PS 408 Midterm Final notecards

Question 1

What is market failure?

Answer 1

The economic situation defined by an inefficient allocation of goods and services in the free market​

Question 2

Why doesn’t the market allocate the particular good efficiently? Hint 4 reasons

Answer 2

Public goods​

Externalities​

Natural monopolies ​

Information asymmetries ​

Question 3

What are the rationales for government intervention? Hint four

Answer 3

Public goods: will not be provided by market because private providers cannot exclude people who do not pay for public goods.​

Externality: a situation in which by-product of either production or consumption of good may benefit or harm other people.​

Natural monopoly: a situation in which one firm can produce the total output of the market at lower cost than several firms could.​

Information asymmetry: occurs when one party to an economic transaction has greater knowledge or information than the other party. ​

Question 4

What are the characteristics of Public Goods?

Answer 4

Non-exclusion: No individuals can be excluded from the benefits of the good. ​ If a good lacks exclusion, no one can be prevented from consuming it. A market failure may occur when nonpayers over-exploit the good, imposing negative externality on other people.​

​Non-rivalry: The benefits of a good can be consumed by any individual without diminishing others benefits. ​
If a good lacks rivalry, the marginal cost of providing the good to one more person is zero. A market failure occurs if a provider charges a positive price.

Question 5

How do the characteristics of public goods result in a market failure?​

Answer 5

Due to non-excludability, it is difficult to charge individuals for the use of public good. ​

Free-rider problem: When individuals get the benefit from public goods without paying for their use because they do not report their true demand for the public goods.

Question 6

Table of Public goods characteristics continued

Give an example of something that is excludable and non-rivalrous:

Give an example of something that is rivalrous and non-excludable:

Give an example of something that is excludable and non-rivalrous:

Give an example of something that is non-excludable and non-rivalrous:

Answer 6

Give an example of something that is excludable and non-rivalrous:
Shoes, clothing, and phones.

Give an example of something that is rivalrous and non-excludable:
A park, and the fishery. Problem, The tragedy of the commons arises when individuals or groups overuse the common-pool resource because they do not bear the full costs of their actions. A resource is overuse.

Give an example of something that is excludable and non-rivalrous:
Concert, tennis, club, and cable television.

Give an example of something that is non-excludable and non-rivalrous:
National defense, and a street lamp

Question 7

What are the 4 sources of government failure?​ and example of each one

Answer 7

Direct democracy ​
e.g., paradox of voting, bundling​

Representative government ​
e.g., rent seeking, electoral cycles​

Bureaucratic supply ​
e.g., agency loss, bureau failure​

Decentralized government ​
e.g., diffuse authority, fiscal externalities​

Question 8

What is the paradox of voting, rent-seeking, principal-agent problem, bureaucratic failure, and Geographic representation?

Answer 8

Paradox voting: brings into question the common interpretation of voting outcome as, “will of the people.”

Rent seeking: occurs when entity seeks to gain the existing wealth without increasing productivity (lobby).

Principal-agent problem: arises when there is a conflict of interest between the agent (bureaucrats) and the principal (politicians).​

Bureaucratic failure is caused by ​
“Information asymmetry” between principals and agents ​
Limited competition makes bureaus “natural monopolies.”

Geographic representation is when politicians may adopt policies with visible “net benefits” to their own districts but large social costs, districts interests override those of the national one. ​

Question 9

What does voting with one’s feet mean?

Answer 9

express one’s preferences through moving to better areas that provide optimal bundle of taxes and public goods. ​Better school district, cheaper property tax rate, etc. ​

​

Question 10

What are fiscal externalities?

Answer 10

Fiscal externalities: Local jurisdictions have an incentive to try to exclude people who have below-average property values (little contribution to revenue), while trying to attract wealthier residents and industry. ​

It results in inequitable distribution of local public goods. ​

e.g., public education funding.​

Question 11

What is passive government failure? Examples?

Answer 11

Government does not diagnose market failures correctly. Some examples include monopolies, externalities, and information asymmetry.

Question 12

What are the four ways of framing public policy problems and one example of each?

Answer 12

Tuition policy ​
→ pricing policy​

Airplane noise ​
→ externality​

Utility ​
→ Natural monopoly​

Research ​
→ public goods

Question 13

What are the 5 ways of supplying goods through nonmarket mechanisms and examples?

Answer 13

Direct supply​: Government bureaus​

Independent agencies​: Government corporations​, Special districts ​

Contracting out​: Direct contracting​, Indirect contracting ​

Providing insurance​: Mandatory insurance​, Subsidized insurance​

Providing cushions​: Stockpiling​, Transitional assistance​, Cash grants​

Question 14

What is the rationale for government corporations?​

Answer 14

Single market failure test:
Natural monopoly ​
Other market failures (e.g., externalities, public goods)​

Question 15

What characteristics define a natural monopoly market?

Answer 15

High fixed costs (e.g., rail track, water, gas, electricity) ​

Potential for economies of scale (Average cost = Total cost/ quantity)​

Rational for one firm to supply the whole market ​

High barriers to entry

Limited competition

Competition leads to a wasteful duplication of resources and non-exploitation of full economies of scale → allocative (or productive) inefficiency

Question 16

What are the advantages and disadvantages of special districts?

Answer 16

Advantages
* Allow consumers to observe the
relationship btw service
provision and tax-price clearly.
* Internalize externalities that spill
across the boundaries of local
governments.

Disadvantages
* The costs that consumers face in
monitoring “mini-governments”
for different services.

Illinois is an example state which has many special districts

Question 17

How to conduct/steps for benefit analysis?

Answer 17

Step 1: Identifying relevant impacts of the policy
Step 2: Assign a monetary value to each item
Step 3: Estimate costs and benefits by discounting for time and risk
Step 4: Selecting among policies, comparing costs and benefits

Question 18

What is Geographic extent & Fiscal externality​?

Answer 18

The intergovernmental grants transfer wealth or rents across the boundaries of local jurisdictions.

Question 19

What is opportunity cost? ​

Answer 19

The implicit value of what you have to give up in order to choose something else. ​

The value of the next best alternative.

Question 20

How can we measure opportunity cost?

Answer 20

It depends on the nature of the market.

Question 21

What is an example of discounting for time and risk​?

Answer 21

Present value: provides the basis for comparing costs and benefits that accrue at different times.​

Expected value: provides the approach to deal with risky situations.​

Question 22

What is the value of 1,000 dollars in 1 year, 2 years, 3 years, and 10 years with a discount rate of 5%?

Answer 22

• 1000 × (1 + 0.05) = 1050, formula for 1 year
• 1050 × (1.05) = 1102.5, formula for 2 years
• 1000 ×(1.05)^3 = 1157.625, formula for 3 years
• 1000 ×(1.05) ^10 = 1628.9, formula for 10 years

Question 23

1. Identify a set of mutually exclusive contingencies
   * One or more major floods in the next 20 years
   * No floods in the next 20 years
2. Estimate the present value of net benefits under each contingency.
   * $25 million if one or more floods
   * - $5 million if no floods.

Assign a probability of occurrence to each contingency
1) P of major floods occurring:
* 0.02 2) P of no floods: 3) P of major floods occurring in the next 20 years: 4) P of no floods occurring in the next 20 years:

Answer 23

2) P of no floods:
* 1– 0.02 = 0.98
3) P of major floods occurring in the next 20 years:
* 1 - 0.98^20 = 0.33
4) P of no floods occurring in the next 20 years:
* 1 – 0.33 = 0.67

Question 24

What project does offer the largest net benefits? need to look at the table

Answer 24

• Project B offers the largest net benefits.

Question 25

What project does have the largest ratio of benefits to costs? need to look at the table

Answer 25

It is not B (cost-benefit ratio of 3), but A (cost-benefit ratio of 10).

Question 26

Which project should be selected? A or B? need to look at the table

Answer 26

Select project B because it offers larger net benefits.

Question 27

What is the procedure to convert the problem of floods to risk?

Estimate the present value of net benefits under each contingency

25 million dollars if one or more floods

-5 million dollars if no floods

Answer 27

Multiply the present value of net benefits for each contingency by the probability that the contingency will occur and sum to arrive at the expected value of the present net benefit.
(0.33)($25 million) + (0.67)(-$5 million) = $4.9 million

Question 28

Assume that none of the projects are mutually exclusive and total costs cannot exceed $10 million. If project B is selected, will budget constraint be met?

Answer 28

• Costs of project B = $10 million. Net benefits = $20 million

Question 29

If projects A, C, and D are selected, will budget constraint be met?

Answer 29

Costs of projects A, C, and D = $8 million. Net benefits = $9 + $14 = 23 million.

Question 30

Which project or projects should be chosen under the budget constraints?

Answer 30

Under the budget constraints, net benefits are maximized by choosing projects A, C, and D.

Question 31

What does mutually exclusive mean?

Answer 31

When two events do not influence each other, and have to be independent.

Question 32

When the government did not diagnose the market failures correctly, for example?

Answer 32

The salmon fishery example since there was an overuse of the resources, more than the fish could be produced.

Question 33

Why do we need to do cost-benefit analysis?

Answer 33

• Governments need to ensure that taxpayer money is being used
  effectively given resource constraints.
• A cost-benefit analysis helps us understand its effectiveness of certain
  policy or program.

Question 34

What are the differences between government corporations and government bureaus?

Answer 34

• Government cooperations operating with their own source of revenue → gives them
  independence from legislative or executive interference.
• The Tennessee Valley Authority (TVA):
• A federal owned electric utility corporation in the U.S.
• The sixth largest power supplier and largest public utility in the U.S.

A government corporation is a public sector entity that operates like a private corporation, but is owned and controlled by the government. It typically operates in a commercial or business-like manner,

Bureaus typically operate in a more bureaucratic and hierarchical environment, with decision-making authority resting with the head of the department or agency. Bureaus usually do not generate revenue or profits, but instead carry out government policy or implement regulations.

Question 35

What is the principal-agent problem?

Answer 35

Principal-agent problem: arises when there is a conflict of interest
between the agent (bureaucrats) and the principal (politicians).

Question 36

Why does decentralization cause government failure?

Answer 36

Bureau failure as market failure
Diffuse authority of Federalism
Fiscal externalities

Question 37

What is the problem of bundling?

Answer 37

Voters evaluate the bundle of positions offered by candidate.
* Different voters vote for the same candidate for different reasons.
e.g., support tax policy (tax cuts), but do not support immigration policy.
* A particular policy in bundle ≠ the will of a majority.

Question 38

What causes bureaucratic failure?

Answer 38

Information asymmetry between principals and agents

Limited competition makes bureaus natural monopolies

Question 39

How to chose the best policy?

Answer 39

Look for one that maximizes net benefits, does not have physical budgetary constraints, and is mutually exclusive from other policies.