Economics 321: Public Economics Prof. Marika Cabral TA: Katherine Keisler Fall 2017 UT Austin Problem Set 1 (Due Monday Sept 18th) 1. (Ch1) Consider the four basic questions of public finance listed in the chapter. Which of these questions are positive—questions that can be proved or disproved—and which are normative—questions of opinion? Explain your answer. 2. (Ch1) In order to make college more affordable for students from families with fewer resources, a government has proposed allowing the student of any family with less than $50,000in savings to attend public universities for free. Discuss the direct and possible indirect effects of such a policy. 3. (Ch1) Proper hygiene, such as regular hand-washing, can greatly limit the spread of many diseases. How might this suggest a role for public interventions? What kinds of public interventions might be possible? Suggest three distinct types of possible interventions. 4. (Ch2) You have $100 to spend on food and clothing. The price of food is $5 and the price of clothing is $10. a. Graph your budget constraint. b. Suppose that the government subsidizes clothing such that each unit of clothing is half-price, up to the first 5 units of clothing. Graph your budget constraint in this circumstance. 5. (Ch2) Consider an income guarantee program with an income guarantee of $6,000 and a benefit reduction rate of 50%. A person can work up to 2,000 hours per year at $8 per hour. (a) Draw the person’s budget constraint with the income guarantee. (b) Suppose that the income guarantee rises to $9,000 but with a 75% reduction rate. Draw the new budget constraint. (c) Which of these two income guarantee programs is more likely to discourage work? Explain.6. (Ch2) Governments offer both cash assistance and in-kind benefits, such as payments that must be spent on food or housing. Will recipients be indifferent between receiving cash versus in-kind benefits with the same monetary values? Using indifference curves, show the circumstances in which individuals would be indifferent and situations in which the form of the benefits would make a difference to them. 7. (Ch3) A researcher conducted a cross-sectional analysis of children and found that average test performance of children with divorced parents was lower than average test performance of children of intact families. This researcher then concluded that divorce is bad for children’s test outcomes. What is wrong with this analysis? 8. (Ch3) You are hired by the government to evaluate the impact of a policy change that affects one group of individuals but not another. Suppose that before the policy change, members of a group affected by the policy averaged $17,000 in earnings and members of a group unaffected by the policy averaged $16,400. After the policy change, members of the affected group averaged $18,200 in earnings while members of the unaffected group averaged $17,700 in earnings. (a) How can you estimate the impact of the policy change? What is the name for this type of estimation? (b) What are the assumptions you have to make for this to be a valid estimate of the impact of the policy change? 9. (Ch3) Suppose that your friend Oscar has collected data and determined that towns with newly constructed high schools tend to have higher SAT scores than other towns. He tells you that he has proved that new high schools cause higher SAT scores. When you object that correlation does not imply causation, he is ready with more data. He shows you convincing evidence that SAT scores tend to increase shortly after towns build new high schools, but that there is no tendency for new high schools to be built in towns that have recently seen large increases in SAT scores. Is this enough evidence to prove that new high schools because higher SAT scores, or can you think of an alternative explanation for Oscars data?10. (Ch. 3) Your state introduced a tax cut in the year 1999. You are interested in seeing whether this tax cut has led to increases in personal consumption within the state. You observe the following information: a. Your friend argues that the best estimate of the effect of the tax cut is an increase in consumption of 30 units, but you think that the true effect is smaller, because consumption was trending upward prior to the tax cut. What do you think is a better estimate? b. Suppose that you find information on a neighboring state that did not change its tax policy during this time period You observe the following information in that state Given this information, what is your best estimate of the effect of the tax cut on consumption? What assumptions are required for that to be the right estimate of the effect of the tax cut? Explain. 11. (Ch4) Why does the Congressional Budget Office construct a cyclically adjusted budget deficit for the purposes of monitoring federal income and outlays? 12. (Ch4)A government is considering paving a highway with a newly developed “wear-proof” material. Paving the highway would cost $2 billion today, but it would save $300 mil-lion in maintenance costs for each of the next 10 years. Use the concept of present value to determine whether the project is worth undertaking if the government can borrow at an interest rate of 5%. Is it worth it if the interest rate is 0%? 10%? A politician says to you, “I don’t care what the interest rate is. The project is clearly a good investment: it more than pays for itself in only 7 years, and all the rest is money in the bank.” What’s wrong with this argument, and why does the interest rate