Download Midterm Exam 2 (F2008)

ECO 5520/6520
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Name_____________________________________
ID _______________________________________
Midterm Exam 2 – ECO 5520/6520
Instructions
This examination has five questions and you are to do all five in a bluebook that you
provide. Please number your answers clearly. Each question will be worth 20 points, and each part
of each question will be weighted as indicated, so allocate your time accordingly. The exam is
“closed book – closed notes.” You may use a calculator, although you shouldn’t need one. Note
that the undergraduates and the M.A/Ph.D. students will do different versions of question 5.
You will have until from 4:30 until 6:20 to complete the exam. Latecomers will not be
given extra time to finish the exam. If you are unsure of a question, indicate what assumptions
you are making and go forward.
1. In our class, we looked at distinctions among regressive, proportional, and progressive taxes.
a. (4 points) Briefly define regressive, proportional, and progressive taxes, with particular
reference to the average tax rate?
i. As income rises average tax rate increases (progressive), falls (regressive),
stays the same (proportional).
b. (4 points) On a diagram, draw a progressive tax schedule, with income on the X-axis and
dollars paid in taxes on the Y-axis. Clearly label both the marginal and the average tax
rates at 3 different levels of income. Diagrams.
Tax
Income
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c. (4 points) Is the Medicare tax a progressive, proportional, or regressive tax? Why?
Proportional – percentage is constant.
d. (4 points) Suppose, in a last ditch effort to balance the state budget, the legislature decides
to extend the 6% sales tax to food, with the tax to be paid by grocers. Is the tax likely to be
progressive or regressive? Explain your answer. Regressive. Poor people pay larger
percentage of incomes to food, compared to the rich.
e. (4 points) They argue that the tax will not harm consumers because it will be paid by the
grocers. Would an economist agree with this argument? Why or why not? Economist
would not agree. Burden depends on elasticities of supply and demand.
2. Here are a few questions about the sales tax and tax incidence that refer to the market for flash
drives, also known as thumb drives or memory sticks.
a. (5 points) Suppose that an economist, hired by the state, estimates that the demand
elasticity for flash drives sold in the state is -1.0, the supply elasticity is +10.0, and the
dequilibrium price is $5 per 1 gB flash drive. Draw a supply and demand diagram with as
much detail as necessary to describe this market. Flat supply curve; steep demand curve.
Price
5
Quantity
b. (5 points) Suppose that the State of Michigan decides to impose a $3 tax on all 1 gB flash
drives sold in the state, to be paid by the demanders. What will happen to the market price
of flash drives? Defend your answer? Downward shift in effective demand curve.
c. (5 points) Given the parameters from part (a), who will pay a larger portion per flash drive
of the $3 tax, the producers or the consumers? Why? Demanders – they are less able to
avoid it.
d. (5 points) Suppose, instead, that the State imposes the $3 tax on the suppliers. Will your
answer to part (c) change? Why or why not? It will not change.
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3. This question addresses the nature of the property tax. Suppose that there are 19,862 property
tax levying districts in the U.S. and that none of them levy a property tax. Now, suppose that
Southfield levies a 3% property tax.
a. (5 points) Draw a diagram that shows what happens to the Southfield capital market after
they levy their tax. Hint: Pay close attention to the return to capital. MPK curve shifts
down. Capital leaves Southfield.
MPK
Capital
b. (5 points) Define each of these effects of the Southfield tax.
i. (2.5 points) The excise effect – Goods made in Southfield cost more.
ii. (2.5 points) The “return to capital” effect – Owners of Southfield capital
earn less.
c. (5 points) Which of the effects (above) will impact Southfield more? Why? Excise tax
effect will impact Southfield more – overall return to capital does not fall much.
d. (5 points) Suppose every one of the other tax-levying districts levies a 2% property tax, but
Southfield keeps their 3% property tax. What will be the ultimate impacts on:
i. (2.5 points) Excise effects and return to capital in Southfield – Much
smaller excise impacts (difference of 1% rather than 3%).
ii. (2.5 points) Excise effects and return to capital elsewhere. Return to capital
falls by about 2% everywhere.
4. Property tax abatements are often proposed to increase economic activity in a city or a region.
Here are some questions about them.
a. (5 points) Why might the inter-metropolitan and intra-metropolitan impacts of property tax
abatements differ? Intra  within a metropolitan area. Inter- is among metro areas.
b. (5 points) Which effect (inter or intra) might we expect to be larger, and why? Intra would
be larger. Better substitutes.
c. (5 points) Consider the following equation for job growth in a region
% change in new jobs = 23 – 10 * (property tax in percent) + 7 * (local services)
Calculate the % change if the property tax = 2 (%), and the local service index = 0.
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Explain your answer in economic terms  a 3% increase in new jobs. Reduces returns to
investment.
d. (5 points) What happens if the property tax rises to 3 (%), accompanied by an increase in
the local service index from 0 to 2? Explain your answer in economic terms. % change =
23 – 30 + 14. Leads to a 7% increase. Taxes are offset by better local services.
5. Undergraduates
These curves are drawn to scale so you can use
them to answer Question 5.
$
MC
20
10
DD
DW
Quantity = Q
5
10 15
20
a. (5 points) Suppose that Duane and Wayne both want public croquet facilities in their
suburb. Duane’s demand curve is DD, and Wayne’s demand curve is DW. Draw the
appropriate marginal benefit curve that summarizes the demand for a public good for the
two of them on the graph above. Discuss briefly how you did it. See red graph
b. (5 points) Suppose at Q = 0 that the marginal cost per unit of croquet facility is 10, and
rises linearly to 20, by quantity Q = 20. How would you use this in your analysis? See
blue line.
c. (5 points) What principal would you use to estimate the optimum amount of this local
public good? Is it the same or different as that used for private goods? Sum of the MB
(vertical) = MC. It is not the same. We add private goods horizontally.
d. (5 points) Show the optimal number of croquet facilities, based on your answers to parts
(a), (b), and (c). Give your best estimate, either geometrically or algebraically.
Q* is approximately equal to 10.
Algebraically, Sum of the MB = 40 – 2.33Q
MC = 10 + 0.5 Q
Q* = 180/17 = 10.59
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5. M.A. students – (Note! 4 points per question)
These curves are drawn to scale so you can use
them to answer Question 5.
Q = 18
$
20
DD
16
10
DW
Quantity = Q
2
5
10 15
20
a. (4 points) Suppose that Duane and Wayne both want public croquet facilities in their
suburb. Duane’s demand curve is DD, and Wayne’s demand curve is DW. Draw the
appropriate marginal benefit curve that summarizes the demand for a public good for the
two of them on the graph above. Discuss briefly how you did it. Sum Vertically.
b. (4 points) Suppose that the marginal cost per unit of croquet facility is starts at 10, at Q =
0, and rises to 20, by quantity Q = 30. How would you use this in your analysis? Draw.
c. (4 points) Show the optimal number of croquet facilities, based on your answers to parts
(a) and (b). Full credit will require that you calculate the amount algebraically. Q* = 8.57.
d. (4 points) If the suburb provides 18 units of the facility, is there a welfare loss? If so,
calculate the loss. Yes, there is a welfare loss. Loss = 63.1315
e. (4 points) In charging for the facility, who should be charged for all units past 10 units?
Why? Duane! He’s the only one that wants more than 10.