Chapter 2

Question 1

Advantages and Disadvantages of Federalism

Answer 1

Local conditions may affect both cost and benefits associated with regulation
o Preferences vary and regional and economic conditions

Diversity of local public goods
o Citizens who want a different mix of public goods can choose to relocate
o Theory of local public goods – built around similar ideas that individuals relocate to establish the best match b/t local public policies and individual preferences
o Diversity of options possible by state regulatory permits allows for these choices to be made; if all policies and public decisions were uniform = no discretion
o Cost and benefits other than regulations in a particular locale

Federalism- Heterogeneity allows for diff. types of innovation
o Can reflect the heterogeneity of costs and benefits in a given location
o Ex: recognizing the need to regulation pollution sources with large areas of population more stringently = Federal regulations rarely reflect his; state regs are rarely structured to meet needs in other states
 National – More information that would be available through resources. (Proposition 65) (Plastic Bags in Austin -federalism)
o Local activity w/ National impact (i.e. Air pollution) (carbon emissions)
o Guarantee of civil rights to individuals

Question 2

Benefit-Cost Analysis-Reagan Executive Order goals

Answer 2

• Benefit-cost test – Issued Executive Orders (Reagan) in section 2 - “regulatory action shall not be undertaken unless the benefits to society for the regulation all way the potential costs to society”
o Not the same as benefit-cost analysis- this looks at max net benefits (benefits minus cost)

Question 3

Benefit-Cost Analysis- Hicksian Potential Compensation Principle

Answer 3

– any time net benefits exceed cost ; the potential compensation would be to compensate the losers and have something left over (positive net benefits) the policy passes the test; there is net gain to society from this
o Benefits to cost ration must be greater than 1

Question 4

Benefit-Cost Analysis- Environmental Quality Control – Figures 2.2 and 2.3

Answer 4

• Figure 2.2 and 2.3 (pg 31 and 32)
o Fig 2.2
 anything b/t 0 and where tc and tb meet follow the rule b/c>1
 however, you want maximum net benefits- costs

o Fig 2.3
 As env. Quality improves you receive additional Benefits but at an additional cost
 As long as the marginal benefit exceed mar cost (MB>MC) you have net gain (up to Q)
 If MB<MC benefits will be less than additional costs
 Society is better off stopping at Q in both figures
o Where do the #s for the charts come from? Estimates
o New regulations must be discounted for the future (will be in place for a while), therefore most of the costs are paid up front. The benefits of the regs happen in the future

Question 5

Benefit-Cost Analysis - Discounting

Answer 5

o New regulations must be discounted for the future (will be in place for a while); therefore most of the costs are paid upfront. The benefits of the regs happen in the future
o Discounting the future
 B-C/(1+r)^n= PV, where r is the rate and n is the number of time periods
 What should you use for “r”?
• Opportunity cost of capital ($)- idea that these projects should compete with all other projects trying to raise money
• Social rate of time preference- idea that society as a whole has a diff discount rate than private business; there may be ppl in society who do not have the opportunity to compete for private funds; time horizon (when payments = 0) of society is longer than that of private business (the longer the lower the int. rate)
• OMB uses int rate of 7%

	What interest rate?  Two views- see above

Question 6

Benefit- Cost Analysis - Table 2.1 (pg 34)

Answer 6

• @ 7% (2.15/(1.07)^1
o =2.01
• Discount rate matters- the higher the less likely it legislation is to pass the test
• If you have a stream of benefits over time in perpetuity/ interest rate = net benefits over time
o 2.15/.07=30.71