1. a. To the extent that autos tend to be used within a given jurisdiction only, it would make sense for states or localities to control pollution regulations. To the extent that a given car is driven in many states, or that pollution created in one jurisdiction affects residents in another, it would make sense for the federal government to be in charge.
b. To the extent that the negative externalities of a landfill affect only people who live nearby them, then local or state regulation is appropriate.
c. Provision of weather satellites would make most sense for the federal government.
d. Public refuse collection seems a natural function for local government.
e. In the case of airport security, inter-jurisdictional externalities are present. If one airport in one community does not have adequate security, it affects the security of individuals at airports in other jurisdictions. Thus, a federal role is appropriate in this situation.
2. Yes. David bore the burden of the tax increase while Jonathan did not. Because the future tax payments are incorporated into the price of the house, Jonathan was able to purchase the (same) house at a lower price. The previous owner effectively “pays” the tax.
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3.
c.
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4. The theory of federalism indicates that one of the main purposes of decentralization is to allow people to select bundles of public services and taxes that suit them. The more diverse their tastes, the greater the benefits of being able to pick different bundles, and hence, the greater the benefit to decentralization. Hence, the finding is consistent with our theory.
5. The figure looks essentially like Figure 20.6 (without segment JH). What actually happens to spending on education depends on the income elasticity. The government need not increase spending on education by the full amount of lottery money collected because the rest of the state revenue is fungible. Thus, if previously 20 percent of general state revenue had been spent on education, after the lottery is implemented, perhaps only 17 percent of general state revenue is spent on education.
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6. In the figure below, the (constant) marginal cost of hiring a firefighter is C. The demands for the two communities are D1 and D2. Suppose that initially the quantity is set at Q0. After decentralization, each community hires firefighters up to the point where the marginal benefit equals marginal cost, i.e., where their respective demand curves intersect C. This is at Q1 for community 1 and Q2 for community 2. Community 1 gains abc. Community 2 gains dbe. Community 1 gains more because its demand curve is more inelastic.
7. The “user-fee” view of property taxes regards property taxes as payment for local public services. The statement “its presence would raise property values and the extra tax revenues would easily repay the construction costs” reflects this view -- that people pay for the recreational services made available by the part with their property taxes. The statement is not consistent with the “traditional view” or the “new view,” both of which ignore the local services aspect.
8. Originally, the effective state price of $1 spending on welfare recipients was $0.50 with a one-for-one federal match rate. If the federal match rate changes to two-for-one, the effective state prices of $1 spending falls to $0.33, or a 34 percent change in the price.
Using Baicker’s (2001) elasticity estimate of 0.38, a 34 percent change in price should increase state spending by 12.92% (=0.38*34%).
LECTURE TIPS
Chapter 1
Decisions about public policy cannot be made on the basis of economic analysis alone. Value judgments are also required. The purpose of the beginning part of Chapter 1 is to make this
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point, and to try to force the students to think hard about the values they bring to bear on public policy problems.
One point I emphasize in class is that even the way we formulate our questions depends on value judgments. For example, the question that economists in the United States and United Kingdom usually ask is, “Under what conditions is it a good idea for the government to intervene in the economy?” I ask the students what question might be asked if the course were being taught in a socialist economy such as Cuba. There the question might be, “Under what conditions is it a good idea to allow the private sector to undertake an activity?”
The lecture on the second part of the chapter should try to convey some sense of the scope of government activity. About a third of the GNP goes through the public sector; most students do not realize that government is that large. The lecture should also emphasize the arbitrariness involved in selecting a measure of public sector size. To make the issue more concrete, one can relate it to current debates over various “mandates.” While any given measure may convey useful information, no single measure can tell the whole story. I try to emphasize that this is a theme that will be recurring in the course – it is often difficult to measure things we care about;
this fact does not mean that we should abandon attempts at measurement, but it does mean that we have to be cautious in interpreting data.
Chapter 2
Students should come away from this chapter realizing that just because economists disagree on many issues does not mean that economists are stupid or dishonest. One point to emphasize is that in this respect, economists are pretty much in the same boat as practitioners in other disciplines generally considered to be more “scientific,” e.g., medicine. Just remember the controversy over whether drinking coffee “causes” cancer of the pancreas.
In recent years there have been more attempts to answer economic questions with experiments.
It might be interesting to use this chapter’s summary of Rouse’s work on the Milwaukee voucher experiment as the basis for a classroom discussion of the advantages and disadvantages of experiments in economics.
Chapter 3
After I distinguish between “positive” and “normative,” I find that students tend to equate
“normative” with “not subject to rational discussion.” This is a good opportunity to remind students that it is possible to have rational discourse about value judgments, despite the fact that it is impossible to prove “scientifically” that one set of values is better than another.
My students are intrigued by Edgeworth Boxes and the notion of Pareto efficiency. It pays to go through this material very carefully. If many of your students have seen the Edgeworth Box analysis of exchange efficiency in a previous course, you may want to go through the analysis of productive efficiency in class. Students have been seeing the production possibilities curve since practically their first day in economics; now they will know where it comes from. One way to provoke discussion on the topics in this chapter is to discuss the longstanding controversy over
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whether to abolish the National Endowment for the Arts. Many students support this and related programs but find it hard to articulate just why. A discussion of paternalism and policy toward cigarettes is another way to students thinking.
Chapter 4
This is the first chapter on the expenditure side of the budget. I have found that there is a tendency for lectures in this part of the course to degenerate into a mere cataloging of programs, without a central theme. The text tries to counter this tendency, but it helps in lecture to keep coming back to the basic question raised in Chapter 3: From the point of view of welfare economists, is this program sensible?
With respect to the material on public goods, I find that students often have problems understanding the necessary condition for Pareto efficiency in their provision. As preface, I began with some intuition of the following kind – given that everyone must consume the public good, it only makes sense to increase its provision by a unit if the sum of the marginal values that each person puts on an extra unit exceeds the marginal cost. Next, review carefully why
“marginal value” corresponds to the familiar notion of marginal rate of substitution, and
“marginal cost” corresponds to marginal rate of transformation. Then it is easy to get to the final step, that the sum of the MRSs must just equal the MRT.
Students are very interested in the issue of privatization. I try to relate current controversies over whether some particular service should be privatized to the theory of public goods. Example:
Should welfare be administered by private companies? The text takes advantage of the Hart- Shleifer-Vishny incomplete contracts framework to analyze the choice between public and private production. My hope is that students will find this a compelling and coherent way to think about privatization issues. To bring the material close to home, try discussing the material on public versus private provision of education.
The material on preference revelation mechanisms is relatively difficult for many students, which is why it has been place in the appendix to this chapter. My experience is that, even after students have read this material, they need to be led through it a step at a time. As above, it helps to keep reminding students that “MRS” corresponds to “marginal benefit,” and “MRT”
corresponds to “marginal cost.” www.elsolucionario.net
Chapter 5
Although environmental externalities are critically important, it is important for students to realize that externalities come up in other contexts as well. Some of the new examples include Lojack devices on cars and the conservation of elephants in Zimbabwe.
I find that students tend to think that any activity that is “desirable” produces positive externalities, and therefore should be subsidized. The book emphasizes that for a subsidy to be efficient, the activity must produce, on the margin, a benefit that exceeds the return to the producer of the activity. Still, this point requires emphasis in class. Ask the students whether they think that medical school educations should be subsidized and, if so, why.
It is important for students to realize the difficulties involved in implementing the models for dealing with externalities. Sometimes it is hard to determine even whether or not a particular substance causes harm. The controversy in early 2001 over standards for arsenic in water might be a good topic to discuss in this context.
Chapter 6
This chapter is divided into two major sections - the first on direct democracy and the second on representative democracy. I prefer to give a separate lecture on each part, but to stress the linkages between the two problems. (For example, the median voter theorem derived in the direct democracy context gives predictions on the outcomes of election contests.)
Virtually all of the students have heard of “logrolling” and tend to assume that is a bad thing. It is, therefore, a good idea to go patiently through the example in which a logrolling system improves efficiency. Of course, the efficiency-decreasing case should also be discussed. Ask the students which case they think is more realistic in their community.
Public discussions of statutory and constitutional measures to reduce government spending continue to be lively. Ask the students if they favor a balanced-budget amendment.
Chapter 7
The material on the optimal income distribution exemplifies the interplay between economics and philosophy. Philosophy determines the form of the social welfare function; economic analysis shows how to maximize this welfare function subject to the relevant constraints.
Students often have strong views on the “fair” distribution of income. One can have a good class discussion by getting the students to try to rationalize their feelings using the framework of welfare economics.
After the discussion of the inferiority of in-kind transfers to cash, students always ask why we have in-kind transfers. This is a good opportunity to relate income distribution policy to the public choice issues raised in Chapter 6. That is, Chapter 6 discussed logrolling and special interest groups; it is useful to analyze how these factors have influenced the formulation of income maintenance policy.
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Chapter 8
This chapter stresses the changes in welfare policy introduced in 1996 and the preliminary research on their impact. Students can be asked whether they think that workfare requirements are good social policy, and whether it makes sense to allow the states a bigger role in determining welfare policy. Such a discussion also provides an opportunity to anticipate some of the federalism issues that will arise toward to the end of the course.
Income maintenance issues provide a good opportunity to show how the economist’s standard leisure-income model sheds light on the labor supply incentives of welfare. It is also a good opportunity to review the points about methodology raised in Chapter 2. Just why is it so hard to find out whether the welfare system creates long-term dependence, whether AFC increases divorce rates, etc.?
Chapter 9
This chapter devotes a substantial amount of space to a potentially confusing topic – the privatization of Social Security. It is important to stress in this lecture that merely investing the Social Security surplus in the stock market will not make future retirees better off. Any serious privatization scheme requires some mechanism for increasing social saving. And given that political and ethical considerations require that obligations to the current generation of retirees be met, this probably means some kind of additional taxation.
In addition to discussing the nuts and bolts of Social Security, it is important to relate this program to broader themes in the course. In particular, why should this kind of “insurance” be provided publicly? What kind of market failure is created in the presence of adverse selection?
Is the government program better than the free market alternative?
Chapter 10
It is important to emphasize that even though health care decisions are often made under conditions of great uncertainty, this does not mean that the tools of positive economic analysis must be discarded. Rather, these tools must be modified to take the uncertainty into account.
Thus, for example, the principal-agent model allows discussion of the incentive problems that arise when physicians act as patients’ agents.
My students tend to have very strong preconceptions about the reasons for the increase in health care costs. To begin the discussion of this matter, I ask the students why they think that the health care sector has been increasing relative to the size of the GDP. Then I ask them how they would test whether their views are correct. This provides a segue into a discussion of Newhouse’s analysis of the sources of growth in health care costs. In the context of this discussion, it is always important to emphasize that it is not obvious whether health expenditures are “too big.”
In recent years, the discussion of health care policy has moved away from global reform to incremental change. Students might be asked whether they think that incremental change is
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sufficient to develop “good” health care policy. A discussion of reform options for Medicare might be helpful in this context.
Chapter 11
There is a tendency for students to think that cost-benefit analysis allows one to make a
“scientific” unambiguous choice among projects. The tricky part of this material is to disabuse the students of this notion, but at the same time convince them that cost-benefit analysis is a useful tool. It is the only way to force an analyst to explain systematically why he or she favors a project.
The students find the material on the value of life to be intriguing. It is useful to keep reminding the students that this is not merely an academic issue. The problem comes up, for example, whenever there is a lawsuit after an air disaster. It is important to emphasize that, in this and other contexts, one cannot avoid explicitly or implicitly putting a value on life.
I find that it is also useful to discuss the material on the problem of double counting in benefit- cost analysis. The text’s discussion of land values can be amplified with an explicit algebraic discussion of the capitalization of benefits into land prices. A side benefit of such a discussion is that is provides another illustration of the usefulness of present value analysis.
This edition contains a new extended example of cost-benefit analysis. The question is whether reductions in class size have benefits that exceed their costs. This is an issue on which the students are likely to have strong opinions, and I have found it worthwhile to work through the example in class carefully.
Chapter 12
This is the first of three chapters on tax analysis. The emphasis in these chapters is providing a theoretical framework for thinking about tax policy issues. The danger in presenting this theoretical material all at once is that students will get impatient to see it applied to the actual tax structure. I have tried to avoid this danger by putting a lot of examples into the text. In particular, in light of the current interest in public policy toward cigarettes, I have included a number of examples dealing with cigarette taxation. I have also framed the discussion of international taxation in terms of “globalization” which may increase its appeal to students.
Many students have seen in an earlier course the standard tax incidence analysis done in a supply and demand framework. My experience is that although such students can shift the relevant curves, they don’t know why they are doing it. Thus, it pays to begin with a patient discussion of the distinction between the price paid by consumers and the price received by producers, and why this leads to a new “effective” demand curve after an excise tax is levied.
I find that working through the partial equilibrium analysis with an explicit algebraic example is often helpful. Posit specific linear supply and demand curves, and demonstrate how a unit tax of a specified amount changes: a) output and b) price paid by the consumer. This will make the incidence model seem more concrete.
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Chapter 13
It pays to spend some time developing an intuition for why taxes create excess burdens before doing any formal analysis. I find that going over the extreme case discussed at the beginning of the chapter is a big help. That is, when a tax drives demand all the way to zero, clearly it generates no revenue, yet it lowers welfare. Thus by distorting choices, a tax can create a burden in excess of the revenues it generates.
After making this point, next go through the indifference curve analysis very carefully. Once this is done, the students will understand why excess burdens arise, but they will still have no idea how they can actually be measured. At this point, the (compensated) demand curve analysis of excess burden should be done. This discussion should emphasize that with knowledge of the relevant supply and demand elasticities, excess burdens can be calculated. Remind students that the tools of positive analysis, discussed in Chapter 2, can be used to find these elasticities; hence, the concept of excess burden is operational.
Chapter 14
This chapter discusses a number of issues that arise in the design of a tax system; you will have to pick and choose with respect to the ones you emphasize in lecture. I like talking about the Ramsey Rule for several reasons. First, it is a nice application of marginalistic logic, and it reinforces the material on excess burden from the previous chapter. Second, it leads to an interesting counterintuitive result – neutral taxation is not necessarily efficient. Third, it shows how empirical work is needed to make theory useful – without knowing the relevant behavioral elasticities, one doesn’t know that set of tax rates will in fact lead to proportional reductions in demand for all taxed goods.
Students find the material on tax evasion to be interesting. There always seems to be someone famous in the newspaper who is being prosecuted for tax evasion. I like to stress that although tax evasion may be undesirable from a social point of view, this is not necessarily the case. As noted in the text, it depends on whether evaders’ utilities appear in the social welfare function, and on the supply elasticities of labor to the “underground” and “above ground” sectors. The material on the optimal punishment for evasion also allows discussion of a philosophical issue raised earlier in Chapter 7 – do we care only about outcomes or the processes used to generate them, as well?
The model of the efficiency consequences of partial factor taxation has been considerably simplified in this edition. However, it still needs some patient explanation in class, particularly about why the area under the value of marginal product schedule is the value of total product.
Chapter 15
Some of your students have never filled out a tax return; those who have done so probably have not had to itemize deductions, be concerned with IRAs, etc. In short, you cannot take for granted that your students are aware of the basic mechanisms of computing income tax liability.
Figure 15.1 is designed to put the income tax system as a whole in perspective. Some time should be devoted to discussing it before turning to the details of the system.
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