Mankiw Unit 4: The Economics of the Public Sector
Definitions Review and Sample Essays
Download Unit 2.4: Market Failure and the Role of Government.pdf
from http://welkerswikinomics.com/blog/ww-study-guides-3/.
Be sure you can write complete definitions of these terms within your essays:
ability to pay
ad valorem tax [VAT]
administrative burden
benefits received
common access
resources
deadweight loss
demerit goods
direct taxes
flat tax
free-rider problem
indirect taxes
Laffer curve
marginal tax rate
market failure
merit goods
MSB
MSC
negative externalities
positive externalities
private goods
progressive tax
proportional tax
public goods
regressive tax
socially optimal
tax reform
Market failure and externalities
• Analyse the concept of market failure as a failure of the market to achieve allocative efficiency,
resulting in an overallocation of resources (overprovision of a good) or an under-allocation of
resources (under-provision of a good)
• Describe the concepts of marginal private benefits (MPB), marginal social benefits (MSB),
marginal private costs (MPC) and marginal social costs (MSC).
• Describe the meaning of externalities as the failure of the market to achieve a social optimum
where MSB = MSC.
• Explain, using diagrams and examples, the concepts of negative externalities of production and
consumption, and the welfare loss associated with the production or consumption of a good or
service.
• Explain that demerit goods are goods whose consumption creates external costs.
• Evaluate, using diagrams, the use of policy responses, including market-based policies (taxation
and tradable permits), and government regulations, to the problem of negative externalities of
production and consumption
• Explain, using diagrams and examples, the concepts of positive externalities of production and
consumption, and the welfare loss associated with the production or consumption of a good or
service.
• Explain that merit goods are goods whose consumption creates external benefits.
• Evaluate, using diagrams, the use of government responses, including subsidies, legislation,
advertising to influence behaviour, and direct provision of goods and services.
• Using the concepts of rivalry and excludability, and providing examples, distinguish between public
goods (non-rivalrous and nonexcludable) and private goods (rivalrous and excludable).
• Explain, with reference to the free rider problem, how the lack of public goods indicates market
failure.
• Discuss the implications of the direct provision of public goods by government.
The role of taxation in promoting equity
• Distinguish between direct and indirect taxes, providing examples of each, and explain that direct
taxes may be used as a mechanism to redistribute income.
• Distinguish between progressive, regressive and proportional taxation, providing examples of each.
• Calculate the marginal rate of tax and the average rate of tax from a set of data.
Common access resources and the threat to sustainability
• Describe, using examples, common access resources.
• Describe sustainability.
• Explain that the lack of a pricing mechanism for common access resources means that these goods
may be overused / depleted / degraded as a result of activities of producers and consumers who
do not pay for the resources that they use, and that this poses a threat to sustainability.
• Explain, using negative externalities diagrams, that economic activity requiring the use of fossil
fuels to satisfy demand poses a threat to sustainability.
• Explain that the existence of poverty in economically less developed countries creates negative
externalities through over-exploitation of land for agriculture, and that this poses a threat to
sustainability.
• Evaluate, using diagrams, possible government responses to threats to sustainability, including
legislation, carbon taxes, cap and trade schemes, and funding for clean technologies.
• Explain, using examples, that government responses to threats to sustainability are limited by the
global nature of the problems and the lack of ownership of common access resources, and that
effective responses require international cooperation.
AP/IB Economics
Mankiw Part 4 Review Questions: The Economics of the Public Sector
1.
2.
3.
4.
Define “market failure”. What are the two ways the market “fails”?
Describe three roles the government plays in the free market.
Define “externality”. Give examples of positive and negative externalities.
Illustrate a negative externality using a supply and demand diagram. Indicate
where equilibrium would be in a free market. Show the socially optimal level
of output.
5. Illustrate a positive externality using a supply and demand diagram. Indicate
where equilibrium would be in a free market. Show the socially optimal level
of output.
6. How can government intervention reduce the effects of externalities and
move the market toward the socially optimal level of output?
7. There are two ways to protect your car from theft. The Club makes it
difficult for a thief to take your car. Lojack makes it easier for police to
catch the thief who has stolen it. What are the externalities of these two
types of protection on other car owners?
8. Explain why fire extinguishers might exhibit positive externalities. If the
external benefit is $10 per extinguisher, explain a government policy that
would help society reach the efficient outcome.
9. Why does the U.S. require all children to get certain vaccines?
10. Why is there trash along most highways but rarely in people’s yards?
11.
12.
13.
14.
15.
16.
In what way does the patent and copyright system help solve an externality
problem?
What are corrective [Pigovian] taxes? Why do economists prefer them over
regulations as a way to protect the environment from pollution?
Explain three ways problems caused by externalities can be solved without
government intervention.
If society wishes to reduce overall pollution by a certain amount, why might it
be efficient to have different amounts of reduction at different firms?
Command-and-control approaches to pollution often rely on fines to cause
similar reductions among firms. Why are these approaches ineffective with
high-polluting firms?
Ringo loves playing rock-n-roll at high volume. Luciano loves opera and hates
rock-n-roll. Unfortunately, they are next-door neighbors in an apartment
building with thin walls…
o Explain the externality.
o What command-and-control policy might the landlord impose?
o How might Ringo and Luciano reach an efficient outcome on their own?
17. There are three industrial firms in Happy Valley. Each pollutes by different
amounts. The government wants to reduce pollution to 120 units, so it gives
each firm 40 permits.
a)
Use the chart below to decide the total cost of pollution reduction if
the permits cannot be sold and traded.
b)
Now, the government allows firms to trade and sell permits. How
might the outcome be different? How might this reduce the total
cost of pollution reduction?
18. Explain what is meant by a good being “excludable” and “rival in consumption”.
19. Explain the difference between private and public goods. Give clear
definitions and examples.
20. Left to itself, the free market system will not provide any public goods. Why
is this?
21. Smart people download the podcast of National Public Radio. However, some
people never sends any money to support the station during its fundraising
drives.
o What name do economists give to these people?
o How might the government solve the problem caused by these people?
o How might the private market solve this problem?
22. How does a government decide which public goods to provide and in what
amounts? Why is this important? Why is this difficult?
23. What are some factors that determine the marginal social cost of a public
good? What are some factors that determine the marginal social benefit of a
public good?
24. Define merit goods and give some examples. Is the free-market quantity of
merit goods generally greater or less than the optimal quantity? Explain.
25. Define demerit goods and give some examples. Is the free-market quantity of
demerit goods generally greater or less than the optimal quantity? Explain.
26. In general, what do governments do in the situation of merit goods? Of
demerit goods?
27. Provide examples of CARs, explaining how they fit the definition.
28. Using a fully-labeled diagram, explain why common-access resources have
sustainability problems.
29. Evaluate whether the following statements are true or false. Explain each
answer with a complete paragraph using economic ideas.
 Property held in common by a community tends to be used effectively.
 There is an incentive to use resources efficiently if property rights are
clearly defined.
 Common-access resources entail negative externalities.
30. Explain why police protection and libraries, despite having common-access
characteristics, are not a threat to sustainability.
31. Explain how property rights can help solve the problems of CARs in some
situations.
32. Explain why property rights cannot solve the problems of CARs in some
situations. What must occur in these cases?
33. Explain some problems with government involvement and international
cooperation in regards to common-access resources.
34. Explain two of Ostrom’s principles for successful CAR institutions.
35. Describe how the personal income tax works. Explain why these taxes are
generally considered “progressive” taxes.
36. Describe the payroll and social insurance taxes. Explain why these taxes are
generally considered “proportional” taxes.
37. Describe sales and excise taxes, property taxes, and users fees. Explain why
these taxes are generally considered “regressive” taxes.
38. What are the two most important sources of revenue for the U.S. Federal
Government?
39. The following table contains information about the income tax system in a
country.
Income Bracket
Tax Rate
$0 - $10,000
0%
$10,001 - $20,000
15%
$20,001 - $35,000
25%
$35,001 +
40%
Three individuals have annual income levels and expenditures as shown below:
Annual income
Level
Deborshi
Marcin
Joey
$14,500
$29,000
$43,500
Annual spending
on goods and
services
$13,000
$24,000
$35,000
a. Calculate the income tax that each individual has to pay.
b. Find the marginal and average income tax rates of each individual.
c. Compare the average income tax rates of each individual to determine
if the income tax system is progressive or regressive.
d. Assume that the amount spent on goods and services is taxed at a
20% indirect tax rate. Calculate the indirect tax for each individual.
e. For each individual, express the amount of indirect tax as a
percentage of their income.
f. Based on e), explain whether the indirect tax system is progressive or
regressive.
40. Suppose that your state raises its sales tax from 5% to 6%. The state
revenue commissioner forecasts a 20% increase in sales tax revenue. Is this
reasonable? Explain.
41. What are the implications of the Laffer curve for governments considering
new tax policies?