Study Questions 3

ECO 4554 Economics of State and Local Government Study/Test Questions Topic 3: The Tiebout Hypothesis These questions are designed as study questions to enhance your economic knowledge and your analytical skills. I will also use them as test questions. Because you have the questions in advance, I expect your answers on the tests to be well-organized, clear, coherent, and concise. You might write trial answers to each question in advance, or at the very least, outline the answers. You may not bring any written materials to the test, but if you’ve prepared answers in advance, you can immediately begin writing and still write competent and thorough answers. Feel free to consult one another on the questions. In fact, I strongly encourage you to discuss the questions with one another. No matter how confident you are of your knowledge, your command of the material and your preparation for the test can be enhanced by sharing your knowledge. Do not, however, simply rely on your fellow students to provide you with the answers. When the time for the test comes, you will be on your own. Although in most cases, the questions do not specifically request that you illustrate your answer with an appropriate diagram, diagrams are usually quite helpful both in undertaking the analysis and in illustrating and explaining your answer. I expect you to know the relevant diagrams, to use them, and to interpret them. I encourage you to include them in your answers. 3-1. For each item below, define the term or state the theorem or explain the concept. • • •

Tiebout hypothesis Fiscal zoning Capitalization

3-2. The Tiebout hypothesis requires that all of the following assumptions be satisfied. 1. 2. 3. 4. 5. 6.

Consumers are mobile and will move their residence to the community that best satisfies their preferences. Consumers are completely knowledgeable about the differences among communities in public services and taxes. Consumers have many communities from which to choose. Employment opportunities do not restrict or limit the mobility of individuals among communities. There are no spillovers of public service benefits or taxes among communities (no interjurisdictional externalities). Each community attempts to attract a population that is exactly large enough to take full advantage of any economies of scale in the supply of public services without being so large as to encounter diseconomies of scale.

For each assumption, explain why the assumption is essential to the validity of the Tiebout hypothesis. That is, explain why, if the assumption is not true, individual choice among communities based on preferences for public services and taxes does not result in a Lindahl equilibrium. 3-3. (Core Principle) Based on the Tiebout hypothesis, 1

ECO 4554: Economics of State and Local Government Study/Test Questions: Topic 3 a.

what is the efficient number of communities and what is the efficient size of each community?

b.

does metropolitan consolidation, where two or more cities merge into one or where a county and one or more cities merge into a single government unit, increase or decrease efficiency and why?

c.

do limits on the use of fiscal zoning and laws and policies that make communities more heterogeneous increase or decrease efficiency and why?

3-4. There are two communities: Hueytown, composed of $150,000 houses, and Deweyburg, composed of $50,000 houses. Hueytown provides its residents with 3 acres per household of parkland; Deweyburg provides 1 acre per household. Each household in Hueytown pays a parkland maintenance fee of $1500 per year; each household in Deweyburg pays a parkland maintenance fee of $500 per year. There are no interjurisdictional benefit or cost spillovers (no spatial externalities). At these prices, the residents of each community are just exactly satisfied with the amount of parkland each community provides. The residents of each community are on their demand curves. Residents of Deweyburg have no incentive to move to Hueytown because the higher parkland fee in Hueytown exceeds the value to them of the additional parkland. Residents of Hueytown have no incentive to move to Deweyburg because the value to them of the additional parkland in Hueytown is worth the higher fee. The parkland fee is a perfect benefit tax, and the result is a perfect Lindahl equilibrium. a.

If the parkland fee in each community were replaced by a property tax equal to 1 percent of house value, how would it change the incentives for residents in each community to relocate to the other community? What happens to the Lindahl equilibrium? Explain.

b.

Would substitution of a property tax for the parkland fee affect the initial Lindahl equilibrium if Hueytown enacted a zoning ordinance establishing a minimum house value of $150,000 before it adopted the property tax? Explain.

c.

Louieville has a mix of big houses and small houses. Like Hueytown, Louieville provides a large amount of parkland per household and pays the costs of parkland from a property tax. However, because of capitalization of fiscal differentials, residents of Deweyburg who own small houses do not relocate to Louieville even though they would get more parkland with no increase in their taxes. Similarly, residents of Louieville who own big houses do not relocate to Hueytown even though they would pay less tax for the same amount of parkland. Explain what “capitalization of fiscal differentials” means in this setting. How does capitalization eliminate the incentive for Louieville’s residents to relocate to Hueytown or for Deweyburg’s residents to relocate to Louieville?

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