Public Finance Study Guide( 6 questions from this study guide will be on the final)
1. A cap-and-trade policy
A) has a set number of permits.
B) allows polluters to trade permits.
C) caps the total level of pollution allowed.
D) all of the above.
Ans: d
2. A Pigouvian subsidy
A) can not exist with externalities.
B) is the same thing as a Pigouvian tax.
C) is measured in terms of Pigouvian dollars.
D) moves production to the socially optimal level of output.
Ans: d
3. Which of the following is correct?
A) SMC = PMC - MD
B) MPB = MSB + MEB
C) SMC = PMC + MD
D) MSC = MPB
E) MSB =MSC + MPB
Ans: c
4. Public goods are characterized by
A) nonrivalness.
B) excludability.
C) the sum of the MRSs equaling MRT.
D) all of the above.
Ans: d
5. Equilibrium for public goods is characterized by
A) MRS – MRT = MSB
B) MRS1 + MRS2 + MRS3+....+ MRSn = MRT.
C) MRS1 = MRS2 = MRS3=…= MRSn = MRT.
D) MC = MB.
6. A ________ is a person who wants to enjoy the benefits of a public good without contributing his or her
marginal benefit to the cost of financing the amount made.
A) free rider
B) politician
C) price maker
D) price optimizer
Ans: a
7. Which of the following is a public good?
A) public defense
B) public television
C) a library
D) schools
E) all of the above
Ans: d
8. Points on the utility possibility frontier are
A) inefficient.
B) points of incomplete preferences.
C) not producible.
D) Pareto efficient
Ans: d
9. Pareto points in the Edgeworth Box are
A) found when utility curves are tangent.
B) found when MRS are equal.
C) found when one person cannot be made better off without making another person worse off.
D) all of the above.
E) none of the above.
Ans: d
10. Pareto improvement can be a reallocation of resources that makes at least one person better off without
making anyone else worse off.
A) True
B) False
C) Uncertain
Ans: a
11. Normative economics
A) does not depend on market interactions.
B) only looks at the best parts of the economy.
C) examines how the economy actually works (as opposed to how it should work).
D) embodies value judgments.
Ans: d
12. When different bundles of commodities give the same level of satisfaction, you are
A) said to be indifferent between the bundles.
B) said to be confused.
C) not able to make a decision.
D) unhappy with any combination.
E) none of the above.
Ans: a
13. Causation and Correlation are generally the same thing.
A) True
B) False
C) Uncertain
Ans: b
14. A government good or service includes
A) bridges.
B) parks.
C) national defense.
D) all of the above.
Ans: d
15. Government is designed to handle problems not addressed by the private sector.
A) True
B) False
C) Uncertain
Ans: c
16. Public finance
A) is not like public economics.
B) develops principles for understanding the economic role of government.
C) only works for local and state governments.
D) is all of the above.
Ans: b
17. With multiple-peaked preferences,
A) a unique political equilibrium does not exist.
B) all individuals have a point that is most preferred.
C) the law of consistency is violated.
D) all of the above.
Ans: d
18. Logrolling is
A) a system used often at lumberjack contests.
B) a system that will always lead to worthy projects getting funded.
C) a system that involves the trading of votes.
I) a system that generally involves double-peaked preferences.
Ans: c
19. Lindahl prices
A) result in efficient levels of public goods provision.
B) require honest revelation of preferences.
C) result in different prices for the same amount of output.
D) cause all of the above.
Ans: d
20. Governement provided healthcare can be justified on the grounds of
A) adverse selection.
B) decision-making costs.
C) income distribution.
D) commodity egelaterianism.
ans: D
21. When people behave in ways that involve increased risk because they have insurance, this is known as
A) adverse selection.
B) moral hazard.
C) asymmetric information.
D) a HMO.
ans: B
22. In Figure 9.3, Panel B, $40,000 for certain is as desirable as $47,000 with risk.
A) True
B) False
C) Uncertain
23. The rate at which future money must be discounted is known as the
A) rate of inflation.
B) exposure rate.
C) discount rate.
D) time rate.
ans: C
24. For a government to be efficient, a project should be funded up to
A) MB = 0
B) MB = Price
C) MC = 0.
D) MC =MB
ans: D
25. The value of a human life
A) can be estimated by potential future earnings.
B) can be subjected to cost-benefit analysis.
C) is an intangible that is hard to price.
D) is all of the above.
ans: D
26. _________ is the investment that individuals make in education, training, and health care that raise their
productive capacity.
A) Capital market
B) Human capital
C) Human engineering
D) Private good production
ans: B
27. Commodity egalitarianism suggests that some goods be available to everyone.
A) True
B) False
C) Uncertain
28. An in-kind transfer is a
A) transfer made by people to be kind to others.
B) transfer of wealth.
C) transfer of goods and services instead of cash.
D) system of clearing checks by local banks.
Ans: C
29. An additive social welfare function would
A) add the incomes of the lowest ten percent of income earners.
B) subtract out the utility functions of all people who are unemployed.
C) sum all individual utilities.
D) maximize the utility of the person with the minimum utility.
ans: C
30. If Gini coefficient has decreased;
A) income distribution has gotton worse(less equal)
B) it does not effect income distribution
C) income distribution has gotton better(more equal)
D) there are fewer poor people in the society
ans: C
31. What will be the consequence of adverse selection problem in a market
A) the market stops functioning
B) the market will be more efficient
C) Moral hazard problem will arise
D) more people will join the market
ans: A
32. The figure above show expected utility when the person gets sick(A) and do not get sick(B). According
to the figure what is the maximum amount this person is willing to spend to buy insurance.
A. 4,0000
B. 47,000
C. 3,000
D. 10,000
ans: D
33. Internal rate of return is
A. discount rate that makes NPV zero
B. discount rate that makes NPV positive
C. always greater than NPV
D. not important for project evaluations.
ans: A
34. If a project costs $100 today and will yield benefit of $50 next year and $60 the year after, what is the
NPV of this project, given the discount rate of 5%.
A. $2.04
B. -$10
C. $110
D. $79
ans:A
35. Which of the below does not explain the reason for government intervention in education
A. positive externality
B. commodity egelaterianism
C. education is a public good
D. education market is profitable
ans:D
36. With multiple-peaked preferences,
A) a unique political equilibrium does not exist.
B) all individuals have a point that is most preferred.
C) the law of transitivity is violated.
D) all of the above.
ans: D
Short Answer Questions
1. The government has hired you to advise them on the merits of a project that is being proposed. The
project is expected to generate benefits of 14 million dollars today, 5 million dollars in one year from today,
and 1 million dollars in two years from today. (These are the only years of concern.) The project costs
nothing today, but will cost 20 million dollars in two years. Assume the interest rate is 10%. If the benefitcost ratio is greater than 1, the project should be allowed. What is your policy suggestion?
Ans: Benefit stream is 5M/1.11 + 1M/1.12 = 5371900.826. Cost stream is 20M/1.12 = 16528925.62.
Therefore, B/C = 5371900.826/16528925.62 >1. Project should be funded.
2. Suppose there are two drivers, Jermaine and Janet. Jermaine is not a very safe driver. In fact, there is a
7.5% chance that he will have an accident within the next year. Janet is a relatively safe driver. Her chances
of having an accident in the next year are only 1%. If Jermaine is involved in an accident, he will cost the
insurance company $1,000,000. If Janet is involved in an accident, she will only cost the company
$500,000. What is the expected pay-out that the company can expect from insuring these two?
Ans: The expected payout is 1,000,000(0.075) + 500,000(0.010) = $80,000.
3. Suppose the factory Afro-Puffs Inc. produces wigs. As a by-product of this wig production, they also
produce dangerous emissions of toxic gases (as a result of the strong glue used to hold the hair in place).
The De-Lite car factory, down the road, experiences a negative externality from this production process.
Suppose that the supply curve (private marginal costs) for the wig factory is X=(2/5)P- 2, and it faces a
market demand of Xd=15 - P/2. The marginal damages caused by the production of wigs can be written as
X=P – 1/2.
(a) Find the equilibrium price and quantity in the market for wigs.
(b) Find the socially optimal level of wigs and the corresponding price.
(c) How much should the wig factory be taxed per wig?
Ans:
(a) Set PMC equal to demand and solve for P and X. X= 50/9, P = 170/9.
(b) Find SMC by adding PMC to MD. Set SMC equal to demand and solve for P and X. X = 49/11, P =
232/11.
(c) At X = 49/11, subtract PMC from SMC. Tax = 109/22.
4. Consider the following net benefits (measured in billions of dollars) that will result from the passage of
two legislative bills, X and Y:
(a) Identify the logrolling opportunity present in this situation.
(b) Identify the potential gains to voters.
(c) Explain why logrolling is efficiency enhancing.
Ans:
(a) On their own, neither issue X nor Y will pass. Both will be voted down by votes of 2-1. If person A
trades a vote with B, then both issues will pass by 2-1 votes.
(b) With both issues passed, overall utility for person A is 3. For person B, overall utility is 4. For person
C, overall utility is –5.
(c) With issue X passed, society is benefited because it had a total benefit to society of 3. Logrolling also
allowed issue Y to pass, though it shouldn’t have since its total benefit to society is –1.
5. Suppose that there are only two fishermen, Ali and Ahmet, 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 Ali of
each additional lighthouse is 90-Q, and the marginal benefit to Jacob is 40-Q, where Q is the
number of lighthouses.
a)
Explain why we might not expect to find the efficient number of lighthouses along this
coast.
b)
What is the efficient number of lighthouses?
What would be the net benefits to Ali and Ahmet if efficient number were
provided?
Ans:
a) since the marginal cost (100) is greater than marginal benefit(when Q=0) for each
individual. When it is left to Ali and Ahmet, they wont demand any lighthouse.
b) For public goods efficient quantity is found when market demand equals market
supply. To find market demand we add individual demands vertically. (90-Q+40Q=130-2Q) Then equalize this with MC=100
130-2Q=100
Q*=15
When Q=15 Net benefit to Ali is and Veli ia consumer surplus(area of the triangle
under market demand line and above MC. (130-100)*15/2 = 225