Unit 7: Public Spending Decisions (cont.)

Question 1

(RM Model) What is the parameter θ?

Answer 1

It represents differences in luck-based attributes such as talent/ability and initial conditions

Question 2

(RM Model) How does government spending policy work?

Answer 2

s(θ): gov. spending per individual with characteristic(s) θ (ie. of type θ) (greater θ represents more ‘good’ characteristics/more luck)

Question 3

(RM Model) How is utility/success generated?

Answer 3

u(s(θ))

Question 4

(RM Model) Define, ITO the model, the 2 policy types?

Answer 4

1) Progressive: Gives more to those who have less initially: s’(θ)<0 (ie. spending rises on those with low luck)
2) Regressive: gives more to those who have more initially: s’(θ)>0

Question 5

(RM Model) Draw diagram for regressive vs progressive policy?

Answer 5

see notes page 2 side 1

Question 6

(RM Model) When is the optimal policy type (ie. utility maximising for society) regressive and progressive? Explain.

Answer 6

see notes bottom of page 2 side 1

Question 7

Explain why the optimal policy in the health sector is progressive?

Answer 7

If you have 2 individuals, one who is very sick, and one who is not, who should additional HC spending go to?

The sick one! (ie. one with less luck and greater θ)
Why? Because they will obtain greater utility from that additional spending than someone who isn’t ill

TF u12(s(θ),θ)<0

Question 8

Explain why the optimal policy in the education sector is regressive?

Answer 8

2 individuals, one who is very clever, and one who is not very clever (ie. high θ and low θ respectively) (having had equal education spending up til now)
It makes more sense to give additional spending to the clever one since they will benefit more from it comparatively more -> TU increases more!
Tf optimal policy is regressive one

TF u12(s(θ),θ)>0

Question 9

What does education policy do in reality ITO policy type? (aim, prediction and reality)

Answer 9

It aims to be progressive (non-optimal) and the standard model predicts it will be progressive due to MVT

BUT documented evidence shows there is actually a regressive distribution

Question 10

What do Fernandez and Rogerson (1995) look at?

Answer 10

Why, when standard models of education predict a progressive effect, is there actually an observed regressive effect (ie. children from higher socioeconomic background benefit more)

Question 11

What do Fernandez and Rogerson (1995) find?

Answer 11

That the regressive distribution is linked to the fact that education is only partially publicly provided

ie. when agents vote to decide on subsidy distribution, if the cost of one’s education is only partly subsidised, then high-income agents can exclude low-income agents from full education access

Question 12

What do Fernandez and Rogerson (1995) investigate the link between?

Answer 12

1) individuals heterogeneity (ie. income levels)

2) their choice of education policy (eg. education tax/subsidy)

Question 13

(F&R, 1995) SEE AND LEARN THE MODEL IN MY NOTES!

Answer 13

now

Question 14

Briefly, F&R (1995) model is like so:

Answer 14

2 period model:
P1) agents decide whether to obtain /not obtain an education. Since income with education - cost of education is assumed to be greater than the income without education, ALL rational agents will want to obtain an education

BUT imperfect credit markets mean this is not possible since cannot pay

THEREFORE there is an education subsidy distributed between all who want an education (ie. everyone) (see rest of notes ,don’t get this!)

Question 15

Which tax rates are preferred (finish)

Answer 15

(finish)