Question

QUESTION TWO

1. Why is it difficult to empirically determine the degree to which government spending crowds
   out private provision of public goods?                                                                              [5 Marks]
2. Suppose 20 people each have the demand Q = 20 - 2P for streetlights, and 5 people have the demand Q = 18 - 2P for streetlights. The cost of building each streetlight is 10. If it is impossible to purchase a fractional number of streetlights, how many streetlights are socially optimal?                                                                                                                     [6 Marks]
3. Some goods and services are provided directly by the government, while others are funded publicly but provided privately. What is the difference between these two mechanisms of public financing? Why do you think the same government would use one approach sometimes and the other approach at other times?                                                           [6 Marks]
4. Consider the four basic questions of public finance listed in Lecture 1. Which of these questions are positive—that is, questions that can be proved or disproved—and which are normative— that is, questions of opinion? Explain your answer.      
5. People in your neighbourhood pay annual dues to a neighbourhood association. This association refunds neighbourhood dues to selected home owners who do a particularly nice job of beautifying their yards. At the most recent home owners’ association meeting, home owners voted to end this practice because they felt that it was unfair that some people would not have to pay their share of the costs of maintaining the neighbourhood. What is likely to happen to the overall level of neighbourhood beautification? Explain.                    
   1. [6 Marks]
6. Consider the rival and excludable properties of public goods. To what degree is radio broadcasting a public good? To what degree is a highway a public good?              [5 Marks

Answer 1

Q a:-

In non-experimental data it is difficult to isolate the effect of the public provision to determine the extent of crowding out. Government provision of a public good reflects, on some level, a political determination that citizens have a preference for that public good. But if citizens like that particular public good, then they may also receive a lot of individual utility from its provision. Because these preferences are correlated, an estimate of crowding out will below: private provision will thrive alongside public provision. Experimental investigations of crowding out can isolate the effect, but these experiments typically take place in laboratory environments. They may therefore lack external validity: behavior in an artificial experiment may not mimic what people do in their day-to-day lives. Reasons for this include the use of undergraduate students as experiment participants; the relatively low dollar values for the experiment goods; and the lack of a realistic context in which experiment decisions are made—in most economic experiments, for example, the public good is not specifically named.

Q b:-

Compute the social optimum by inverting the demand curves and summing to get the social demand:

P = 20(20 − Q) + 5(9 − Q/2) = 445 − 45Q/2. Setting the result equal to the marginal cost of 10 and solving for Q gives 10 = 445 − 45Q/2, or Q = 58/3 ≈ 19.33. This indicates that the social optimum is somewhere between 19 and 20. We need to figure out whether society is better off with 19 or 20 units. To do so, first compute the total social benefit (ignoring costs) from 19 and 20 units, respectively. This is the area underneath the social demand curve to the left of 19 and 20 units. The social demand curve has the equation P = 445 − 45Q/2, so the antiderivative of this curve is 445Q − (45/4)Q2. Plugging in Q = 19 yields a total social benefit of 4,393.75, while the total social benefit at Q = 20 is 4,400.00; the twentieth streetlight costs 10 and is only worth 6.25, so the total surplus is maximized at Q = 19.

Q c:-

Direct public provision of a good or service occurs when the government itself produces the good or service. Police forces and military are examples of direct provision. Public financing of private provision of goods and services occurs when the government wishes to increase the provision of a good or service, but it does not want to directly involve itself in its provision. An example is when the government hires private companies to build or repair roads, or when the government purchases military aircraft from private companies instead of building them itself.

Public funding for private provision is appealing relative to direct public provision whenever the private market can produce the goods or services more efficiently than the government. This is likely to be the case where there is an existing market or industry for the good or service, especially when that market is competitive. When there is no existing market for a good or service provided by the government, or when that market is characterized by an imperfectly competitive industry, there may be a stronger case for direct provision (although it is important to recognize that direct provision can also suffer from efficiency failures). There may be national security concerns related to private provision of certain goods and services, especially those performed by the military and police forces. The government is more likely to provide these goods and services directly.

Q d:-

The four basic questions of public finance:

1.         When should the government intervene in the economy? The word “should” suggests that this is a question about which opinion will vary, so it is normative.

2.         How might the government intervene? This question is positive. It asks: How does the government actually intervene now, and how might it intervene in the future? One can check whether a government might intervene in a particular way directly by examining the behavior of existing and future governments.

3.         What is the effect of those interventions on economic outcomes? Economic effects can be measured and thus are not a matter of opinion, so this question is positive.

4.         Why do governments choose to intervene in the way they do? This is a factual (positive) question. It may be difficult to directly observe the answer, but one can potentially learn about the motivations behind a government’s interventions by looking a patterns of behavior over time.

Q e:-

a.         Neighbors who are good gardeners provide an external benefit to the entire neighborhood. Everyone’s property values are a little higher when the neighborhood looks nice. The refund helps to compensate the gardeners for providing this public good and might induce other neighbors to beautify their lawns in hopes of receiving the refund.

b.         Ending the refund program removes the private incentive to provide the positive externality. The benefits to gardening have declined but the costs have remained the same. Because maintaining a lawn is costly in terms of time and money, those who once received the refund but no longer do will cut back on their gardening efforts. When there is no compensation for providing the positive externality, people are likely to free ride on those who do provide it. However, it is unlikely that canceling the refund program would completely eliminate private provision of nice lawns and gardens. People who like to garden and receive private utility from doing so will continue to maintain their yards but at level at which marginal private benefit just equals marginal private cost. This level will be less than the level at which marginal private benefit plus the refund equaled marginal private cost.

Q f:-

Radio broadcasting is nonrival: airwaves can be consumed (listened to) simultaneously by many consumers with no deterioration in sound quality. Perhaps radio signals can beamed excludable by the use of scramblers, much like the ones used for pay-per-view TV. Anyone who has driven during rush hour knows that highways are subject to congestion. At these times, highways are rival: additional cars reduce the utility everyone receives from driving. Highways can also be excludable through the use of tolls. In practice, however, most highways are not excludable: any (licensed) driver is allowed to use them.

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