EC325 Problem Sets

Question 1

Condorcet Cycle

Answer 1

Question 2

Legacy debts constitutes a major problem for PAYG pension scheme.

Comment

Answer 2

No.

Legacy debts do not constitute a problem in themselves, as they can be carried through a pension system. Legacy debts only become a problem when they are combined with declining population growth

Question 3

PAYG pension schemes are more appropriate for developing countries.

Comment

Answer 3

Question 4

An observed drop in consumption at retirement has consequences for the optimal level of government-mandated pension schemes.

Answer 4

Question 5

PAYG pension schemes are superior to Fully Funded Schemes because there is no moral hazard cost associated with them.

Comment.

Answer 5

Question 6

The fact that the percentage of adult life spent in retirement has increased in the last decades has no implications for pension schemes.

Comment.

Answer 6

Question 7

The existence of adverse selection in annuitization markets is the main rationale for the existence of public retirement pension systems.

Comment.

Answer 7

False. There are other reasons: individual failures, redistribution

(see first slide of retirement lecture)

Question 8

What is the difference between health outcomes and healthcare utilisation?

How would you measure them?

(PS9)

Answer 8

Question 9

**Moral hazard in healthcare

• Explain why moral hazard increases the price of health insurance.
• Why is that a problem?
• How is related to the price elasticity of healthcare?

Answer 9

Question 10

Reducing moral hazard in healthcare

Explain:

1. Deductibles
2. Coinsurance
3. Co-payments

Answer 10

Question 11

Why might in-kind transfers fare better in reducing moral hazard than cash transfer?

Answer 11

Question 12

Question 13

Why policy is preferred:

1) saving subsidy
2) increase default saving rate?

(PS10)

Answer 13

Question 14

Does increasing default saving rate necessarily increase total savings?

(PS10)

Answer 14

Question 15

Tax vs bonus to correct externality

(PS10)

Answer 15

Question 16

Discuss under which circumstances the tax neutrality result does not hold

(LT PS1)

Answer 16

Question 17

Provide cash transfer or in-kind transfer to low-ability individuals and high-ability masquerading individuals

Answer 17

In-kind transfer is better because some masquerading H type would drop out if they get the good rather than cash transfers. In kind transfers would impose a utility cost on the non-deserving type

Question 18

What happens when in-kind transfers is not indicator good

Answer 18

Question 19

What is meant by the terms “extensive margin” and “intensive margin” in the context of labour supply models?

(PS 13)

Answer 19

Question 20

What does the “stable composition” assumption mean in the context of this experiment?

How might the identifying assumption underlying Eissa & Liebman’s estimate be violated if the assumption does not hold?

Answer 20

Question 21

Empirically, changes in labour supply very frequently take the form of large discrete jumps – entering the labour force and working full time, or close to it – instead of incremental changes in the number of hours supplied. The existence of fixed costs of work is one way of explaining this empirical observation.

What other explanations for this observation have been put forward?

Answer 21

Question 22

True or False? “The Ramsey Rule implies higher taxes on goods with higher demand elasticities.” Justify your answer.

(LT PS17)

Answer 22

The Ramsey Rule, reported in the question below, states that more elastic goods should be taxed less compared to other goods. As larger elasticities imply larger behavioral responses, the central planner should tax them less to minimize deadweight losses.

Question 23

Assumptions of ramsey model

Answer 23

Question 24

What is your understanding of the term “marginal cost of public funds”?

What is its relationship to the above formulation of the Ramsey rule?

Answer 24

Question 25

Consider a simple tax schedule involving a constant marginal tax rate 𝜏 and a guaranteed minimum income G > 0. Is the tax schedule progressive, regressive, or neither? Justify your answer.

(PS18)

Answer 25

Question 26

**Rawlsian SWF: What is the optimal (social-welfare-maximising) tax rate 𝜏∗?

Answer 26

Question 27

Assumptions of Rawlsian SWF to find optimal tax rate

Answer 27

Question 28

**Economic intuition of Rawlsian SWF optimal tax rate

(LT18)

Answer 28

Question 29

Income vs commodity taxation

Under what circumstances might it be desirable to use commodity taxation in combination with income taxation, as opposed to relying on income taxation alone? Does your answer depend on whether the N-Z condition is satisfied? Explain your answer intuitively.

(PS18)

Answer 29

Question 30

Economic intuition of “A-S model”

PS19

Answer 30

Question 31

How is the degree of tax evasion aected by the probability of being caught?

PS19

Answer 31

Question 32

Probability of detection and cost of monitoring

Answer 32

Question 33

Reasons of tax evasion

Answer 33

Possible reasons: belief of appropriateness of government spending and size of government. Moral and ethical dimension. Civic virtue.

Question 34

Tax evasion in developing country

In developing countries tax enforcement structures often have limited capacity. Why might this be the case? Why might we expect tax evasion to be high in developing countries?

Answer 34

Discuss issues such as political economy, tax enforcement problem or a large informal sector

Question 35

What is the proposed explanation of Kleven, Kreiner, and Saez (2016) for the fact that the growth of the state is funded mostly by “modern taxes” meaning taxes that are supported by extensive third-party information reporting?

Question 36

Income tax exemption threshold varies

Answer 36

Question 37

The evidence in these figures are based on correlations between economic development and the nature of the tax system. The way we have been discussing them presumes development causes the changes to the tax system.

Can you think of alternative explanations for these patterns?

Answer 37

There are many correct answers. Another is that as incomes grow in an economy, society deems the harm done by taxing incomes to be more worthwhile to achieve redistribution. That is, societies may wish to redistribute from the rich to the poor with income taxes, but they may perceive less social welfare gain from redistributing from the poor to the very poor.

Question 38

Ways to alter taxable income

Answer 38

Question 39

Wealth inequality

Answer 39

Question 40

Regulation: Cap - Carbon reduction

(Mock)

Answer 40

Question 41

First fundamental welfare theorem

(Mock)

Answer 41

Question 42

What according to New Contract Theory, is the main risk(s) of contracting out a state’s prison system?

What are the potential benefits?

(Mock)

Answer 42

Question 43

Describe the moral hazard problem for publicly funded unemployment insurance.

What are the key unknowns in determining the extent of this problem?

(Mock)

Answer 43

Question 44

Majority Voting

(Mock)

Answer 44

Question 45

Describe the empirical analysis a researcher could run to estimate the crowd- out effect of this new government spending on private spending by charities.

(Mock)

Question 46

If there is complete crowd out, what should we expect the results of this analysis to be? Explain your answer.

(Mock)

Answer 46

Question 47

Reasons for less than complete crowding out

(Mock)

Answer 47

Question 48

Validity problem of research

(Mock)

Answer 48

Question 49

***Tax incentives and default contribution affects total savings

(Mock)

Answer 49

Question 50

**Tax incentives and default contributions on passive savers

(Mock)

Answer 50

• Tax incentives should also have little effect on total saving by inattentive/passive savers. Taking advantage of a tax incentive by changing pension contributions requires that agents be paying attentive.
• Increasing default contributions should have a significant positive (perhaps one-for-one) effect on saving by inattentive/passive savers. When individuals are inattentive, they will tend to make the default contribution to their pension, so increasing this default can increase their total saving.

Question 51

**Empirical evidence on attention to savings

(Mock)

Answer 51

Question 52

Tax on petrol

“A tax on petrol will reduce the profits of large oil companies without harming consumers.” Is this true or false?

Explain your answer.

(LT Assignment)

Answer 52

Question 53

Indicator good

“To redistribute resources towards individuals with low earnings potential, governments should always subsidize necessities such as food, and tax luxury goods.” Is this true or false? Explain your answer.

(LT Assignment)

Answer 53

Question 54

EITC and labour supply

“Wage subsidy policies like the EITC unambiguously increase aggregate labor supply.” Is this true or false? Explain your answer.

(LT Assignment)

Answer 54

False. Depends on intensive vs extensive LS elasticity.
2 points for stating correct answer- 8 for explanation, especially if well explained diagram

Question 55

Explain why Coase’s theorem likely breaks down in the case of negative externality from air pollution.

(2019)

Answer 55

Solution should include what an externality is, explanation of Coase theorem. Breakdown of Coase theorem due to difficulty defining property rights of air

Question 56

Discuss some evidence that people are inattentive to their pension savings. What does this evidence suggest about the effect of subsidies for pension contributions on overall saving?

(2019)

Answer 56

Tax incentives have small effect on overall saving as most people are passive savers.

Answer should include reference to Chetty et al.

Question 57

Empirical evidence on minimum wage

The minimum wage is about 25 percent higher in the Republic of Ireland than in Northern Ireland. A researcher proposes studying the effects of minimum wages on employment by conducting a regression discontinuity analysis, using distance to the border between Northern Ireland and Ireland as the running variable.

Explain the identifying assumptions behind regression discontinuity designs and argue whether they are likely to be satisfied in this context.

(2019)

Answer 57

Question 58

Asymmetric information

Explain how asymmetric information creates a rationale for the public provision of unemployment insurance.

(2019)

Answer 58

In private markets, asymmetric information will lead to adverse selection. When people that have low chance of becoming unemployed don’t buy unemployment insurance, rising premia for the insurance will likely lead to market unravelling.

Question 59

**Political economy

Show, using a situation with three voters and three possible levels of spending on public goods, that majority voting does not always produce a stable equilibrium.

What assumption on the preferences of the three voters is sufficient to guarantee the existence of a stable equilibrium?

(2019)

Answer 59

Condorcet paradox. Example at slide 10 of 43, lecture 6 MT.

Single peaked preferences (and unidimensional problem).

Maybe add extra points for this last bit assuming that levels of public expenditure might involve different public goods mix.

Question 60

Income tax reform

Researchers have attempted to estimate the effect of changes in the marginal tax rate on top-1% income earners in the United States by examining changes in the top 1% income share around top income tax reforms such as TRA1986.

Describe the key identification assumption of this research design and two reasons why it may not hold.

(2019)

Answer 60

Question 61

Ordeal mechanism

To improve efficiency, the government is contemplating the idea of forcing people to queue in administration offices in order to be able to collect their welfare benefit checks every week.

Explain under which condition such a mechanism could improve the equity/efficiency trade-off created by the transfer program

(2019)

Answer 61

Ordeal type of mechanism introducing a pure deadweight cost on recipients. We need the utility gain from the program to be lower for the non-deserving or the utility cost of the ordeal mechanism to be higher for the non-deserving.

E.g: Higher ability that would translate in higher productivity, and higher wage per hour. This would make the cost of 1 hour of queuing relatively larger for high types

Question 62

Net foreign asset position

“Net foreign asset positions of most developed countries are negligible nowadays.”

True or False?

Was this always the case throughout history?

(2019)

Answer 62

• True, NFA are on average equal to zero for developed countries nowadays, and are hence negligible in terms of their value.
• They nevertheless mask significant gross foreign positions, which can have large political consequences.
• Not true throughout history, think about colonial empires

Question 63

Income share trend

How has the labor income share in total national income evolved in developed countries over the last 40 years?

What forces can explain this trend?

(2019)

Answer 63

Question 64

Moral hazard of public healthcare

In the absence of cost-control measures, why does publicly funded health insurance create a moral hazard problem in the first place?

(2019)

Answer 64

Going to doctor becomes less costly than true cost. This increases the use and of health care due to moral hazard.

4 dimensions of moral hazard:

1. Reduced precaution against entering the adverse state.
2. Increased propensity of claiming the adverse state.
3. Increased expenditures when in adverse state.
4. Supplier responses to insurance against adverse state

Question 65

Equity improvements in healthcare

Show how in a simple model of moral hazard (such as Feldstein 1973 JPE), both policies, the quantity instrument and the price instrument, can achieve equal improvements in the efficiency of the health care system.

(2019)

Answer 65

Price and quantity regulation for externalities can help achieve the efficient outcome.

Solution should include graph.

Question 66

Critics of the quantity instrument point out that care must be rationed, which creates the potential for additional inefficiency.

Essentially, with quantity restrictions, it is difficult to ensure that the marginal dollar is spent on the highest-value care.

In the classic framework described by Feldstein, why does the price instrument not have the same problem?

(2019)

Answer 66

With price instrument (letting people pay for their own health care), high-value care will still be bought as people who derive the greatest marginal benefit from consuming health care will still consume health care.

With rationing, this might not be true as the government doesn’t have perfect information.

Question 67

Quantity Instrument

In reality, the NHS has opted for much heavier use of quantity based regulation, with the decisions about rationing primarily made by General Practitioners (doctors).

Describe why, contrary to the logic in part b, it might actually be more efficient to control costs in this way. Refer to relevant empirical evidence in your answer.

(2019)

Answer 67

Doctors are better at determining the value of healthcare than individuals.

Eg. Brot-Goldberg et al show that even costs for sick individuals decrease when deductible increases, so high-value care not be bought.

Question 68

Majority rule vs median voter theorem relationship

(2019)

Answer 68

Majority rule with single peaked preferences = median voter theorem

Question 69

Labour income share trend

Describe the evolution of the top 1% labor income share in the US and in the UK over the last century. Describe the differences in the recent evolution of labor income inequality in English-speaking countries versus Japan or continental European countries like France.

(2019)

Answer 69

Question 70

Supply of high and low skilled labour

(2019)

Answer 70

Question 71

Race between education and technology

(2019)

Answer 71

Question 72

The marginal deadweight loss of commodity taxation is, to a first order approximation, equal to zero when we start from a situation with zero tax. True or false? Explain.

(2017)

Question 73

PS7

Answer 73

Question 74

Show that Fully funded insurance is only optimal when r>0

(PS8)

Answer 74