Topic 1 Study Questions

1-1. Economic Efficiency - The marginal costs to society should equal to the sum of the marginal benefits of all consumers, which is the marginal social benefit Externalities - exist if one economic agent’s actions (consumption or production) affects another agent’s welfare outside of changes in market prices or quantities. Increasing Returns to Scales - a proportional change in all production inputs causes a greater than proportional change in output. Private Goods - A good or service such that each individual consumes separate and identifiable units of the good, a unit of the good consumed by one individual cannot be consumed by any other individual Public Goods - goods or services that exhibit two properties. Public goods are non rival, and non excludable. Example: National Defense Free-Rider Problem - benefiting, without paying, from the amount of goods purchased by others. Because all individuals have this incentive to understate their true demand, the quantity of these goods provided usually are inefficiently low. Lindhal Equilibrium - Each person pays a price for a good that equals their MB and the resulting equilibrium that is provided is efficient. 1-2 The average level of U.S. expenditure is $6,166 per capita; Florida’s is $5,449 which is slightly lower than the National Average. Florida’s Local Government provides almost half (49%) of own source funds. Florida’s Federal Aid is third lowest only behind Virginia and Nevada. Florida does not have an individual income tax, the National Average is 12%. More of a regional pattern exists in the reliance on different revenue sources than in the level of taxes and expenditures. However, Florida’s property tax is relatively higher than the National Average. General Sales Tax seems to be relied on more in the Southeast than the rest of the nation. Florida depends on sales tax especially because it is a high tourism state. 1-3 Assuming no public goods, we can conclude that MB(QD) = P. Assuming no increasing returns to scale, it can also be concluded that the MC(QS) = P. The price in which MB = MC is the Equilibrium quantity, QEquil. Therefore MB(QEquil) = MC(QEquil). For efficiency, first it is defined as MSB = MSC. Then, operating under the final assumption of no externalities it can be concluded that MSB and MSC equal marginal private benefit and marginal private cost respectively, or just MB = MC. MSB = MB, MSC = MC, therefore MB(QEquil) = MC(QEquil) = MSC(QEff) = MSB(QEff), and thus finally QEquil = QEff.

1-4a The problem with increasing returns to scale is that the efficient quantity is not compatible with making profits. Since the efficient quantity implies losses, the equilibrium quantity (what actually will be produced) is less than what is efficient. Diagrammatically, the equilibrium quantity will be where the average total cost equals the demand/marginal benefit, again at a quantity less than what is efficient. 1-4b When there are positive externalities, the good/service is undervalued in the market because the marginal social benefit is actually greater than the marginal private benefit, but it is not taken into account when making the purchasing decision. Not enough of the good is produced; the equilibrium quantity is less than the efficient quantity. When encountering a negative externality, the opposite is true. The marginal social benefit is less than the marginal private benefit, therefore too much of the good is produced and the equilibrium quantity is greater than the efficient quantity. 1-4c The competitive market may fail with a collective consumption good both when nonpayers are excluded and when they are not excluded. First it may be inefficient when non-payers are excluded because there will be too little of the good supplied because it excludes some people who would benefit from the good at no additional cost to provide it to them. But the voluntary contributions method doesn’t provide the efficient quantity either because of free loaders who either don’t pay at all, or pay below their marginal benefit of the good. 1-5 Government model – government usually supplies a public good or service at no charge (non-exclusion) but attempts to overcome the free-rider problem by financing the good with mandatory (involuntary taxes). One reason is since there is no direct cost to an individual for consuming the good (that is, no price charged), crowding may emerge as individuals overcome the good. Also because we don’t know the consumers’ marginal benefits, it is difficult to determine the efficient quantity of the good, such information is not usually available to the government. Finally the taxes required to finance the good create offsetting inefficiencies in the markets for the taxed activities.