern University offers faculty members a coffee perk. Each faculty member can spend up to $5.00 per
week at the coffee house.
A. For some faculty member this will lead to an inefficient allocation of resources. Discuss what would have to be
true if this lead to an inefficient allocation. Discuss.
B. For some, this will still be efficient. What must be true if this program leads to an efficient allocation of
resources? Discuss
C. In the space below, use a graph to help explain your answers to parts A and B.
4. Vouchers have also been tried at the elementary and secondary levels. Paul Peterson in “Vouchers and Test
Scores” examines the data on these experiments. The following questions are related to his article.
a. He describes his study as a “randomized field trial.” Briefly explain what he means by this and why the study he
discusses fits this definition.
a. Did he find benefits associated with offering children vouchers to attend private schools? Explain.
b. We discussed how Omitted Variable Bias could confound the results of studies examining whether private
schools do a better job of education children. Give an example illustration the concept of Omitted Variable Bias
related to private schooling. Explain.
5. The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 drastically altered the concept of
welfare in the U.S. In particular, we saw a move from a program called AFDC to TANF.
a. What does AFDC stand for?
b. What does TANF stand for?
c. What was the biggest change from AFDC to TANF?
d. Fairlie and London examine one possible incentive set up by the AFDC program. Briefly discuss the research
question and findings of their study “Incremental Benefit Levels . . “
e. Fairlie and London offer several explanations for their findings. Give two of these explanations.
The TANF program is run as a negative income tax. The following is an analysis of such a program. The space
below contains the budget constraint between consumption and leisure of someone with wage of $15 and 200/month
to allocate between work and leisure. Label both axes and both intercepts.
f. Show the effects of introducing a NIT with the following specifics; income guarantee = $500 and the marginal tax
rate is 1/3. Be sure to indicate the value at any new intercepts, kinks, etc.
Consider the following two people and determine what economic theory would predict to happen to their
consumption after the introduction of the NIT. Be sure to use the tools of economics in your answers.
h. A person who took 150 hours of leisure before the introduction of a NIT.
i. A person who took 100 hours of leisure before the introduction of a NIT.
6. The space below shows the budget constraint between food (F) and non-food consumption (X). This household
has $800/month to spend on the two goods, the price of food = $4/unit and P X = 1. Label both axes and both
intercepts. Current food consumption = 150 units/month.
a. The government introduces a food stamp program that gives this household $300 worth of food stamps. Show the
effects of this in the above budget constraint. Be sure to indicate the value at any new intercepts, kinks, etc.
b. What does the income effect predict will happen to the level of food consumption? Explain.
c. What does the substitution effect predict will happen to the level of food consumption? Explain.
d. Using appropriate arguments, justify the introduction of a food stamps program.
e. Relative to the size of the subsidy, what is your prediction regarding the increase in food consumption of this
household? Explain. What information is needed to make an exact determination?
f. If you offered the above household a lump-sum cash grant = $200/month to give up their food stamps, would they
agree to this deal? Explain.
7. Edgar Olsen in “Housing Policy and the Forgotten Taxpayer” lists several criteria he argues are needed for sound
housing policy.
a. List three of those criteria.
b. Using your knowledge of U.S. housing programs discuss whether two of the above criteria are being met.
Explain.
c. Apply two of his criteria to the TANF program. Does this program meet these criteria? Explain.
d. Dirk Early in “The Role of Subsidized Housing in Reducing Homelessness” examines the causes of homelessness
as well as the role subsidized housing plays in reducing the number of homeless. Below is part of the results
presented in the article.
Table 2. Results of the logit regression.
Dependent variable = 1 if
homeless, 0 otherwise.
Coefficient
Variable
(T-Ratio)
Real Monthly Income
-0.009
(-5.541)
Temperature
0.077
(1.579)
- How would you interpret the relationship between the probability of being homeless and real monthly income? Be
sure to discuss how confident we are that this variable alters the probability of being homeless. Explain.
- How would you interpret the relationship between the probability of being homeless and temperature? Be sure to
discuss how confident we are that this variable alters the probability of being homeless.
e. How does Early examine the role subsidized housing plays in reducing homelessness?
f. What conclusion is reached regarding the role of subsidized housing? Explain briefly.
8. Edgar Browning in “Alternative Programs for Income Redistribution: The NIT and the NWT” examines the
differences between these two programs.
a. The line below represents the budget constraint between leisure and consumption for a worker in the absence of
any government involvement with a wage of $7/hour and the choice of working up to 200 hours/month. Label both
axes and both intercepts. Before the introduction of a NWT this person works 160 hours/month. Show this bundle
below.
b. Consider a NWT with the following specifics, the rate of subsidy (s) is .40 and the breakeven wage (W S) is $12.
Show the budget constraint under the NWT program. Be sure to indicate the value at any new intercepts, kinks, etc.
c. Using the tools of economics discuss what will happen to hours of work for this person.
d. Label as lNWT and CNWT the bundle of leisure and consumption under the NWT.
e. If we replace this program with an equally costly unrestricted cash grant, would the recipient be better off, worse
off, or indifferent. Explain. Use your graph in your explanation by showing the budget constraint under the cash
grant.
f. Browning argues that the NWT is superior to the NIT. Give two of his arguments in support of the NWT.
Explain both.