ECO 5520/6520Page 1 of 6

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Midterm Exam 2 – ECO 5520/6520

Instructions

This examination has five questions and you are to do all five in a bluebook that you provide. Please number your answers clearly. Each question will be worth 20 points, and each part of each question will be weighted as indicated, so allocate your time accordingly. The exam is “closed book – closed notes.” You may use a calculator, although you shouldn’t need one. Note that the undergraduates and the M.A/Ph.D. students will do different versions of question 5.

You will have until from 3:00 until 4:50 to complete the exam. Latecomers will not be given extra time to finish the exam. If you are unsure of a question, indicate what assumptions you are making and go forward.

1. In our class, we looked at distinctions among regressive, proportional, and progressive taxes.

  1. (5 points) Briefly define regressive, proportional, and progressive taxes, with particular reference to the average tax rate? As y: R AT; Prop AT same; Prog. AT 
  2. (5 points) How is the average tax rate related to the marginal tax rate?For ATR to , MTR > ATR.
  3. (5 points) Is the social security tax a progressive, proportional, or regressive tax? Why? SS is regressive. It stops at y = 100,000. Then ATR .
  4. (5 points) Suppose, in order to increase tax revenues, the State of Michiganconsidered a 10% tax on all jewelry in the state that contains diamonds (precious stones). Is this likely to be a progressive, proportional, or regressive tax? Why? Progressive. As y we buy proportionally more fancy jewelry, and ATR.

2. Here are a few questions about the sales tax and tax incidence that refer to the market for flash drives, also known as thumb drives or memory sticks.

  1. (5 points) Suppose that an economist, hired by the state, estimates that the demand elasticity for flash drives sold in the state is -4.0, the supply elasticity is +1.0, and the equilibrium price is $15 per 1 gB flash drive. Draw a supply and demand diagram with as much detail as necessary to describe this market.
  2. (5 points) Suppose that the State of Michigan decides to impose a $5 tax on all 1 gB flash drives sold in the state, to be paid by the suppliers. Will the market price of flash drives rise to $20? Why or why not?
  3. (5 points) Given the parameters from part (a), who will pay a larger portion per flash drive of the $5 tax, the producers or the consumers? Why?
  4. (5 points) Suppose that the State imposes the $5 tax on the demanders? Will your answer to part c change? Why or why not?

a.

b. Dashed line. Price will not rise to $20.

c. Producers will pay more.

d. Demand shifts down. Producers will still pay more.

3. This question will look at the “privatization” of the provision of public goods.

  1. (5 points) Suppose the residents of a small town out in LapeerCounty decide to put in sidewalks. What are the characteristics of the decision that make this a public rather than a private decision? Lots of people walk on property, not just owner.
  2. (5 points) In an election it is decided to tax the property owners based on how wide their property is, in terms of $X per foot. Is this an appropriate means for paying for the sidewalks? Why or why not? Yes, it is a good measure of marginal benefits.
  3. (5 points) If you are the city manager of the town, what are some brief arguments “for and against” as to whether you privatize the production of the sidewalks? For: (1) lots of construction companies can do this  competition. (2) Town does not regularly do this. Against: (1) Collusion of bidders. (2) Quality may be low.
  4. (5 points) If you did privatize, how would you go about contracting out the construction of the sidewalks? What criteria would you use to make sure that it would be done properly? Stipulate width and depth of sidewalk. Randomly check samples of the work.

4. Joe Michaels gave a presentation about the circumstances regarding mandated staffing in cities. In particular the City of Pontiac voted to continue mandating a particular level of fire department staffing:

  1. (5 points) Discuss briefly the nature of the Pontiac issue and the election result. Pontiac mandated size of fire department. It gave them a bigger department than they wanted. Voters refused to vote a change.
  1. (5 points) Suppose we measure the amounts of different public goods by the size of the staff producing each one. In the diagram suppose that the optimum fire department staffing, was 200 fire fighters, but that the “City Charter” mandated that 250 be hired. Label the optimum as point A, and the mandated amount as point B, and explain why point B is suboptimal by economic criteria.
  1. (5 points) Suppose that the State of Michigan provides grants that pay entirelyfor the first 100 fire fighters that are hired, and then Pontiac has to pay market wage for the rest. Redraw, re-label and explain the impacts of this grant program. Leads to more being hired.
  2. (5 points) Suppose instead of the program in part c, that the State of Michigan provides a dollar-for-dollar matching subsidy for the hiring of all fire-fighters. Redraw, re-label and explain the impacts of this program. Hint: Pay special attention to the budget constraint. As drawn. It may or may not be better for city that part c answer. It depends on price and income effects.

5. Undergraduates

  1. (5 points) Suppose that Ed and Phil both want skateboard facilities in their suburb. Ed’s demand curve is DE, and Phil’s demand curve is DP. Draw the appropriate marginal benefit curve that summarizes the demand for a public good for the two of them on the graph above. Discuss briefly how you did it. Sum demand curves vertically.
  2. (5 points) Suppose that the marginal cost per unit of skateboard facility is starts at 12, at Q=0, and rises to 18, by quantity Q = 30. How would you use this in your analysis?
  3. (5 points) What principal would you use to estimate the optimum amount of this local public good? Is it the same or different as that used for private goods?Sum of MB = MC.
  4. (5 points) Show the optimal number of skateboard facilities, based on your answers to parts (a) and (b). Give your best estimate, either geometrically or algebraically.

Answer to d: Q* is 8.85, although answers in that neighborhood got full credit. If you were too far away  no credit.

5. M.A. and Ph.D. students – (Note! 4 points per question)

  1. (4 points) Suppose that Ed and Phil both want skateboard facilities in their suburb. Ed’s demand curve is DE, and Phil’s demand curve is DP. Draw the appropriate marginal benefit curve that summarizes the demand for a public good for the two of them on the graph above. Discuss briefly how you did it.
  2. (4 points) Suppose that the marginal cost per unit of skateboard facility is starts at 12, at Q= 0, and rises to 18, by quantity Q = 30. How would you use this in your analysis?
  3. (4 points) Show the optimal number of skateboard facilities, based on your answers to parts (a) and (b). Full credit will require that you calculate the amount algebraically.
  4. (4 points) If the suburb provides 25 units of the facility, is there a welfare loss? If so, calculate the loss.
  5. (4 points) In charging for the facility, who should be charged for all units past 15 units?Why?

a. MB = 30 –1.83 Q

b. MC = 12 + 0.2 Q

c. Q* = (30/61)*18 = 8.85

d. Yes there is a welfare loss. Triangle C and Trapezoids A and B

Areas: C = 38.4375; A = 82.50; B = 71.25  Total = 192.1875.

e. Phil should pay everything from 15 to 20. Either neither or both should pay for anything more.