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Public Finance > Exam II Review > Flashcards

Exam II Review Flashcards

1
Q

efficiency condition for leftover curve (production of public goods vs private goods)

A

MRT = MRSv + MRSj

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2
Q

Lindahl Pricing

A

an approach to financing public goods in which individuals honestly reveal their willingness to pay, and the government charges them that amount to fniance the public good

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3
Q

What process is followed to carry out Lindahl Pricing?

A
  1. government announces a set of tax prices for the public good, the share of the cost that each individual must bear
  2. individual announces how much she wants of public good
  3. government repeats these steps to construct a marginal willingness to pay and quantity of public good desired
  4. governmetn adds up individual willingness to pay at each quantity of public good provided to get an overall demand curve for public goods
  5. government relates this overall demand curve to the MC curve for the public good to solve for optimal public good quantity
  6. government finances this public good by charging individuals their willingness to pay for the quantity of good
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4
Q

benefit taxation

A

taxation in which individuals are taxed for a public good according to their valuation of the benefit they receive from that good

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5
Q

problems with Lindahl pricing

A

preference revelation problem: individuals have an incentive to lie about their willingness to pay because the amount of money they pay to finance the public good is tied to their stated willingness to pay

preference knowledge problem: even if they’re honest, consumers might have no idea of what there valuation is

preference aggregation problem: getting the preferences of 260 million US citizens seems impossible

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6
Q

three things which must be satisfied to provide a successful meansn of aggregating preferences of individual votes

A
  1. dominance: if one choice is preferred by all votes, the aggregation mechanism must be such that this choice is made by society; that is, if eery individual prefers building a state to a park, the aggregation mechanisum must yield a decision to build a statue
  2. transitivity: if a large statue is preferred to a medium statue, and a medium size statue is preferred to a small statue, then a large statue must be preferred to a small one
  3. independence of irrelevant alternatives: choices must satisfy the condition that if one choice is preferrred to another, the entry of another choice will not change that ranking
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7
Q

two reasons majority voting doesn’t work for aggregating preferences

A
  1. violates property of transivity: when we aggregate preferences of the individuals, we do not get a consistently preferred outcome
  2. Arrows Impossibility Theorem: there is no social decision rule that converts individual preferences into a consistent aggregate decision without either restricting preferences or imposing a dictatorship
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8
Q

median vote theorem

A

majority voting will yield the outcome preferred by the median voter if preferences are single peaked

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9
Q

potential inefficiency of median voter outcome

A
  1. implies that the government need find only one voter whose preferences for the public good are right in the middle of the distribution of preferences and implement that level of public goods preferred by that voter
    - convenient, but not socially efficienct
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10
Q

assumptions of median voter model

A
  1. single dimensional voting: assumers that voters are basing their votes on a single issue
  2. only two candidates
  3. no ideology or influence: median voter theory assumes that politicians only care about maximizing votes
  4. no selective voting: assumes all citizens vote…simply not the case
  5. no money: ignores the role of money as a tool of influence in elections
  6. full information: median voter model assumes perfect information along three dimensions. Namely, voter knowledge of issues, politician knowledge of issues, politician knowledge of voter preferences
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11
Q

public choice theory

A

a school of thought emphasizing that the government may not act to maximize the well being of it’s citizens

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12
Q

size maximizing bureacracy

A

idea that bureaucracies might be more interested in their own preservation and growth than in carrying out their assigned missions efficiently

  • private sector rewards employees for efficienct production
  • public sector compensation for workers is based on the total measurable output of the bureaucracy
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13
Q

problems with privitization

A
  1. some markets maybe natural monopolies
  2. while privitization of good markets may increase efficiency, it is not clear that private provision of social services is more efficient than public provision
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14
Q

Tiebout Model for optimal fiscal federalism

A

assumes that there are many people who divide themselves up so that each resident in any town has the same taste for public goods, and so demands the same level of public good spending

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15
Q

problems with Tiebout Model (wrong assumptions)

A
  1. perfect mobility: individuals must not only want to vote with their feet, they must be able to
  2. perfect information: assumes that individuals have perfect information on the benefits that they receive from the town and taxes they pay
  3. must be able to choose freely among the range of towns
  4. provision of some public goods requires sufficient scale or size
    - not efficient to run a school with only a few students or to build a park that will be used by only a few residents
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16
Q

problem with Tiebout financing

A

model requires equal financing of the public goods among all residents
-towns typically finance their public goods instead through a property tax that is levied in proportion to the value of their homes

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17
Q

burden of city: in the optimal city size model, N is a function of what?

A

the price of the private good

-as N increases, Ppri also increases

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18
Q

advantage of city: in the optimal city size model, what advantages are to be had with respect to paying for public goods?

A

you can all combine your money and pay less for public goods

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19
Q

optimal city size model I: axis and intercepts

A 
X axis: public goods
y axis: private goods
Xintercept: N1*I / Ppub
Yintercept: I / (Ppri(N1))
I being income, N1 being city size
20
Q

optimal city size model II: axis

A

X axis: city size

Y axis: Utility

21
Q

in the optimal city size model II, what is the problem with having them arrange themselves at the absolute max of both curves?

A

-it leaves a giant gap of people in the middle with nowhere to live! what do you do with them?

22
Q

optimal city size model II: why don’t the two intersection points on the tails of the curves count as an optimal allocation?

A

they’re not stable equilibria
-if someone moves just a little to the right, utility in one city will be higher than the other, so others will continue to move until we reach our old equilibrium point

23
Q

optimal city size model II: what happens if we switch the Ua and Ub curves in the model?

A

central equilibria becomes unstable, two tail equilibria becomes stable

24
Q

median voter model: axis and intercepts

A 
X: public
Y: private
Xintercept: I / alpha*Ppub
Yintercept: I / Ppri
alpha here represents share of the cost of the public good that voter will incur, tax rate he will see
25
Q

median voter model: where along our budget constraint line will the person choose?

A

WHEREVER THE PEOPLE VOTE IT TO BE, may not be inline with person’s preferences, may sacrifice utility

26
Q

median voter model: how do you derive those utility humps?

A

you find the points where a person’s different IC’s run through the budget constraint, connect them all together…

  • person will have a different level of utility relating to each voting outcome
  • you can take these utility humps, put them on one graph, and look at all these different preferences
27
Q

market demand curve: how to derive it

A
  1. draw two separate graphs of two peoples demand curves
  2. draw another graph, the market demand curve graph
  3. set a price, draw a line straight across, see how much is demanded from both consumers
  4. add up the individual demands horizontally and graph for your market demand curve
28
Q

Lindahl Equilibrium: how to model the aggregate demand for a public good

A
  1. draw one individual’s demand curve, and draw another individual’s demand curve directly BELOW
  2. ask “how much is person is person A willing to pay for a quantity of X, how much is person B willing to pay for a quantity of X.”
  3. add both of these up vertically, graph in another graph for make a “WILLINGNESS TO PAY” curve
  4. draw a MC of production curve on that same graph, find optimal amount to produce (note: this is different from the point you graphed when adding up the demands and graphing)
  5. from your equilibrium point, draw a vertical line and see how much each person should actually spend on the public good…this should add up to the total amount you actually have to spend on the public good
29
Q

Lindahl equilibrium: alternative way to plot aggregate demand for a public good

A
  1. draw one person’s demand curve
  2. draw another person’s demand curve, upside down, on the same graph
  3. find the point where they both cross
  4. price paid for first person will be shown by the distance from the bottom to the equilibrium point
  5. price paid for second person will be shown by the distance from the top to the equilibrium point
30
Q

Pareto efficiency and public goods: X and Y intercepts, Axis

A

X axis: Good Xpublic
Y axis: Good Yprivate
X intercept: I/Py
Y intercept: I/Px

should give you a pretty little budget constraint line, this graph represents an individual’s preferences for public this good

31
Q

Pareto efficiency and public goods: what happens if another individual chooses to buy some of the public good?

A
  1. your budget constraint line shifts straight out, intercepts do not change though
  2. you get to a new, higher indifference curve
32
Q

Pareto Efficiency and public goods: when your budget constraint line shifts out, how do you know how much you’re going to buy and how much another person is going to buy?

A

this is the difference between the total amount that the person is consuming and how much of the public good person two purchased
-if person two purchases enough of the public good, person one is going to have a corner solution where person one buys none and person two buys both

33
Q

Pareto efficiency and public goods (game theory graph with public good on both axises): how do you derive a reaction curve?

A
  1. you say Person B is going to buy certain amounts of the public good, draw a horizontal line straight across to represent this
  2. from that horizontal line, you draw IC’s where Person A’s utiltity is the highest
  3. connect all of these points together
  4. should be a downward sloping line with an X and Y intercept
34
Q

Pareto Efficiency, Public Goods, adn Game Theory: where is the Nash Equilibrium? Is this efficient?

A

This is the point where the two individual’s reaction curves cross

  • this is not efficient, because Person A’s IC is tangent to the horizontal line at that point while Person B’s IC is tanget to the vertical line at that point
  • this creates a mismatch of preferences, and creates a lens shaped area where they both would be better off
  • if they both act independently, both will NEVER reach this Pareto approving lens area
35
Q

The Leftover Curve: basic problem

A

we want to maximize person J’s utility, which is dependent on how much of PublicGoodj and PrivateGoody he gets
-constraints: must be in PPF, Person V’s utility and choice, Xj + Xv = X

36
Q

The Leftover Curve: step to deriving it

A
  1. draw PPF, with public good on X axis, private good on Y axis
  2. draw in Person V’s Indifference Curve, intersection at two points, not tangent to PPF
  3. gives us options for production, at the top or bottom intersection, both resulting in a vastly different amount of public and private goods…oh and anything between those points on the PPF can be chosen
  4. from these hypothetical points, draw lines down into another graph directly below
  5. this new graph below should have Xj on the Y axis and amount of public good on X axis
  6. anything inside that leftover curve is the amount of Xj leftover
  7. to maximize person J’s utility, we want slope of Person J’s IC to match the slope of the lectover curve
  8. this is written as: MRT - MRSv = MRSj OR MRT = MRSv + MRSj
37
Q

optimal club size for given number of members: axis

A

northeast quadrant: x axis is club size (s), y axis is monetary measure of costs and benefits

  • linear curve is cost per member of size, slope is Ps / N
  • concave down curve (above linear curve) is benefit per member for size

southeast quadrant: y axis is N-bar, straight horizontal line

38
Q

optimal club size for a given number of members: where is our optimal point?

A

find the greatest distance between the benefit and the cost

-where slope of cost curve is equal to the slope of the benefit line

39
Q

optimal club size for a given number of members: what do we do once we find the optimal point in the northeast quandrant?

A

draw line straight down into southeast quadrant and connect it to the N-bar line

40
Q

optimal club size for a given number of members: what happens to the curve as N increases?

A

as N increases, both curves shift down a tad, equilibrium point will move right a tad…draw that down to the southeast quandrant and youll find that a larger size club is now more optimal

41
Q

optimal club size for a given number of members: how do you find the curve for optimal size?

A

change in N’s and in the Northeast quadrant, find the optimal points there, draw lines down to southeast quadrant until they run into N-bar…connect all of these points

42
Q

optimal number of members for a given sized club: describe the basic structure of the west quadrants

A

northwest quadrant: X axis is number of members, Y axis is dollar measure of value
concave up curve: Ps*Sbar/N…represents declining cost per member as member goes to infinity
concave down curve: represents benefit per member

43
Q

optimal number of members for a given sized club: how do we find optimal point for Northwest curve?

A

find spot where slope of cost/n curve is equal to cost/benefit of member is the same (biggest gap between the two)

44
Q

optimal number of members for a given sized club: describe the southwest quadrant

A

y axis = number of members

x axis = club size

45
Q

optimal number of members for a given sized club: how do we find the point of the optimal size club and optimal size of members?

A

find the point where the two curves in the southeast quadrant meet

46
Q

optimal number of members for a given sized club: whats the problem with this approach?

A

N isn’t always perfectly divisible, so there are often leftovers…what do we do with these people that are left out?

Public Finance (3 decks)

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