Test Review 2

Test Review 2 Study Question Answers 4.1 A.) Contracting out is when each community contracts with a private supplier or with another community to supply it with public services. The producer of public services supplies a number of different communities, each of which is homogeneous, but by serving multiple communities, the producer is able to achieve maximum economies of scale. B.) Joint Service Agreements are when several small jurisdictions join together to supply public services while maintaining their population at a size consistent with homogeneity of preferences. (Both contracting out and joint-service agreements allow each community to benefit from lower costs by achieving maximum economies of scale in production while each community retains the ability to provide a different quantity of the public service that is efficient for its residents.) C. Correspondence Principle is when the size of a government corresponds to the area of benefit from the goods it provides. Each public good is provided in the smallest (that is, the lowest-level) government consistent with no externalities. It generates a federal system of governments along a spectrum from many small local governments to one national government. To justify any sub national government, there must be variation in the desired amounts of public goods so that each government can provide a different amount of that good and confine the benefits within its boundaries. Otherwise, it would be just as efficient to have one central government provide those goods to all using a number of different production plants. D. Clustering is a way to reduce decision making costs. By clustering goods together with similar optimal sizes into single government units, reduces both the number of government layers and the number of separate governments in each layer. 4.2 The optimal number of communities is contingent with the demands of the community. If all the people in the area demand an exact amount of services and the entire community is uniform, there is no need for multiple, smaller communities. One large governmental unit would be sufficient. This would be very close to the Tiebout hypothesis. What happens is, though, the community may have many different demands and the general welfare of the people cannot be supported without the need of splitting up the areas by the efficient measure of the government and the people. •

Spatial Externalities: The community must include the correct size of people with the correct benefits with both taxes and spillovers of benefit. An example would be a government run education system in which the community benefits from an educated populace while the taxes for the schools are portioned out to the correct

tax payer base. •

Economies of Scale: The correct size of the economy so that a community can take full advantage of their ability to supply a resource but to spot at a point where their costs are more than their benefits, such as a diseconomy of scale. The diseconomy of scale costs more person than the correct, efficient amount.

4.3 A.) Deconsolidation of the single large homogeneous community into two smaller homogeneous communities simultaneously allows satisfaction of the Tiebout criterion of homogeneity and takes advantage of maximum economies of scale without encountering diseconomies of scale. B.) Contracting out and joint service agreements allow each community to benefit from lower costs by achieving maximum economies of scale in production while each community retains the ability to provide a different quantity of the public service that is efficient for its residents. a.) The residents of each community are homogeneous in their preferences for public services, but the residents in different communities have different preferences for public services. b.) Each community attains a Lindahl equilibrium that satisfies the Tiebout hypothesis. c.) Because the public service is supplied to multiple communities, it is still possible to achieve maximum economies of scale in production. C.) Intergovernmental grants from a higher level of government to a lower level of government can compensate for inter-jurisdictional benefit spillovers while allowing each community to maintain the size that satisfies the Tiebout criterion. Theoretically, intergovernmental grants can internalize either benefit spillovers (a positive grant or subsidy) or cost spillovers (a negative grant or charge imposed by a higher level of government on a lower level of government). However, in the real world, we do not observe negative grants, so the device of intergovernmental grants is mainly useful for internalizing inter-jurisdictional benefit spillovers. D.) Suppose that grants are not feasible for internalizing spatial externalities. Then, it may be necessary to compromise between a smaller size community with homogeneous preferences and a larger, non-homogeneous community that internalizes all the spatial externalities. There is a trade-off between the inefficiency costs of less homogeneity in a larger community and the inefficiency costs of un-internalized externalities in a smaller community. If it is not possible to satisfy both criteria simultaneously, an alternative approach is to satisfy neither one, but instead to compromise between them. We find a community size that minimized the combined inefficiency costs of heterogeneity and uninternalized spatial externalities. The community will be larger than the optimal Tiebout size but smaller than the size that internalizes all inter-jurisdictional spillovers. 4.4 Consolidation of communities in a metropolitan area or consolidation of city and county governments may enhance efficiency by internalizing spatial externalities or by achieving

greater economies of scale. If consolidation of communities reduces the homogeneity of preferences among the residents, however, the greater efficiencies from internalizing externalities or from greater economies of scale are reduced or offset by the inefficiencies from less homogeneity of preferences among the residents of the consolidated community. Consolidation of governments may also result in jurisdictions that are too large. In other words, the consolidated jurisdictions may be larger than the optimal size to achieve minimum average cost. The result of consolidation may be a change from multiple communities that are inefficiently small to a single consolidated community that is inefficiently large. Consolidation may even result in a change from multiple smaller communities that are optimal with respect to returns to scale to a consolidated community that is inefficiently large. 6-1a) Four General Principles of efficient user charges. Demand is relatively elastic Collection costs are low The users are relatively easy to identify. Price can be based on Marginal Benefit 6-1b )The advantage to user fees is that they limit the quantity demanded by limiting free-riding. If a good does not cost anything to use, then people who normally would not pay their marginal benefit for the good use it. A user fee charges the people who would normally use the good, whereas the free-riders will not. 6-2a) For one thing, people may still not use the public facilities with the best efficiency. Over crowding might become an issue once the facility is free and open to the public if it is under priced. Ultimately, the problem is that the capital investment for the facility still needs upkeep. 6-2b) The problem is that the individuals benefit from the facility may not match up with the correct price or the efficient amount. The operating costs of a facility may also need to run completely off the fees collected by the people who receive direct benefit. There is also the concern about any spill over benefit from a facility, depending on the type. Also, the money used to help build the facility may be been debt. That extra dept will need to be payed off. 6-3) Public Higher Education: In public higher education, capital costs are paid by taxes, which places the costs on the taxpayers. The operating costs are paid half with tuition and half with tax dollars, splitting costs between users and taxpayers. Congestion costs are allocated by tuition and are allocated to the students K-12 Education: In K-12 education, capital costs are paid for by taxes, usually on property. This puts the costs on the taxpayers who live in the area where the school(s) is (are) located. User fees only account for 4% of the school revenue, so operating costs are paid mainly by taxes as well, which again is putting cost on the tax payers. Congestion fees are covered by the school lunch fees and the fees associated with activities to keep overcrowding down, and the costs are incurred by the participants in the school lunch programs or the activities. Water and sewer service capital costs are allocated by connection fees, capital and distribution charges, and water supply charges. These fees are allocated to the users of

the water and sewer systems. The operating costs are covered by fees based on your water usage. This places the costs on the users. Congestion costs are covered in the initial capital costs as well as the fee based on use. This prevents overuse because people must not only pay to connect to the system, but also to use it. The cost is incurred by the user. For refuse collection the capital costs are covered by either the local government or private firms. The government pays out of taxes, placing the cost on taxpayers, and the private firm pays with user charges to those who use their services. The operating costs are covered either by user fees or by forcing the purchase of specific containers or bags to use. This places the cost on the user. Congestion costs are allocated by requiring people to pay to use. This prevents too many people from using the service. Capital costs for parks are covered by tax revenues, placing the costs on the taxpayers. Operating costs are either paid by taxes or by user fees in the form of user fees or parking fees, which place costs on the users. Congestion costs are allocated on users, either in the form of fees to enter the park or parking fees. This eliminates freeriding by preventing people who normally would not pay from using the park. 6-4a.) If the parking at Florida State is not too inelastic but relatively elastic, sure. There would easily be identifiable users: those with cars that park on campus. The marginal benefit must also equal the marginal cost which could need to be researched. However, the major issue would be in the collection cost. To redo the garages to allow some sort of system to charge people with cars would be expensive to implement. Either with security, or special toll guards, or times passes would cost lots of money to change. 6-4b.) The parking at the University would be used more efficiently by those that need parking and would have people reconsider if they wanted to leave their cars there overnight (such as those at live in university housing). People would only park on campus when they had class or needed to use a specific facility. 6-4c.) Depending on how the garages were built (if they were financed with debt) user charges would help pay for the cost of construction and the maintenance. Also, they would help keep the amount of cars using the facility to a limit that would not lead to over crowding – or a congestion cost. This is assuming that the problem of fee collection problem is solved. The fees may also be used to help expand future parking construction.

Topic 7: Intergovernmental Grants 7-1. General grant and categorical grant; • General grant; A general grant is unrestricted as to the use; it may be used for any public expenditure program.(ex. Federal grants to the states for Medicaid, unemployment compensation, education, and mass transit.)

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Categorical grant: A categorical grant is designated for a specific public expenditure program. (Examples: federal grants to the states for Medicaid, unemployment compensation, education, and mass transit.)

Lump sum vs. matching • Lump-sum grant: A lump-sum grant does not require the government receiving the grant to spend any of its own funds on the good or service for which the grant is provided. • Matching grant: A matching grant requires the receiving government to spend some of its own funds on the good or service for which the grant is provided. The grant provides an additional amount of funding for the good or service to match the amount provided by the receiving government. • • Closed-ended vs. open-ended • Closed-ended: The maximum amount of grant funding that a community can receive from a closed-ended grant is limited. • Open-ended: There is no maximum amount of grant funding that a community can receive from an open-ended grant. 7-2 A) With a lump sum grant the community income is increased, the total resources available to the community is increased and therefore it is equivalent to an increase in the median voters real income. AKA the income effect. Both the general lump-sum grant and categorical grants have the same effect on fire protection spending. Restricting use of the grant to fire protection has no effect on total expenditure because the grant simply replaces other funds that the community would have spent on fire protection, allowing those funds to be reallocated to other public goods. B) A matching grant stimulates a community more than a lump sum grant dollar for dollar because a matching grant reduces the tax-price of the public service to the community providing an incentive for the community to substitute the public service, which is now cheaper, for other goods and services. The income effect of the matching grant is identical to the income effect of the lump-sum grant. But the matching grant also lowers the median voters marginal tax price (substitution effect) making the public service cheaper and more attractive than alternative good and services. Ex… Before the matching grant the community spends $1 on the fire protection now grants pays for the half of the expenditures on fire protection. The community spends only $.50 now. This frees up another extra $.50 that the community can spend d on fire protection or use on other public goods or to reduce taxes. C) A Matching Grant causes the community to spend less than or equal to $100 of local funds. Because fire protection is matched at $100 the community’s total expenditure on fire protection will be 200 dollars. However, because of the substitution effect, it is possible that they will spend less than 100 if their demand for the good is inelastic or they will substitute the amount on fire protection to other services. If they spend any more than $100 they will use all of their own local funds (making it more expensive because it

is not matched) and the good is now relatively more expensive so they will not desire as much of the good. D) An open ended grant will get matched to any amount spent. In contrast, close ended grants will only get the substitution effect until the cap limit and then they turn into lump sum grants. Close ended are like categorical grants and will not achieve full substitution effect. 8-1 • • • • • • • •

Legal incidence- the individual or group that is legally responsible for paying a tax to the government Economic incidence- the individual or group that bears the real burden of the tax and the individual or group whose real income is reduced by the tax Excess burden or welfare cost- the effect of a tax on economic efficiency Average tax rate- indicates the individual’s total tax liability as a percentage of an appropriate index or benchmark Marginal tax rate- indicates the percentage chance in your tax liability when the benchmark changes Progressive tax- when the average tax rate increases when the benchmark increases Proportional tax- when the average tax rate remains constant when the benchmark increases Regressive tax- when the average tax rate decreases when the benchmark increases

8-5a Price increases, amount of beer sold in Tally decreases, and number of sellers of beer in Tallahassee decreases. 8-5b The amount of beer sold and the number of beer sellers outside of Tallahassee will increase because people from Tallahassee will go outside the city to sell and purchase beer.

8-5c Tallahassee is a college town with many alcoholic beverages to choose from. If beer is taxed, citizens will simply drink something else. 8-5d The economic incidence is shared by all suppliers and consumers, because every bottle is taxed $0.60. The welfare cost is relatively large because both the supply and demand curves are highly elastic.