Public Finance and Public Policy 7th Edition by Gruber Jonathan | TEST BANK

Test Bank for Public Finance and Public Policy, 7e Jonathan Gruber (All Chapters Download link at the end of this file) Chapter 1 1. An early response to the Covid-19 pandemic was the $2.2 trillion CARES Act signed into law that included: a. funding for broadband infrastructure, renter's assistance, and food security for low-income households only. b. a mandate for individuals who could not afford health insurance to purchase it or pay a penalty. c. direct payments to American households, unemployment benefits, and payroll protection for small businesses. d. a bailout plan to U.S. automakers to address impending cash shortage, the risk of bankruptcy, and massive job losses.

ANSWER: c 2. The goal of public finance is to: a. understand the proper role of corporations in the economy. b. understand the proper role of the government in the economy. c. determine the best way to increase government's role in the economy. d. determine the best way to decrease government's role in the economy.

ANSWER: b 3. The goal of public economics, or public finance, is to answer which question? a. How might the government intervene in the economy, and what are the likely effects? b. Why do profit-maximizing firms attempt to set marginal revenue equal to marginal cost? c. How are the terms of trade determined when countries choose to engage in international trade? d. What are the goals and tools of macroeconomic policy?

ANSWER: a 4. Government intervenes in a market economy to: a. create externalities. b. prevent competition. c. enhance economic efficiency. d. achieve perfect income equality.

ANSWER: c 5. Suppose Juan values a slice of pizza at $1.50, but the pizza shop is unwilling to sell a slice of pizza for less than $2.00. These values imply that: a. it is efficient for the shop to sell a slice of pizza to Juan for $1.50. b. it is efficient for the shop to sell a slice of pizza to Juan for $2.00. c. the shop needs to produce more efficiently in order to lower the price. d. it is not efficient for the shop to sell a slice of pizza to Juan.

ANSWER: d

6. Suppose Ali values a slice of pizza at $1.50, but the pizza shop is unwilling to sell a slice of pizza for less than $1.00. These values imply that it is efficient for the shop to sell a slice of pizza to Ali for any price: a. greater than or equal to $1.50. b. greater than or equal to $1.00 and less than or equal to $1.50. c. less than or equal to $1.00. d. less than or equal to $1.00 and greater than or equal to $1.50.

ANSWER: b 7. Suppose a student values a textbook at $50, and the publisher is unwilling to sell the textbook at a price lower than $30. What price will lead to an efficient transaction between the student and publisher? a. a price of $0 b. any price greater than $0 and less than $30 c. any price greater than or equal to $30 and less than or equal to $50 d. any price greater than $50 ANSWER: c 8. Suppose a consumer values a certain 19-inch television set at $150, and the seller is unwilling to sell the set for less than $200. These values imply that: a. it is efficient for the seller to charge a price of $0. b. it is efficient for the seller to charge any price greater than $0 and less than $150. c. it is efficient for the seller to charge any price greater than or equal to $150 and less than or equal to $200. d. it is not efficient for a transaction to take place.

ANSWER: d 9. Suppose someone argues that the proper role of government is to increase the size of the pie. Which justification for government intervention in the economy is this person referring to? a. increasing equality in the economy b. promoting social justice c. improving efficiency d. preventing competition ANSWER: c 10. Suppose the government proposes a program that will transfer income from one group to another. The goal of this government intervention in the marketplace is BEST characterized as: a. redistribution. b. increasing market efficiency. c. correcting a market failure. d. achieving competitive equilibrium.

ANSWER: a 11. If the competitive equilibrium does not lead to the efficiency-maximizing outcome, then government intervention: a. will increase efficiency. b. will reduce efficiency.

c. may increase or decrease efficiency. d. will not affect efficiency.

ANSWER: c 12. Suppose government proposes taxing Peter to pay Paul. The goal of this intervention could be BEST characterized as an attempt to achieve: a. redistribution. b. efficiency. c. market failure. d. competitive equilibrium.

ANSWER: a 13. The equity–efficiency trade-off means that obtaining _____ in equality may also lead to a(n) _____ in the so-called size of the pie. a. no change; decrease b. no change; increase c. a decrease; decrease d. an increase; decrease ANSWER: d 14. Suppose the government taxes the rich to distribute money to the poor. Which of these is an example of an efficiency loss? a. Rich people take home less of the money from their jobs because of the tax. b. Rich people don't work as hard because of the tax. c. Poor people are better off because of the redistribution. d. Poor people work just as hard because they still need to make ends meet.

ANSWER: b 15. An intervention in which government establishes a federally funded health care service for everyone and pays doctors and medical practitioners directly is called: a. private provision with public financing. b. restriction or mandate of private sale or purchase. c. subsidy. d. public provision.

ANSWER: d 16. Both the federal and state governments collect fees for each gallon of gasoline sold. This is an example of which type of government intervention? a. restriction of private sale or purchase b. taxation c. a subsidy d. public provision ANSWER: b 17. Which type of government intervention can be used to lower the price for private sales or purchases of

underproduced goods? a. public financing of private provision b. restrictions or mandates of private sale or purchase c. taxes d. subsidies ANSWER: d 18. Veterans receive health benefits directly through hospitals owned and operated by the Veterans Health Administration. This is an example of: a. public financing of private provision. b. restriction or mandate of private sale or purchase. c. a subsidy. d. public provision.

ANSWER: d 19. The Medicare insurance program in the United States reimburses hospitals and doctors for providing health care services to older adults This is an example of: a. public financing of private provision. b. restriction or mandate of private sale or purchase. c. a tax. d. a subsidy.

ANSWER: a 20. Public schools in the United States are operated by the government. This is an example of: a. public financing of private provision. b. restriction or mandate of private sale or purchase. c. a subsidy. d. public provision.

ANSWER: d 21. The government has passed many school accountability measures that reward schools if their students score highly on standardized tests. Suppose schools respond by manipulating the set of test takers to increase average scores. This outcome is an example of a(n): a. intended effect. b. direct effect. c. indirect effect. d. desired outcome.

ANSWER: c 22. The government has passed many school accountability measures that reward schools if their students score highly on standardized tests. Suppose schools respond by more efficiently teaching their students. This outcome is an example of an: a. intended, direct effect. b. intended, indirect effect. c. unintended, direct effect.

d. unintended, indirect effect.

ANSWER: a 23. Suppose that because the government increases the minimum wage, employees who were earning the minimum wage get a pay increase. This is an example of an: a. intended, direct effect. b. intended, indirect effect. c. unintended, direct effect. d. unintended, indirect effect.

ANSWER: a 24. Which of these might be a direct effect of providing free health care for those without insurance? a. Those who were without private health insurance are now better off. b. Those with private health insurance may drop their coverage. c. Those without health insurance may purchase private health insurance. d. Those eligible for free health insurance are not aware of the benefit.

ANSWER: a 25. Which of these is the government agency that uses empirical economics to achieve its mission of providing Congress with objective, nonpartisan analyses necessary for economic and budget decisions? a. National Bureau of Economic Research b. Office of Management and Budget c. Antitrust Division of the Department of Justice d. Congressional Budget Office ANSWER: d 26. Suppose that because the government increases the minimum wage, employers choose to hire fewer workers. This is an example of a(n): a. intended effect. b. direct effect. c. indirect effect. d. desired outcome.

ANSWER: c 27. The government offers unemployment benefits to workers who have lost their jobs and not yet found new ones. Which of these is an example of an indirect, unintended effect of the government intervention? a. Recipients reduce their job search activities. b. Recipients can still afford to pay health insurance premiums. c. Recipients are at less risk for falling into poverty. d. Potential recipients choose not to file for benefits.

ANSWER: a 28. Which of these might be an indirect, unintended effect of providing income support to those without jobs? a. Those without jobs are made better off.

b. Those without jobs are made worse off. c. People without jobs now search for and acquire jobs. d. People without jobs no longer search for and acquire jobs.

ANSWER: d 29. How governments should intervene is a _____ question, and why governments intervene in the way they do is a _____ question. a. normative; normative b. positive; negative c. normative; positive d. positive; normative ANSWER: c 30. If government revenues exceed government spending, the difference is called the: a. cash flow deficit. b. cash flow surplus. c. debt. d. budget.

ANSWER: b 31. The accumulation of past deficits over time is measured by the: a. cash flow deficit. b. cash flow surplus. c. debt. d. budget.

ANSWER: c 32. The current federal debt of the United States is _____ of the gross domestic product. a. less than 15% b. approximately 30% c. approximately 60% d. over 100% ANSWER: d 33. National defense is a classic example of what economists call: a. a public good. b. entitlement spending. c. social insurance. d. a private service.

ANSWER: a 34. Which of these correctly depicts the changes in the sources of federal, state, and local receipts in the past 50 years? a. Income taxes are now a larger share of federal receipts.

b. Property taxes are now a larger share of state and local receipts. c. Corporate and excise taxes are now a smaller share of federal receipts. d. Sales taxes constitute the exact same share of state and local receipts.

ANSWER: c 35. By 2010, approximately _____ of the non-elderly U.S. population did not have health insurance. a. 5% b. 15.5% c. 18.5% d. 25% ANSWER: c 36. The state government collects $400 billion in tax revenue during the current fiscal year and spends all of it.

The government is running a: a. cash flow deficit. b. cash flow surplus. c. debt. d. balanced budget.

ANSWER: d 37. The state government collects $400 billion in tax revenue during the current fiscal year and spends nearly $390 billion. The government is running a: a. cash flow deficit. b. cash flow surplus. c. debt. d. balanced budget.

ANSWER: b 38. During the second quarter of 2020, the GDP: a. fell by about 312%. b. rose by about 10%. c. fell by about 10%. d. remained constant.

ANSWER: a 39. The state government collects $400 billion in tax revenue during the current fiscal year and spends $415 billion. The government is running a: a. cash flow deficit. b. cash flow surplus. c. debt. d. balanced budget.

ANSWER: a 40. The state government collects $400 billion in tax revenue during the current fiscal year and spends $415

billion. Which of these is TRUE? a. The government is running a cash flow surplus. b. The national debt will decrease by about $15 billion. c. The government will cut taxes to cover this shortfall. d. The national debt will increase.

ANSWER: d 41. The state government collects $405 billion in tax revenue during the current fiscal year and is running a cash flow surplus. Which of these is TRUE? a. Government spending is greater than or equal to $405 billion. b. The national debt is less than $405 billion. c. The government will cut taxes because it is running a surplus. d. Government spending is less than $405 billion.

ANSWER: d 42. Which was the first state to issue a stay-at-home order on March 19, 2020? a. New York b. California c. Florida d. Michigan ANSWER: a 43. Which of these BEST describes the debates over how the government should respond to the unprecedented economic dislocation caused by the pandemic? a. Both parties favored no restrictions on individuals and businesses. b. Both parties favored active and large government fiscal responses. c. One party favored fewer restrictions, while the other favored active intervention. d. Both parties opposed active and small government fiscal responses.

ANSWER: c 44. Which of these BEST describes the debates in Congress over provisions of the CARES Act? a. Both Republicans and Democrats favored mandates for masks for schools and businesses. b. Democrats favored loans to businesses, while Republicans favored benefits for unemployed individuals. c. Democrats favored protecting businesses from the legal liabilities of Covid-19, while Republicans prioritized funding for state and local government. d. Democrats favored expansions in benefits for unemployed individuals, while Republicans favored loans to businesses.

ANSWER: d 45. By April 2020, what percentage of working papers distributed through the National Bureau of Economic Research were Covid related? a. 18.5 b. 90

c. 2 d. 23.58 ANSWER: d 46. Early working papers distributed through the National Bureau of Economic Research show that: a. provision of the CARES Acts led to much higher consumption. b. the Paycheck Protection Program (PPP) saved many jobs. c. unemployment insurance expansions deter workers from returning to work. d. government interventions to limit economic activity had a large effect.

ANSWER: a 47. Does taxing the wealthy to give benefits to the poor increase social welfare? Explain.

ANSWER: It depends. Taxing the rich to give benefits to the poor may decrease efficiency. For example, it may reduce rich people's incentive to work, which would reduce the total size of the economic pie. In addition, raising money through taxes is not free. There is typically an administrative cost of doing so, which reduces the size of the economic pie. However, taxing the wealthy to give benefits to the poor would increase equity, which may be valued by society in and of itself. Consequently, the answer to this question about social welfare depends on how the society values the efficiency–equity trade-off.

48. Suppose the White House could appoint the lead officials at the Congressional Budget Office (CBO). How could this change affect the level of budget deficits? Explain.

ANSWER: It is possible that the analysts at the CBO would be pressured to make particularly rosy budget predictions of the cost of legislation supported by the administration. Those predictions could help pass that legislation either because politicians believed the estimates or because they were unsure about the true costs. The result could easily be an increase in budget deficits.

49. Are all of the indirect effects of government intervention in the economy unintended effects? Explain.

ANSWER: In many cases, indirect effects of government intervention are unintended. For example, if the government offers a plan to the uninsured in order to make sure that everyone can afford health insurance, an indirect result of that policy might be that the insured drop their insurance. Such an effect is indirect because it resulted from a change in behavior induced by the policy, and in this case, the effect is also unintended. In contrast, however, many government interventions are intended to change people's behavior. For example, government may institute fines for traffic infractions like speeding. To the extent that these fines reduce speeding, that policy has an indirect effect that is also an intended effect.

50. Suppose someone says that a relatively small percentage of Americans own a large percentage of total assets and therefore that the government should redistribute wealth to those less fortunate. Which part of that statement is normative, and which part is positive, if any? Explain.

ANSWER: Pointing out the facts about the income or wealth distribution is a purely positive statement since it is describing how things are. Stating that the government should do something in response is a normative statement, however, since it is saying how things should be as opposed to how they are.

Consequently, the first part of the statement is positive, and the second part is normative.

51. Were the government responses to the Covid-19 pandemic primarily lessons from economics?

ANSWER: Government responses to the Covid-19 pandemic were primarily driven by the political process and the preferences of those in charge of the government rather than by lessons derived from economics.

For instance, when the Republicans were in control of Congress, government provisions to address the effect of the pandemic prioritized business funding and no money for state and local government. On the contrary, when Democrats gained control of the presidency and Congress, the provisions favored unemployment insurance and funding for local governments. Thus, the political process, rather than economics, had the final word on how governments do what they do.

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Chapter 2 1. What is the name of the social assistance program that provides cash payments to single parents whose income is below a specified level? a. Supplemental Nutrition Assistance Program b. Mainstream Vouchers c. Emergency Food Assistance Program d. Temporary Assistance for Needy Families ANSWER: d 2. _____ tools refer to the set of tools designed to understand the mechanics behind economic decision making. a. Efficiency b. Empirical c. Theoretical d. Data ANSWER: c 3. _____ tools refer to the set of tools designed to analyze data and answer questions raised by theoretical analysis. a. Efficiency b. Empirical c. Theoretical d. Abstract ANSWER: b 4. Which is NOT consistent with non–satiated preferences? a. Maria prefers four hamburgers to three hamburgers. b. Kevin enjoys the third hamburger more than the fourth hamburger. c. Lisa prefers five hamburgers to six hamburgers. d. Ron likes to take home leftover hamburgers for later use.

ANSWER: c 5. Consider three bundles: Bundle A: 2 hamburgers and 1 soda Bundle B: 2 hamburgers and 2 sodas Bundle C: 1 hamburger and 1 soda Which does NOT violate the assumption of non–satiated preferences? a. Laura prefers bundles B and C to bundle A. b. Mike prefers bundle B to bundle A and bundle C to bundle B. c. Robin is indifferent between bundle A and bundle C. d. Julio prefers bundles A and B to bundle C. ANSWER: d Copyright Macmillan Learning. Powered by Cognero.

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Chapter 2 6. Consider three bundles: Bundle A: 2 DVDs and 3 CDs Bundle B: 3 DVDs and 1 CD Bundle C: 1 DVD and 3 CDs Which violates the assumption of non–satiated preferences? a. Bart is indifferent between bundles C and B and prefers bundle A to C. b. Mona prefers bundle C to B and is indifferent between bundles A and B. c. Don prefers bundle A to C and is indifferent between bundles B and C. d. Patty prefers bundle A to C and bundle B to C. ANSWER: b 7. Consider three bundles: Bundle A: 1 shirt and 2 hats Bundle B: 2 shirts and 2 hats Bundle C: 3 shirts and 1 hat Which violates the assumption of non–satiated preferences? a. Nancy prefers bundle B to C. b. Diane prefers bundle B to A. c. Steve prefers bundle C to B. d. Ryan prefers bundle A to B. ANSWER: d 8. Graphically, the budget constraint can be described as: a. the slope being the difference between the prices of the goods. b. the slope being the sum of the prices of the goods. c. a downward-sloping line. d. the slope being the product of the prices of the goods.

ANSWER: c 9. Suppose Jon likes to eat both pizza and hamburgers. As John consumes less pizza and holds steady his consumption of hamburgers, the marginal utility of a piece of pizza _____, and the marginal utility of a hamburger _____. a. increases; is unchanged b. increases; increases c. decreases; decreases d. decreases; is unchanged ANSWER: a 10. Assume a convex utility function in which a consumer chooses some of each good. Which is NOT represented by the slope of the budget constraint at optimal consumption?

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Chapter 2 a. the marginal rate of substitution of the two goods b. the relative price of the good drawn on horizontal axis in terms of the other good drawn on vertical axis c. the relative price of the good drawn on vertical axis in terms of the other good drawn on horizontal axis d. the ratio of the marginal utility of the good on the horizontal axis to the marginal utility of the good on the vertical axis ANSWER: c 11. The marginal rate of substitution measures: a. the increase in utility from an additional unit of income. b. the slope of the budget constraint. c. the relative rate of trade-off between two goods. d. the relative price of two goods.

ANSWER: c 12. This figure shows a consumer's budget constraint for apples (vertical axis) and oranges (horizontal axis). If the price of oranges increases, how is the budget constraint affected?

a. The budget constraint shifts inward. b. The budget constraint does not change. c. The vertical intercept E decreases, and the horizontal intercept F remains the same, making the budget constraint flatter. d. The vertical intercept E is unchanged, and the horizontal intercept F decreases, making the budget constraint steeper.

ANSWER: d 13. Suppose that Gustavo spends all of his income on DVDs and (legally) downloaded songs. At the optimum, which of these must be TRUE? a. Gustavo spends all of his income on songs and none on DVDs if songs are cheaper. b. Gustavo spends all of his income on DVDs and none on songs if DVDs are cheaper. c. The marginal utility of the last song downloaded equals the marginal utility of the last DVD purchased.

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Chapter 2 d. The ratio of the marginal utility of the last song downloaded to the price of the song is equal to the ratio of the marginal utility of the last DVD to the price of the DVD. ANSWER: d 14. Which is TRUE when a consumer is maximizing their utility? a. They consume where the budget constraint intersects the midpoint of their indifference curve. b. They consume halfway between the two intersections of their budget constraint and indifference curve. c. They consume at the point at which the slope of their indifference curve is zero. d. They consume at the point at which their budget constraint is tangent to their indifference curve.

ANSWER: d 15. Like all rational consumers, Shana wants to maximize her utility. This means that she will consume at her _____ indifference curve subject to her budget constraint. a. highest b. most efficient c. lowest d. steepest ANSWER: a 16. The slope of an indifference curve is always: a. less than one. b. positive. c. negative. d. greater than one.

ANSWER: c 17. Suppose Tyrone spends his entire income on books and clothing. If the prices of both books and clothing fall by 10%, which statement is TRUE? a. Tyrone is not able to move to a new indifference curve. b. The budget constraint shifts outward. c. The budget constraint becomes flatter, that is, the slope is smaller in absolute value. d. The budget constraint becomes steeper, that is, the slope is larger in absolute value.

ANSWER: b 18. Suppose Tim spends his entire income on hot dogs and hamburgers and consumes at least some of both.

Now suppose that the price of hot dogs increases and the price of hamburgers remains the same. If Tim is compensated so that his utility is held constant, which statement must be TRUE? a. Tim is better off than he was. b. Tim's utility decreases.

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Chapter 2 c. Tim consumes more hamburgers and fewer hot dogs. d. Tim consumes more hot dogs and fewer hamburgers.

ANSWER: c 19. A utility function describes the relationship between _____ by the individual and utility. a. goods consumed b. income earned c. goods produced d. financial investments ANSWER: a 20. Suppose that you buy a lot of music and that the prices of CDs go up. The income effect means that you buy fewer CDs because: a. your nominal income has fallen. b. your real income has fallen. c. you now enjoy music less. d. CDs are less expensive relative to other goods.

ANSWER: b 21. Suppose that you buy a lot of music and that the prices of CDs go up. The substitution effect means that you buy fewer CDs because: a. your nominal income has fallen. b. your real income has fallen. c. you now enjoy music less. d. CDs are more expensive relative to other goods.

ANSWER: d 22. If pasta is an inferior good and if the price of pasta increases, the income effect _____ the quantity demanded, and the substitution effect _____ the quantity demanded. a. reduces; reduces b. increases; increases c. reduces; reduces d. increases; reduces ANSWER: d 23. Economists define marginal analysis as: a. the cost of any purchase that is the next best alternative use of that money. b. the consideration of the costs and benefits of an additional unit of consumption or production. c. the set of tools that allows you to analyze data and answer the questions that are raised by theoretical analysis.

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Chapter 2 d. the net gains to society from all trades that are made in a particular market.

ANSWER: b 24. Suppose that under Temporary Assistance for Needy Families, your state provides an income guarantee of $5,000 and a benefit reduction rate of 40%. The typical recipient can work up to 2,000 hours per year at a wage of $10 per hour. If the recipient works 300 hours per year, the effective take-home wage rate is: a. $0 per hour. b. $4 per hour. c. $6 per hour. d. $10 per hour.

ANSWER: c 25. Under Temporary Assistance for Needy Families, your state provides an income guarantee of $5,000 and a benefit reduction rate of 40%. The typical recipient can work up to 2,000 hours per year at a wage of $10 per hour. By how much does the benefit fall if the recipient works 300 hours per year? a. $3,000 b. $1,800 c. $1,200 d. $600 ANSWER: c 26. Suppose that a 5% rise in the price of apples does not cause the quantity demanded to change. The elasticity of demand for apples would then be: a. 0. b. −1. c. −2. d. infinitely large.

ANSWER: a 27. Suppose that a 50% increase in the price of a good causes a 25% reduction in the quantity demanded. The elasticity of demand is: a. −0.5. b. −1. c. −1.33. d. −2.

ANSWER: a 28. When production exhibits diminishing marginal productivity: a. unskilled workers are less productive than skilled workers. b. output must increase with each additional unit of the input used in production.

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Chapter 2 c. increasing the amount of one input used means more of another input must be used. d. adding additional inputs may still cause output to increase.

ANSWER: d 29. Consumer surplus is highest when the demand curve is _____; producer surplus is greatest when the supply curve is _____. a. elastic; elastic b. inelastic; inelastic c. perfectly elastic; perfectly inelastic d. inelastic; elastic ANSWER: b 30. For a given supply curve, consumer surplus is greater when the demand curve is more _____; producer surplus is greater when the demand curve is more _____. a. elastic; elastic b. inelastic; inelastic c. perfectly elastic; perfectly inelastic d. inelastic; elastic ANSWER: d 31. In the accompanying figure, area _____ is consumer surplus, whereas area _____ is producer surplus.

a. A; D b. A + B; C + D c. D; A d. B; C ANSWER: d 32. We define consumer surplus as: a. the area under the demand curve and above the price of the good. b. the area above the supply curve and below the price of the good.

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Chapter 2 c. the intersection of the supply curve and the demand curve. d. the difference between the price charged by sellers and the price paid by buyers.

ANSWER: a 33. We define producer surplus as: a. the area under the demand curve and above the price of the good. b. the area above the supply curve and below the price of the good. c. the intersection of the supply curve and the demand curve. d. the difference between the price charged by sellers and the price paid by buyers.

ANSWER: b 34. The First Fundamental Theorem of Welfare Economics states that: a. the competitive equilibrium, where supply equals demand, is achieved whenever the government intervenes. b. social efficiency can be achieved if and only if government intervenes in the economy. c. the competitive equilibrium, where supply equals demand, maximizes social efficiency. d. social efficiency cannot be achieved in any competitive equilibrium.

ANSWER: c 35. Suppose voters choose to increase their state's minimum wage to $20 per hour. The accompanying figure shows the market for unskilled labor in that state after the change. Area(s) _____ is the total consumer surplus after this change, while area(s) _____ is the deadweight loss.

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Chapter 2

a. A; C + E b. A + B + C; F c. B + C; H d. A + B; C + E ANSWER: a 36. Suppose voters choose to increase their state's minimum wage to $20 per hour from $15 per hour. The accompanying figure shows the market for unskilled labor in that state after the change. Area _____ is the total worker surplus after this change.

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Chapter 2

a. B + D b. B + D + J c. B + C d. D + E + J ANSWER: b 37. A utilitarian social welfare function implies that: a. the well-being of the worst-off member is maximized. b. income redistribution reduces social welfare. c. everyone in society has the same marginal utility. d. no redistribution should occur.

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Chapter 2 ANSWER: c 38. Which statement does a Rawlsian social welfare function imply? a. The well-being of the worst-off member is maximized. b. The sum of individual utilities is maximized. c. The marginal utility of everyone in society is equal. d. No redistribution should occur.

ANSWER: a 39. Which BEST explains the view that nothing matters except that individuals have met a basic level of need for goods, such as housing or medical care, and that once they have met this basic level, income distribution is irrelevant? a. First Fundamental Theorem of Welfare Economics b. utilitarian social welfare function c. Rawlsian social welfare function d. commodity egalitarianism ANSWER: d 40. The Rawlsian social welfare function SW = min(U1, U2, . . , UN) is equivalent to a utilitarian social welfare function when which conditions are met? a. Individuals are identical and redistribution does not have efficiency costs. b. Redistribution does not have efficiency costs and capital is constant. c. Capital is constant and all basic needs are met. d. All basic needs are met and individuals are identical.

ANSWER: a 41. Cutting Temporary Assistance for Needy Families (TANF) benefits would _____ social efficiency and _____ equity in society. a. increase; increase b. decrease; decrease c. increase; would not change d. increase; decrease ANSWER: d 42. Florence can work up to 2,000 hours per year at a wage of $12 per hour. What is the slope of her budget constraint? a. −0.08 b. −10 c. −12 d. −2,000 Copyright Macmillan Learning. Powered by Cognero.

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Chapter 2 ANSWER: c 43. Florence can work up to 2,000 hours and earn $22,000 annually. What is the slope of her budget constraint? a. −0.09 b. −10 c. −11 d. −12 ANSWER: c 44. Suppose that under Temporary Assistance for Needy Families (TANF), your state provides an income guarantee of $5,000. The typical recipient can work up to 2,000 hours per year at a wage of $10 per hour.

Assume the recipient works 300 hours per year and the effective take-home wage rate is $6. What is the benefit reduction rate? a. 0% b. 1.7% c. 40% d. 60% ANSWER: c 45. Suppose that under Temporary Assistance for Needy Families (TANF), your state provides an income guarantee of $5,000. The typical recipient can work up to 2,000 hours per year at a wage of $10 per hour.

Assume the recipient works 300 hours per year and the effective take-home wage rate is $7.50. What is the benefit reduction rate? a. 0% b. 25% c. 75% d. 100% ANSWER: b 46. What happens to the labor supply curve of single parents when Temporary Assistance for Needy Families (TANF) benefits are introduced? a. It shifts to the right. b. There is movement downward along the curve. c. It shifts to the left. d. There is movement upward along the curve.

ANSWER: c 47. When Temporary Assistance for Needy Families (TANF) benefits are introduced, the labor supply curve of single parents _____, and social efficiency _____. a. shifts to the left; increases Copyright Macmillan Learning. Powered by Cognero.

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Chapter 2 b. shifts to the right; increases c. shifts to the right; decreases d. shifts to the left; decreases ANSWER: d 48. When Temporary Assistance for Needy Families (TANF) benefits are reduced, the labor supply curve of single parents _____, and social efficiency _____. a. shifts to the right; increases b. is not affected; decreases c. shifts to the right; decreases d. shifts to the left; decreases ANSWER: a 49. What happens to the labor supply curve of single parents when the government reduces Temporary Assistance for Needy Families (TANF) benefits? a. It shifts to the right. b. There is movement downward along the curve. c. It shifts to the left. d. There is movement upward along the curve.

ANSWER: a 50. Moira's utility function is given by U = 110 × ln(C) + 55 × ln(L), where C is consumption (in dollars) per year and L is hours of leisure per year. Moira can make $18 per hour and can work up to 2,000 hours per year.

Which correctly represents her budget constraint? a. C = 18 × L b. C = 110 × ln(C) + 55 × ln(L) c. C = 18 × (2,000 − L) d. C = (2,000 − L) ANSWER: c 51. Moira's utility function is given by U = 110 × ln(C) + 55 × ln(L), where C is consumption (in dollars) per year and L is hours of leisure per year. Moira can make $10 per hour and can work up to 2,000 hours per year.

Which correctly represents the utility maximization problem and budget constraint? a. Max U = 100 × ln(C) + 50 × ln(L) subject to C = 10 × L b. Max U = 110 × ln(C) + 55 × ln(L) subject to C = 10 × (2,000 − L) c. Max U = 100 × ln(C) + 55 × ln(L) subject to C = 15 × (2,000 − L) d. Max U = 100 × 10 × (2,000 − L) subject to C = (2,000 − L) ANSWER: b 52. Carefully explain the principle of diminishing marginal utility using a relevant example.

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Chapter 2 ANSWER: The principle of diminishing marginal utility suggests that the consumption of each additional unit of a good makes an individual less happy than the consumption of the previous unit. Consider the example of concerts. There is one particular heavy metal band you want to see, so you buy tickets to all four of the Headbanger concerts in your area. You get the highest marginal utility from the first concert, less from the next, and so on.

53. Assume that both air travel and travel by car are normal goods and you spend a fixed amount of income on both goods. Suppose that when the price of crude oil goes up by 30%, the price per mile of air travel goes up by 10% and the price per mile traveled by car goes up by 20%. Explain how the increase in the price of crude oil affects air travel and travel by car in terms of the income effect, the substitution effect, and the overall (net) effect.

ANSWER: If the price of oil goes up, your real income falls because your income can buy less of both air and car travel. Consequently, the income effect will reduce your travel by air and by car because they are both normal goods. However, because the price of car travel has increased more than the price of air travel, air travel is now a more attractive option. Therefore, the substitution effect of the increase in the price of oil is to increase the amount of air travel you do and decrease the amount of car travel you do. The net effect on car travel is clear: You will drive less. However, the net effect on air travel depends on the relative magnitude of the income and substitution effects.

54. Explain what is represented by the slope of the budget line and the slope of the indifference curve. How does an increase in income affect the slopes?

ANSWER: The slope of the budget constraint is the ratio of the prices of the two goods. This is the rate at which the market allows you to trade off one good for another. The slope of the indifference curve is the marginal rate of substitution, which is the rate at which the consumer wants to trade off one good for another. An increase in income does not change the slope of either because the ratio of prices has not changed (the slope of the budget constraint) and the consumer's preference for trading off one good for the other has not changed (the slope of the indifference curve).

55. Suppose you receive a raise from $10 to $20. Explain how both income and substitution effects would affect your labor supply at the new and higher wage. What will be the effect overall?

ANSWER: At the higher wage, you will have a higher income. The income effect means that you'll consume more of every normal good, including leisure. That is, the income effect means you'll work less. The substitution effect results because leisure is now more expensive than it was before your wage was increased. Before, an hour of leisure costs you only $10, and now it costs you $20. Consequently, the substitution effect means that you'll work more because leisure is more expensive. Whether you ultimately work more or less has to do with which effect is bigger.

56. Suppose that the market demand curve is given by Q = 100 − P and the market supply curve is given by Q = 3P. (a) What is the deadweight loss that would result if the government were to institute a price cap of 20 in this market? (b) What is the deadweight loss that would result if the government were to institute a price cap of 30 in this market?

ANSWER: (a) The market equilibrium with no government intervention is P = 25 and Q = 75. If the price is capped at 20, only 60 units are produced. The social surplus from the last 15 units produced is $150 Copyright Macmillan Learning. Powered by Cognero.

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Chapter 2 (at a price of $20, 40 units are demanded, so the height of the deadweight triangle is 20, and half of 20 × 15 is 150). Because these units are no longer being produced, that means that the deadweight loss is $150. (b) Because the price in market equilibrium (25) is less than 30, this price cap doesn't affect the market at all. Therefore, there is no deadweight loss.

57. Let Jane's utility function be given by: U = 100 × ln(C) + 50 × ln(L) where C is consumption (in dollars) per year and L is hours of leisure per year. Jane can make $15 per hour and can work up to 2,000 hours per year. (a) Set up the maximization problem, showing the budget constraint. (b) How many hours will Jane want to work per year?

ANSWER: (a) The problem is as follows: Max U = 100 × ln(C) + 50 × ln(L) subject to C = 15 × (2,000 − L) The budget constraint simply states that consumption must be equal to $15 per hour × hours worked.

Since hours worked is simply 2,000 − L, we write it that way so that everything is in terms of L. (b) Substituting the budget constraint into the utility function, we get U = 100 × ln(30,000 − 15L) + 50 ln(L) Taking the derivative of U with respect to L and setting it equal to zero, we get 100/(30,000 − 15L) × (−15) + 50/L = 0 1,500/(30,000 − 15L) = 50/L After cross multiplying, we get 1,500L = 50 × (30,000 − 15L) 1,500L = 1,500,000 − 750L 2,250L = 1,500,000 L = 666.67 Labor = 2,000 − L Labor = 2,000 − 666.67 Labor = 1,333.33 So, Jane will work 1,333.33 hours per year.

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Chapter 3 1. What term denotes the use of data and statistical methodologies to measure the impact of government policy on individuals and markets? a. constrained utility maximization b. empirical public finance c. welfare economics d. a balanced budget requirement ANSWER: b 2. Two economic variables that move together are: a. correlated. b. uncorrelated. c. causal. d. casual.

ANSWER: a 3. Two economic variables are _____ if movement of one causes the other to move. a. correlated b. uncorrelated c. causally related d. casually related ANSWER: c 4. Banou observes that two variables move together. She wants to determine whether a movement of one variable causes the movement of the other. In other words, she must solve: a. the social efficiency maximization problem. b. the social welfare maximization problem. c. the identification problem. d. the model misspecification problem.

ANSWER: c 5. Which is definitely TRUE if two measures, A and B, are correlated? a. A causes B, or B causes A. b. A third factor causes both A and B. c. There is no causation between A and B. d. It is possible that there is a causal relationship between A and B. ANSWER: d 6. Ideally, policy makers should rely on studies that show _____, not just _____. a. permanent relationships; trends b. causal relationships; correlations c. trends; isolated variables Copyright Macmillan Learning. Powered by Cognero.

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Chapter 3 d. correlations; causal relationships ANSWER: b 7. Which of these is NOT a potential problem with randomized trials? a. Treatment and control groups tend to be very different. b. Such experiments can raise ethical concerns. c. Participants may differ from the underlying population. d. Some individuals may leave the experiment before it is complete.

ANSWER: a 8. Suppose that, using a large data set, a statistician perform a cross-sectional regression analysis that indicates that a 7% increase in wages leads to a 5% reduction in employment, whereas the true effect is -2%. The difference of 3% represents which of these? a. measurement error b. bias c. small-sample error d. a difference-in-difference estimation ANSWER: b 9. Which would would be the BEST approach to determine whether exercise improves academic performance? a. compare the academic achievements of the athletes who play on the school’s teams and nonathletes who do not participate in sporting events over a period of time. b. collect testimonials from professors who have observed many students, both athletes and nonathletes, over the years and are therefore well-placed to have insights on this issue c. randomly assign participants to two groups, one that undertakes regular exercise and one that does not, and compare the course grades of members of the two groups after a period of time has elapsed d. randomly assign participants to two groups, one that undertakes regular exercise and one that does not, and compare the results of IQ tests administered to members of the two groups after a period of time has elapsed ANSWER: c 10. Which of these is NOT true? a. Randomized trials generate observational data used to estimate the causal effects of particular treatments. b. Researchers use observational data in time series analysis. c. Researchers use observational data in cross-sectional regression analysis. d. Randomized trials generate experimental data used to estimate the causal effects of particular treatments.

ANSWER: a 11. Suppose a researcher who wants to examine the effect of job training on work efficacy randomly enrolls half of new workers at an assembly plant in a job training program. The people who receive the training form the _____ group; the people who do not receive training form the _____ group.

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Chapter 3 a. control; treatment b. treatment; treatment c. treatment; control d. control; control ANSWER: c 12. Any difference between treatment and control groups that is correlated with, but not caused by, the treatment is called: a. measurement error. b. bias. c. small-sample error. d. difference-in-difference estimation.

ANSWER: b 13. Randomized trials: a. cannot effectively establish causation. b. can be very expensive. c. avoid ethical problems. d. are the least expensive way to test a hypothesis.

ANSWER: b 14. Suppose that to examine the effect of the TANF program on labor supply, researchers were to explore how labor supply by poor households has changed over the past 20 years and then compare that change with changes in the income guarantee over time. This would be an example of: a. time series analysis. b. cross-sectional regression analysis. c. a randomized trial. d. a quasi-experiment.

ANSWER: a 15. Which of these would be the MOST useful source of time series variation with which to identify the effect of income guarantees on labor supply? a. an abrupt increase in the income guarantee over a short time b. a steady increase in the income guarantee over a long time c. no change in the income guarantee over time d. an expansion of the Earned Income Tax Credit ANSWER: a 16. Suppose that to determine how non-labor income affects labor supply, Dalibor gives everyone born on an even-numbered day in August 1979 $1,000 per year and observes how they change their labor supply compared to people born on odd-numbered days in August 1979. This approach is which of these? a. time series analysis Copyright Macmillan Learning. Powered by Cognero.

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Chapter 3 b. cross-sectional regression analysis c. a randomized trial d. a quasi-experiment ANSWER: c 17. Suppose a researcher were to estimate the effect of public smoking bans by observing rates of smoking across states over a time period in which some of those states adopt smoking bans. This study takes which approach? a. time series analysis b. cross-sectional regression analysis c. a randomized trial d. a quasi-experiment ANSWER: d 18. Which of these is a TRUE statement? a. Control variables used in cross-sectional regression analysis typically remove all bias. b. Attrition of volunteers in randomized trials rarely occurs. c. Randomized trials are typically expensive. d. Randomized trials do not have causal implications.

ANSWER: c 19. Suppose an empirical researcher estimates the effect of drug use on high school dropout rates by examining how the two variables changed over the 1980s and 1990s. This empirical approach can BEST be characterized as: a. a time series analysis. b. a cross-sectional regression analysis. c. structural modeling. d. a quasi-experiment.

ANSWER: a 20. Which of these is a potential problem with time series analysis? a. Time series analysis cannot effectively establish causation. b. Time series analysis trials can be very expensive. c. Time series analysis is subject to ethical problems. d. Time series analysis cannot establish causation when one variable is slow-moving.

ANSWER: d 21. A statistical method used to assess the relationship between two variables while holding other factors constant is called: a. time series analysis. b. cross-sectional regression analysis. c. a randomized trial.

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Chapter 3 d. a quasi-experiment.

ANSWER: b 22. Which of these statements is TRUE? a. Cross-sectional regression analysis cannot account for factors that vary between the treatment and control groups. b. Cross-sectional regression analysis yields only qualitative, not quantitative, conclusions about relationships between variables. c. Since tastes and preferences cannot be easily measured, empirical researchers need not concern themselves with these. d. Cross-sectional regression analysis assesses the relationship between two variables while holding other factors constant.

ANSWER: d 23. Suppose an empirical researcher estimates the effect of parental divorce on children's high school graduation in 2017 by comparing children whose parents divorced with children whose parents remained married, controlling for other observable characteristics. The researcher's approach is BEST characterized as: a. time series analysis. b. cross-sectional regression analysis. c. a quasi-experiment. d. a random trial.

ANSWER: b 24. Suppose an empirical researcher estimates the effect of HMO membership on health care costs by comparing costs with membership across various states last year. The researcher's approach is BEST characterized as: a. time series analysis. b. cross-sectional regression analysis. c. a quasi-experiment. d. a random trial.

ANSWER: b 25. Which of these statements is TRUE? a. Control variables used in cross-sectional regression analysis typically remove all bias. b. Attrition of volunteers in randomized trials is rare. c. Randomized trials are typically inexpensive. d. Cross-sectional analysis may involve comparing many individuals at one point in time.

ANSWER: d 26. Suppose an empirical researcher wants to analyze the impact of restricting HMO membership on insurance rates among workers. The researcher notices that one state passed a law restricting HMO membership and that an otherwise similar state did not pass such a law. Which empirical approach would be BEST suited to this analysis?

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Chapter 3 a. time series analysis b. cross-sectional regression analysis c. a quasi-experiment d. a random trial ANSWER: c 27. Suppose that one state establishes a job-training program for all high school dropouts. Which empirical approach would be BEST suited to estimating the effect of the job-training program on earnings? a. time series analysis b. cross-sectional regression analysis c. structural modeling d. a quasi-experiment ANSWER: d 28. Suppose that a state were to cut the welfare guarantee from $6,000 to $3,000 between 2017 and 2019.

Furthermore, suppose that hours of work per year among single parents rose from 900 to 1,200 hours per year.

Using the time series approach, what is the effect of the reduction for the average single parent? a. −300 hours per year b. 300 hours per year c. 900 hours per year d. 1,200 hours per year ANSWER: b 29. Suppose a state were to cut the welfare guarantee by 30% between 2016 and 2018. Furthermore, suppose that hours of work per year among single parents rose by 20%. Use the time series estimate of the effect to determine the elasticity of total hours worked with respect to benefits. a. −0.67 b. 0.67 c. −1 d. 1 ANSWER: a 30. Suppose a state were to cut the welfare guarantee from $6,000 to $3,000 between 2016 and 2018.

Additionally, suppose that hours of work per year among single parents rose from 900 to 1,200. Which of these, if true, would give a researcher greater confidence that a time series estimate of the effect of the reduction in the welfare guarantee on labor supply is unbiased? a. Single parents in that state in 2012 were very different from single parents in 2014. b. There was no period of substantial economic growth or decline between 2012 and 2014. c. The welfare guarantee was cut only for a portion of single parents. d. Other factors besides welfare benefits also help determine how many hours a single parent works ANSWER: b Copyright Macmillan Learning. Powered by Cognero.

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Chapter 3 31. Suppose 15 states pass laws limiting trial lawyer compensation, while the remaining 35 states pass no such laws. Additionally, suppose that the value of malpractice suits goes from an average of $2.4 billion to $2.8 billion in the 15 states that pass laws limiting trial lawyer compensation and from $2.3 billion to $2.6 billion in the remaining 35 states around the time that the laws are passed. What is the difference-in-difference estimator of the effect of these laws on the value of malpractice suits? a. $0 b. $0.1 billion c. $0.3 billion d. $0.4 billion ANSWER: b 32. Which of these is TRUE concerning structural estimates? a. The researcher does not need more information than a researcher who estimates reduced form estimates only. b. The researcher cannot impose assumptions on the functional form of utility. c. The researcher must use a randomized study. d. The variables in the study cannot be correlated with each other.

ANSWER: a 33. Suppose one study uses data on prices and cigarette smoking behavior to estimate the overall effect of cigarette-price changes on smoking, while another uses the same data to decompose the effect into income and substitution effects. The first study provides _____ estimates; the second provides _____ estimates. a. reduced form; reduced form b. structural; structural c. quasi-experiment; randomized d. reduced form; structural ANSWER: d 34. Randomized trials and quasi-experiments: a. cannot distinguish causality from correlation without making unrealistic assumptions. b. cannot find the effect of a particular treatment. c. often cannot tell us why outcomes change with a given intervention. d. are designed only to identify the consequences of a given intervention.

ANSWER: c 35. Suppose an economist estimates underlying features of utility functions. What type of empirical analysis would this researcher MOST likely engage in? a. time series analysis b. cross-sectional regression analysis c. structural modeling d. a quasi-experiment ANSWER: c Copyright Macmillan Learning. Powered by Cognero.

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Chapter 3 36. The difference-in-difference estimator is used in: a. time series analysis. b. cross-sectional regression analysis. c. structural modeling. d. quasi-experiments.

ANSWER: d 37. R2 is a measure of: a. the statistical significance of a regression. b. how well a regression model fits the underlying data. c. the statistical significance of a given coefficient. d. how well a structural model explains the differences between treatment and control groups.

ANSWER: b 38. Which of these interpretations did the Harvard administrator draw regarding SAT prep courses and SAT performance? a. SAT prep courses worsen preparation for SATs. b. Those who are of lower test-taking ability take preparation courses to try to catch up. c. Nervous people take prep courses because they perform poorly on standardized exams. d. Students do not study for the SATs. ANSWER: a 39. Opponents of minimum wage laws argue that higher wages lead to unemployment. They believe higher minimum wages and unemployment are: a. randomly correlated. b. uncorrelated. c. causally related. d. casually related.

ANSWER: c 40. What does the regression model, HOURSi = α + βTANFi + εi, suggest about the relationship between welfare and hours of work? a. Welfare impacts hours. b. Hours and welfare have no relationship. c. Hours impacts welfare. d. Hours and welfare are perfectly correlated.

ANSWER: a 41. Which component in the regression model, HOURSi = α + βTANFi + εi, is constant? a. HOURS b. α Copyright Macmillan Learning. Powered by Cognero.

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Chapter 3 c. β d. TANF ANSWER: b 42. Which component in the regression model, HOURSi = α + βTANFi + εi, is the slope coefficient? a. HOURS b. α c. β d. TANF ANSWER: c 43. Consider the regression estimates below for the model, HOURSi = α + βTANFi + εi Estimates Constant

1,325 (11)

TANF benefits (1,000s)

−167

(8) According to the estimates, how many hours will an individual work if they receive no welfare benefits? a. 8 b. 11 c. 167 d. 1,325 ANSWER: d 44. Consider the regression estimates below for the model, HOURSi = α + βTANFi + εi Estimates Constant

1,325 (11)

TANF benefits (1,000s)

−167

(8) According to the estimates, what is the expected impact of a $1,000 increase in welfare benefits? a. The number of hours worked falls by about 13. b. The number of hours worked falls by 1,325. c. The number of hours worked falls by 167. d. The number of hours worked falls by 1,670 ANSWER: c 45. Consider the regression estimates below for the model, HOURSi = α + βTANFi + εi Estimates Copyright Macmillan Learning. Powered by Cognero.

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Chapter 3 Constant

1,325 (11)

TANF benefits (1,000s)

−167

(8) Which of these is the standard error of the slope coefficient? a. 8 b. 11 c. 167 d. 1,325 ANSWER: a 46. Consider the regression estimates below for the model, HOURSi = α + βTANFi + εi Estimates Constant

1,560 (15)

TANF benefits (1,000s)

−183

(11) According to the estimates, how many hours will an individual work if they receive no welfare benefits? a. 15 b. 11 c. 183 d. 1,560 ANSWER: d 47. Consider the regression estimates below for the model, HOURSi = α + βTANFi + εi Estimates Constant

1,560 (15)

TANF benefits (1,000s)

−183

(11) According to the estimates, what is the expected impact of a $1,000 increase in welfare benefits? a. The number of hours worked falls by about 15. b. The number of hours worked falls by 1,560. c. The number of hours worked falls by 183. d. The number of hours worked falls by 1,830.

ANSWER: c 48. Which of these was a major problem of the Indonesian Raskin program, which provides subsidized rice to Copyright Macmillan Learning. Powered by Cognero.

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Chapter 3 households in the bottom 25% of the income distribution? a. Eligible households were receiving too much rice. b. Ineligible households were receiving too little rice. c. Eligible households were receiving too little rice. d. It was impossible to tell the difference between eligible and ineligible households.

ANSWER: c 49. Which of these was thought to prevent eligible households in the Indonesian Raskin program from receiving the quantity of rice to which they were entitled? a. Family sizes were too small in eligible households. b. Eligible households lived too far away from distribution sites. c. Households did not really know if they were eligible. d. There was a shortage of rice in the program.

ANSWER: c 50. From 2014 to 2018, youth cigarette consumption declined by about 29%. Which of these MOST likely caused this decline? a. The settlement of a series of expensive lawsuits against the tobacco industry by many states. b. A shift in smoking habits from traditional cigarettes to e-cigarettes. c. A price war in the tobacco industry, leading to a drop in real cigarette prices. d. An increased appreciation of the health risks associated with smoking.

ANSWER: b 51. What is the MOST fundamental issue facing economists who do empirical work in public finance? a. finding market equilibrium quantities b. finding market equilibrium prices c. disentangling causality from correlation d. designing graphical representations of economic problems ANSWER: c 52. Which of these scenarios illustrates the identification problem? a. Anuman observes a negative correlation between malnutrition and the length of time women breastfeed children in developed countries but a positive correlation in less developed countries. b. The data obtained on breast-feeding and malnutrition comes from a random sample of infants from unknown communities; Anuman therefore cannot identify the subject of his study. c. Anuman shows that infants who are in the poorest health breastfeed the longest, and the government, mistaking correlation for causation, enacts a policy based on the assumption that longer breastfeeding is bad for children. d. Anuman observes a positive correlation between malnutrition and the length of time women breastfeed children, but does not know which variable is causing this pattern.

ANSWER: d Copyright Macmillan Learning. Powered by Cognero.

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Chapter 3 53. An economist wants to determine whether cognitive-behavioral therapy reduces substance abuse. Ten students volunteer to participate in a randomized trial in which those with a birthday on an even day receive the therapy, and those with a birthday on an odd day do not. Of the following individuals, who is part of the control group? a. a person whose birthday is on the first day of April b. a person whose birthday is on the last day of April c. no control group in this scenario d. a person whose birthday is on April 2 ANSWER: a 54. An economist wants to determine whether cognitive-behavioral therapy reduces substance abuse. Ten students volunteer to participate in a randomized trial in which participants with birthdays on even days receive the therapy, and those with birthdays on odd days do not. Of the following individuals, who is part of the treatment group? a. a person whose birthday is on January 2 b. a person whose birthday is on the first day of January c. no treatment group in this scenario d. a person whose birthday is on January 30 ANSWER: b 55. Which of these descriptions of the relationship between the employment rate and cash welfare benefits is stated in elasticity form? a. A reduction of $1,000 in welfare results in a 10% increase in employment. b. A reduction of $1,000 in welfare increases employment by 1,000 workers. c. A 20% reduction in welfare benefits results in a 10% increase in employment. d. A 20% reduction in welfare benefits increases employment by 1,000 workers.

ANSWER: c 56. Suppose Abraham performs a randomized trial to evaluate the causal relationship between classroom intervention and academic performance by students. Ten private elementary schools volunteer to take part in the experiment, and Abraham randomly assign five of them to the treatment group and five to the control group.

What is one problem with the results obtained from this experiment? a. The results only measure the correlation but not causation between the treatment and academic performance. b. Randomization does not solve the problem of inherent differences between the treatment and control groups. c. Randomized trial results are only valid for medical experiments, not social experiments. d. The results may only be valid for the ten private schools that participate in the experiment.

ANSWER: d 57. To measure the impact of education on earnings, Sieghild performs a regression analysis that includes parents' education and family income as control variables. Which of these is the dependent variable in her regression analysis?

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Chapter 3 a. earnings b. education c. parents' education d. family income ANSWER: a 58. To measure the impact of education on earnings, an economist performs a regression analysis that includes the independent variables education, parents' education, and family income. Which of these is a control variable in this analysis? a. earnings b. family income c. age d. preference for leisure ANSWER: b 59. What is the fundamental difference between correlation and causality? Why is it important to distinguish between them?

ANSWER: Two economic variables are correlated if they move together. But this relationship is causal only if movements of one variable cause movements of the other. If, instead, there is a third factor that causes both to move together, the relationship is not causal. It is important to distinguish correlation and causality because knowledge that two factors are correlated provides no predictive power; prediction requires an understanding of the causal links between the factors.

60. A paper published in a medical journal found that children who said they dieted gained more weight over time than children who said they did not diet. The authors concluded that dieting may lead to binge eating, causing weight gain, a conclusion that was widely reported in the press. What are some alternative explanations?

ANSWER: Although dieting may cause binge eating, which may in turn cause weight gain, dieting is not the only possible explanation. For example, it could be that the children who diet are the ones most prone to gaining weight.

61. Suppose a study finds that college students who received financial aid have a greater tendency to graduate than college students who do not receive financial aid. What identification problem must the researchers solve?

If the researchers conclude, on the basis of the data, that receiving financial aid increases the ability of college students to graduate, are they correct? What would be the BEST solution to the identification problem? Explain.

ANSWER: The identification problem encountered by the authors is to determine which of these possibilities is true: (a) Financial aid causes students to graduate from college more easily than they otherwise would. (b) Students receive financial aid because they are more likely to graduate from college. (c) A third factor causes students both to graduate from college and to receive financial aid.

The authors may not be correct in their conclusion. It could be that (b) is the real explanation; perhaps students receive financial aid because the universities think they'll be more likely to graduate. However, the correlation is most probably due to the fact that students who receive meritbased financial aid are bright, hardworking students and therefore more likely to graduate than other students. The best solution to solving the identification problem would be to assign financial aid to Copyright Macmillan Learning. Powered by Cognero.

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Chapter 3 randomly selected students and compare their graduation rates with those of students who didn't receive financial aid.

62. Suppose a study found that gasoline prices are lower in markets in which certain gas stations (call them CheapGas stations) are present. What possibilities would explain this correlation?

ANSWER: There are several possibilities. It could be that CheapGas stations compete more aggressively in pricing than do other gas stations, which leads to lower prices. However, it could also be that CheapGas gas stations choose to locate in areas where gasoline can be sold cheaply, whether because of lower taxes, closer proximity to refineries, or some other factor. Perhaps the least plausible explanation is that gas stations like CheapGas choose to locate in certain markets because the prices there are lower, all things equal.

63. Name one potential problem that could lead to biased results if a school administration were to try to identify the effect on academic achievement of attending a charter school by comparing the scores of students from charter schools with the scores of students from traditional public schools.

ANSWER: The advantage of identifying the effect in this way is that it is simple. However, there are several pitfalls to such a simple approach. To the extent that students at charter schools are different from students at traditional public schools in any way other than the type of school they attend, this identification strategy may lead to a biased estimate if the difference also affects achievement. For example, if a higher proportion of students who attend charter schools are from disadvantaged families relative to traditional public school students (or vice versa), the estimate will be biased.

64. (a) Suppose more students wanted to attend a charter school than the charter school could accept, and the school’s administration wanted to identify the effect of attending a charter school by comparing the outcomes of students who attended charter schools with those of students who wanted to but could not. Would a quasiexperimental approach be acceptable if the charter school accepted students on the basis of their characteristics? (b) Would the answer to (a) change if students were accepted on the basis of a lottery instead?

ANSWER: (a) A quasi-experimental approach would not be acceptable because students in the control group (students who are unable to attend the charter school) have different characteristics than students in the treatment group (students who attend the charter school). (b) If students were accepted on the basis of a lottery, using the traditional quasi-experimental approach would lead to an unbiased estimate of the effect of attending charter school, since both the treatment group and control group are otherwise similar: The two groups had an equal probability of attending charter school.

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Chapter 4 1. Under which President did the United States experience the greatest decline in the deficit? a. Jimmy Carter b. Ronald Reagan c. Bill Clinton d. George W. Bush ANSWER: c 2. Under which President did the United States experience the greatest increase in the deficit? a. Jimmy Carter b. Ronald Reagan c. Donald Trump d. George W. Bush ANSWER: c 3. Which is TRUE? a. Both debt and deficit are flow variables. b. Debt is a stock variable, whereas deficit is a flow variable. c. Debt is a flow variable, whereas deficit is a stock variable. d. Debt is measured in dollars, whereas deficits are measured in jobs lost.

ANSWER: b 4. Government _____ existed throughout the 1980s. a. surpluses b. deficits c. balanced budget requirements d. spending reductions ANSWER: b 5. The Covid-19 pandemic drove the U.S. budget deficit to approximately what percent of GDP? a. 8 b. 12 c. 15 d. 21 ANSWER: c 6. Capital income taxes are taxes on: a. asset expenditures. b. asset returns. c. business profits. d. real estate sales ANSWER: b Copyright Macmillan Learning. Powered by Cognero.

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Chapter 4 7. The _____ marked the end of an era of post-World War II balanced budgets in the United States. a. late 1950s b. mid 1970s c. mid 1980s d. late 1990s ANSWER: b 8. The budget process sets: a. entitlement spending. b. discretionary spending. c. debt levels. d. total spending.

ANSWER: b 9. Congress's budget resolution includes each item EXCEPT: a. expenditures on Social Security and Medicare. b. instructions for changing entitlement programs and tax policy. c. projections about the deficit. d. discretionary spending.

ANSWER: a 10. Which is TRUE about balanced budget requirements (BBRs)? a. The federal government has a BBR, but most state governments do not. b. BBRs that require that the governor/president submit a balanced budget or that the legislature pass a balanced budget are more effective than BBRs that require that the budget is balanced at the end of the year. c. BBRs that require that the governor/president submit a balanced budget or that the legislature pass a balanced budget are less effective than BBRs that require that the budget is balanced at the end of the year. d. BBRs have never been an effective method of reducing the size of the government's budget deficit.

ANSWER: c 11. The difference between an ex ante and ex post balanced budget requirements (BBRs) is that: a. ex ante BBRs require a submission of a balanced budget at the start of the year, whereas ex post BBRs require states to balance their budget by the end of the year. b. ex post BBRs require a submission of a balanced budget at the start of the year, whereas ex ante BBRs require states to balance their budget by the end of the year. c. ex ante BBRs forbid governments from issuing bonds, whereas ex post BBRs only require the bonds to be collateralized. d. ex post BBRs forbid governments from issuing bonds, whereas ex ante BBRs only require the bonds to be collateralized.

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Chapter 4 ANSWER: a 12. Why are ex ante BBRs easier to evade than ex post BBRs? a. Ex ante BBRs are not enforced by law, whereas ex post BBRs have legal standing. b. Ex ante BBRs do not account for discretionary spending, unlike ex post BBRs. c. Ex ante BBRs only require submission of a balanced budget, and so do not necessarily consider unexpected events that result in expenditures. d. Ex ante BBRs give unchecked power over spending to government executives, which contributes to a political business cycle of spending before elections.

ANSWER: c 13. BBRs can be problematic for each reason EXCEPT: a. preventing stimulative spending in economic downturns. b. forcing tax raises and layoffs when revenues fall in recessions. c. limiting the issuing of government bonds. d. preventing the government from taking advantage of unforeseen and advantageous spending opportunities.

ANSWER: c 14. Suppose the government spends $3 trillion and collects $2 trillion in taxes this year. The _____ is equal to _____. a. debt; $1 trillion b. deficit; $1 trillion c. debt; $2 trillion d. deficit; $2 trillion ANSWER: b 15. Which statement must be TRUE? a. If debt increased from one year to the next, there must have been a budget deficit. b. If debt decreased from one year to the next, there must have been a budget surplus. c. If debt increased from one year to the next, entitlement spending must have been increased. d. If debt increased from one year to the next, discretionary spending must have been increased.

ANSWER: a 16. The federal government's budget deficit ballooned to nearly 10% of GDP in 2009 and then: a. remained about the same percentage in subsequent years. b. continued to increase in subsequent years. c. fell briefly before rising to nearly 15% in 2014. d. began falling in subsequent years.

ANSWER: d 17. The budget process distinguishes between: Copyright Macmillan Learning. Powered by Cognero.

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Chapter 4 a. entitlement spending and deficit spending. b. discretionary spending and deficit spending. c. surplus spending and deficit spending. d. entitlement spending and discretionary spending.

ANSWER: d 18. _____ spending refers to funds for programs for which funding levels are automatically set by the number of eligible recipients, and Congress sets _____ spending by annual appropriations. a. Entitlement; discretionary b. Discretionary; entitlement c. Deficit; entitlement d. Deficit; discretionary ANSWER: a 19. A balanced budget requires that: a. to be reelected, politicians vote for a budget in which spending exceeds revenues. b. a deficit in that year to be smaller than that of the previous year. c. entitlement spending equals discretionary spending. d. total spending equals total revenue.

ANSWER: d 20. When the 2001 tax cuts were passed, they were set to expire after: a. ten years, but the reduced tax rates for those making under $400,000 were permanently extended in 2012. b. two years, but the reduced tax rates for those making under $400,000 were permanently extended in 2003. c. ten years, so tax rates reverted to 2001 levels in 2011. d. two years, so tax rates reverted to 2001 levels in 2003.

ANSWER: a 21. "Sequestration" in the context of government budgets refers to: a. presidential authority to unilaterally decide on annual discretionary spending. b. an act by the Congressional Budget Office (CBO) to cut government spending. c. forced reconciliation between the House of Representatives and Senate in budget negotiations. d. automatic reductions in discretionary spending to offset an increase in the deficit.

ANSWER: d 22. Suppose the price of a beer is $2.50 in 2004 and $3 exactly a year later. The price in 2004 is measured in _____ dollars; the price in 2005 is measured in _____ dollars. a. real; real b. nominal; real Copyright Macmillan Learning. Powered by Cognero.

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Chapter 4 c. real; nominal d. nominal; nominal ANSWER: d 23. Suppose that the Consumer Price Index rises 3% from this year to next year. In addition, suppose that the price of a popular pizza rises 3% over that time as well. Which statement is TRUE? a. The nominal price of pizza has increased. b. The real price of pizza has increased. c. The real price of pizza has fallen. d. The nominal price of pizza has remained the same.

ANSWER: a 24. Which statement is TRUE? a. Neither the federal nor state governments have been able to control deficits for long periods. b. Both the federal and state governments have been able to control deficits for long periods. c. Both the federal and state governments have effective balanced budget requirements in place. d. State governments have been able to control deficits for long periods, whereas the federal government has not.

ANSWER: d 25. A cyclically adjusted budget deficit accounts for the effect of _____ on the budget deficit. a. economic expansions only b. politicians' attitudes regarding balanced budgets c. recessions only d. both economic expansions and recessions ANSWER: d 26. _____ accounting measures the deficit as the difference between current spending and current revenues, whereas _____ accounting considers the change in the value of the government's net asset holdings. a. Short-term; long-term b. Long-term; short-term c. Cash; capital d. Capital; cash ANSWER: c 27. Suppose that the Consumer Price Index rose by 3% from 2013 to 2014. Suppose that the price of a pizza increased by 5% during that time. Which is TRUE? a. The nominal price of pizza decreased. b. The real price of pizza increased. c. The real price of pizza did not change. d. The real price of pizza decreased.

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Chapter 4 ANSWER: b 28. Suppose that the Consumer Price Index fell by 4% between this year and last year, and the price of a typical automobile fell by 3%. Which is TRUE? a. The nominal price of a car increased. b. The real price of a car increased. c. The real price of a car did not change. d. The real price of a car decreased.

ANSWER: b 29. Which must be TRUE if the price of college tuition has risen faster than the Consumer Price Index in the past 20 years? a. The real price of college tuition has risen. b. The nominal price of college tuition has fallen. c. The real price of college tuition has not changed. d. The nominal price of college tuition has not changed.

ANSWER: a 30. If debt is a nominal obligation to borrowers: a. debt is irrelevant for government. b. inflation decreases the burden of the national debt. c. inflation increases the burden of the national debt. d. inflation has no effect on the burden of the national debt.

ANSWER: b 31. The Consumer Price Index captures the change over time in: a. a typical bundle of goods. b. the price of food, shelter, and transportation. c. raw materials used by industry. d. a bundle of goods, subtracting volatile items such as food and gasoline.

ANSWER: a 32. When the price level rises, the: a. real deficit increases. b. real deficit falls. c. nation forgoes more consumption to pay the debt. d. real burden of the deficit is not affected.

ANSWER: d 33. The cyclically adjusted budget deficit differs from the nominal budget deficit in that it: a. presents the budget as a projection of the year's spending, effectively annualizing it.

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Chapter 4 b. controls for the impacts of economic activity on the budget. c. controls for the impacts of political business cycle on the budget. d. projects the budget into the future using information from the previous cycle of business activity.

ANSWER: b 34. Which is TRUE? a. When the economy is in recession, the cyclically adjusted budget deficit is lower than the reported deficit. b. In periods of economic expansion, the cyclically adjusted budget deficit is lower than the reported deficit. c. The reported budget deficit always equals the cyclically adjusted budget deficit with automatic stabilizers during recessions. d. The reported budget deficit always equals the cyclically adjusted budget deficit with automatic stabilizers during expansions.

ANSWER: a 35. Cash accounting measures the deficit as the: a. amount by which current spending exceeds current tax revenues. b. amount by which current tax revenues exceed current spending. c. increase in the value of the government's net asset holdings. d. decrease in the value of the government's net asset holdings.

ANSWER: a 36. The U.S. government uses: a. cash accounting for discretionary spending and capital accounting for defense spending. b. cash accounting for discretionary spending and capital accounting for nondiscretionary spending. c. cash accounting for both discretionary spending and defense spending. d. capital accounting for both discretionary spending and defense spending.

ANSWER: c 37. Which is TRUE? a. Cash accounting is easier to implement in practice than is capital accounting. b. Capital accounting is easier to implement in practice than is cash accounting. c. Spending $1 billion on highways would change the capital account balance but not the cash account balance. d. Spending $1 billion on unemployment benefits would change the capital account balance but not the cash account balance.

ANSWER: a 38. Which is TRUE? a. Static scoring and dynamic scoring do not account for a policy's effects on behavior. b. Both static scoring and dynamic scoring account for a policy's effects on behavior.

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Chapter 4 c. Static scoring accounts for a policy's effect on the size of the economy. d. Dynamic scoring assumes that the size of the economy is fixed.

ANSWER: b 39. Despite significant increases in spending due to the Covid-19 pandemic, why, in 2020, did the CBO expect only a small increase in the primary deficit over the next ten years? a. Higher incomes will lead to greater tax collections. b. Lower interest payments will lead to lower payments on government debt. c. A younger population will lead to less spending on Medicare. d. Balanced budget requirements will force the government to cut spending due to declining revenues.

ANSWER: b 40. Suppose cutting taxes both reduces the percentage of income that is taxed and increases the size of taxable incomes. Which scoring method takes both effects into account? a. neither static nor dynamic scoring b. dynamic scoring but not static scoring c. static scoring but not dynamic scoring d. capital scoring but not cash scoring ANSWER: b 41. An implicit obligation is: a. a financial obligation of the federal reserve made to banks for future purchases/sales of government bonds. b. a financial obligation of the government made for the future that is recognized on the current budget. c. a financial obligation of the government made for the future that is not recognized on the current budget. d. a financial obligation of the treasury made to banks and foreign entities for future purchases/sales of government bonds.

ANSWER: c 42. If the interest rate is 10%, what is the present discounted value of receiving $100 next year? a. $10.10 b. $90.00 c. $90.91 d. $110.00 ANSWER: c 43. If the interest rate is 10%, what is the present discounted value of receiving $100 two years from now? a. $90.00 b. $90.91 c. $82.64 d. $111.11 Copyright Macmillan Learning. Powered by Cognero.

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Chapter 4 ANSWER: c 44. Max Scherzer, a baseball pitcher, signed a seven-year, $210 million contract. However, the money is being paid out in $15 million increments over 14 years. Using a discount rate of 6.5%, the money received in the last year of his deal, i.e., year 14, is worth _____ as much as if he had received it in the seventh year of his contract. a. 64% b. 73% c. 18% d. 50% ANSWER: a 45. Which is a factor of concern about long-run imbalance measures? a. The measures are politically motivated; objective forecasters typically don't acknowledge them. b. The measures depend, critically, on assumptions about things like the future growth rates of costs and incomes. c. The measures assume that government policy will change over time. d. The measures do not take into account the political motivations of decision makers.

ANSWER: b 46. Suppose the federal government has to borrow money because it has budget deficits. What is the mechanism through which this borrowing might crowd out private borrowing and capital accumulation? a. interest rates b. discretionary spending c. defense spending d. entitlement spending ANSWER: a 47. If the interest rate is 10%, what is the present discounted value of receiving $100 now, $140 next year, and $200 two years from now? a. $440 b. $409.09 c. $386 d. $392.56 ANSWER: d 48. If the present discounted value of $200 received three years from now is $134.32, what is the interest rate? a. 9.6% b. 10% c. 12% d. 14.2% ANSWER: d Copyright Macmillan Learning. Powered by Cognero.

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Chapter 4 49. According to the approach developed by Gokhale and Smetters in 2003, the discounted value of the longrun fiscal imbalance of Social Security and Medicare programs, as of 2012, was approximately: a. $6.0 trillion. b. $54.4 trillion. c. $64.8 trillion. d. $106.5 trillion.

ANSWER: c 50. In January 2001, the Congressional Budget Office (CBO) projected a budget surplus of nearly $6 trillion over the next ten years, but it never materialized. What does this erroneous projection imply? a. Forecasting five or ten years into the future is very difficult. b. The CBO produces politically biased forecasts. c. The forecasters at the CBO provide less accurate estimates than would forecasters in private practice. d. Long-term forecasts are more accurate than short-term forecasts.

ANSWER: a 51. Suppose a state government passes a law that adjusts spending, based on a preset formula, to offset cyclical changes in the economy. This is an example of: a. static scoring of a policy. b. dynamic scoring of a policy. c. automatic stabilization. d. discretionary stabilization.

ANSWER: c 52. Suppose that a state legislature votes to increase spending because of an unexpected recession. This is an example of: a. discretionary stabilization. b. dynamic scoring of a policy. c. capital accounting. d. automatic stabilization.

ANSWER: a 53. The difference between the present discounted value (PDV) of projected expenditures each year in the future and the PDV of projected revenues each year in the future is the PDV of the government's: a. generational imbalance. b. structural deficit. c. cyclically adjusted deficit. d. fiscal imbalance.

ANSWER: d 54. Which is an example of entitlement spending? a. building a new highway Copyright Macmillan Learning. Powered by Cognero.

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Chapter 4 b. renovating a public elementary school c. Social Security d. national defense ANSWER: c 55. Which is an example of discretionary spending? a. Medicaid b. Medicare c. Social Security d. national defense ANSWER: d 56. From 1982 through 2018, the Consumer Price Index rose by 154%. Using this rate of inflation, how much would a cup of coffee cost in 2018 if it cost $1.50 in 1982? a. $1.50 b. $2.31 c. $3.81 d. $5.31 ANSWER: c 57. Assume the national debt is $18 trillion and the inflation rate is 2%. What is the inflation tax? a. $60,000 b. $18.36 million c. $36 billion d. $360 billion ANSWER: d 58. Assume the national debt is $18 trillion and the inflation rate is 4%. What is the inflation tax? a. $720 billion b. $140 billion c. $640 billion d. $10 billion ANSWER: a 59. What happens to the supply of savings available to the private capital market if the government issues bonds to fund the deficit and crowding out occurs? a. It shifts to the right. b. It shifts to the left. c. There is movement along the curve. d. It remains static.

ANSWER: b Copyright Macmillan Learning. Powered by Cognero.

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Chapter 4 60. The term secular stagnation refers to: a. a permanent decline in global real interest rates. b. stagflation occurring from unknown causes. c. the recent trend for low-growth, low-inflation macroeconomy. d. falling real wages that are eroding standards of living in developed economies.

ANSWER: a 61. Which is NOT a proposed reason for secular stagnation? a. longer retirement periods b. increased inequality c. increased certainty in the economy d. slower labor force growth ANSWER: c 62. What does secular stagnation imply for policy makers? a. Government spending has a great effect in the economy, leading to a greater spending multiplier. b. Any productive government investments that have a rate of return in excess of the economy's longrun growth rate should be made. c. Any productive government investments that have a rate of return lower than the economy's long-run growth rate should be made. d. Few productive investments are possible by the government, and instead policy makers must focus on paying down government debt.

ANSWER: b 63. What happens to the interest rate firms pay if the government issues bonds to fund a deficit and crowding out occurs? a. It increases. b. It decreases. c. It falls to zero. d. It remains unchanged.

ANSWER: a 64. Which result follows if the government issues bonds to fund a deficit and crowding out occurs? a. Capital expenditures by firms increase because interest rates are lower. b. Capital expenditures by firms decrease because interest rates are higher. c. The government is unable to pay interest payments on national debt. d. The government is able to balance the budget with borrowed funds.

ANSWER: b 65. Which result follows if the government issues bonds to fund a deficit and crowding out occurs? a. Economic growth increases as capital expenditures by firms increase.

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Chapter 4 b. Economic growth slows as capital expenditures by firms decrease. c. Economic growth remains unchanged because deficits do not impact capital accumulation. d. Economic growth slows as firms borrow more in the capital markets.

ANSWER: b 66. Which result follows if the government issues bonds to fund a deficit and crowding out occurs? a. Firms' demand curve for capital shifts to the right. b. Firms' demand curve for capital shifts to the left. c. The quantity of capital firms' demand falls. d. The quantity of capital firms' demand increases.

ANSWER: c 67. What happened to U.S. government spending in 2016 and 2017? a. Government spending decreased overall. b. Government spending increased in a few areas. c. Government spending increased in every area of the budget. d. Government spending decreased in every area of the budget.

ANSWER: c 68. Which is TRUE of the U.S. budget deficit in 2021? a. It is expected to fall due to the tax overhaul. b. It is expected to fall due to a decrease in spending across the budget. c. It is expected to rise due to increases in spending. d. It is expected to be close to zero.

ANSWER: c 69. The "new view" of macroeconomic policy suggests: a. the United States can absorb large increases in debt without interest rates rising. b. crowding out will always occur. c. the United States should decrease the amount of debt it issues. d. the United States can absorb large increases in debt, but interest rates will rise.

ANSWER: a 70. There is a(n) _____ relationship between the interest rate and demand for capital. a. inverse b. direct c. quadratic d. hyperbolic ANSWER: a 71. There is a(n) _____ relationship between the interest rate and supply of savings.

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Chapter 4 a. inverse b. direct c. quadratic d. hyperbolic ANSWER: b 72. The Covid-19 pandemic led to an increase in the savings rate, as people had fewer places to spend money and were uncertain about the future. All else equal, this would lead interest rates to: a. increase. b. decrease. c. remain the same. d. increase, then decrease.

ANSWER: b 73. Suppose the Federal Reserve chairperson announced that they were optimistic about the outlook of the economy. All else equal, this would _____ the demand for capital and _____ interest rates. a. increase; increase b. increase; decrease c. decrease; decrease d. decrease; increase ANSWER: a 74. Explain the views of conservatives and liberals regarding the causes of persistent federal budget deficits.

ANSWER: Conservatives often blame the deficit on the growth in spending by the federal government, whereas liberals counter that an insufficiently progressive tax system is failing to raise revenues needed for valuable government programs. The generally persistent budget deficits could thus be due to a clash between conservatives, who oppose raising taxes, and liberals, who oppose cutting government programs.

75. Suppose that the government was forecast to spend $3 trillion this year and take in $2.5 trillion in revenues.

Suppose one politician argued for selling enough federally owned land in the West to bring in $0.5 trillion in revenue. If this proposal were to pass, describe the effect it would have on the budget in terms of both cash accounting and capital accounting.

ANSWER: Cash accounting measures the deficit by the difference between total spending and total revenues.

Consequently, the politician's proposal would reduce the budget deficit from $0.5 trillion to $0.

Capital accounting, however, also takes into account the effect of the change in the government's net asset holdings. Because assets are reduced by exactly $0.5 trillion in the politician's proposal, his proposal would not affect the deficit in the capital account.

76. Compare and contrast static scoring of the budget with dynamic scoring when it comes to evaluating the effect of a policy change.

ANSWER: Both the static and the dynamic approaches to evaluating the effect of a policy change on the budget take into account how the policy change will affect the behavior of individuals and firms. However, Copyright Macmillan Learning. Powered by Cognero.

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Chapter 4 current budget modelers who use the static approach do not take into account the fact that government policy may affect the size of the economic pie. In contrast, the dynamic scoring approach to budget modeling does take into account the fact that government policy may affect the size of the economic pie itself.

77. Suppose that the federal government is considering two alternative spending bills. The first would purchase land for $80 billion to protect an endangered species, whereas the second would use the $80 billion to build new highways. How would these spending bills affect the cash and capital accounts of the federal government?

ANSWER: Both bills would require an expenditure of $80 billion, so each would reduce the cash account balance by $80 billion because the cash account takes into account only revenues and expenditures.

However, in both cases, the government is purchasing an asset, essentially transferring $80 billion in cash assets to $80 billion in a noncash asset. Consequently, neither bill would affect the capital account.

78. Suppose that the economy is in a recession and that revenues for the current year are equal to expenditures. (a) What is the budget deficit in this case? (b) How would a cyclically adjusted budget deficit be different? Explain.

ANSWER: (a) Because revenues are equal to expenditures, the current budget deficit would be $0. (b) A cyclically adjusted budget deficit determines how much revenue loss and spending increase are because of the economy's deviation from its full potential GDP. Because the economy is in a recession and the unadjusted deficit is $0, the cyclically adjusted budget deficit would in fact be a surplus.

79. Some have argued in favor of reducing taxes on repatriated earnings that companies operating in the United States have made in other countries. Such a tax break could lead to a sharp increase in the amount of repatriated earnings and raise tax revenues. If such an increase were temporary, what would be the effect on the real budget deficit for the current year? What would be the effect on the structural deficit? Explain.

ANSWER: Because this policy change would increase tax revenues without increasing spending, it would reduce any budget deficit in the current year; however, if this increase were temporary, it would not affect the structural budget deficit because, by definition, the structural budget deficit excludes short-term factors, such as this temporary spike in revenues because of the change in the tax policy.

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Chapter 5 1. In December 2015, representatives from 195 nations met in Paris, France, to discuss global warming, which is caused by the: a. burning of fossil fuels such as coal and oil. b. use of renewable sources of energy. c. natural conversion of carbon dioxide into oxygen. d. attempts by various governments to reduce acid rain.

ANSWER: a 2. _____ arise(s) whenever the actions of one party make another party worse or better off, yet the first party neither bears the cost nor receives the benefits of doing so. a. Internalities b. Externalities c. Moral hazard d. Adverse selection ANSWER: b 3. _____ is a problem that causes the market economy to deliver an outcome that does not maximize efficiency. a. Internalities b. Externalities c. Moral hazard d. Market failure ANSWER: d 4. If plumes of exhaust from passing buses are inhaled by bicyclists, a _____ externality is being imposed on _____. a. positive; bus riders b. negative; bus riders c. positive; bicyclists d. negative; bicyclists ANSWER: d 5. Suppose a company that produces chemicals disposes of PCBs (a cancer-causing toxin) in the local lake. The private costs of production are incurred by _____; the social costs of production are incurred by _____. a. the company; the company b. the company; people affected by the PCBs and the company c. people affected by the PCBs; the company d. people affected by the PCBs; people affected by the PCBs and the company ANSWER: b 6. The purchase of coal by a utility is BEST described as a: a. social cost. b. private cost.

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Chapter 5 c. private benefit. d. negative externality.

ANSWER: b 7. Which of these is defined as the private marginal benefit to the consumers less any costs associated with the consumption of the good that are imposed on others who are not fully compensated? a. total social benefit b. total private benefit c. social marginal benefit d. private marginal benefit ANSWER: c 8. To maximize social welfare, which of these must always be TRUE? a. Marginal social benefit equals marginal social cost. b. Marginal private benefit equals marginal social cost. c. Marginal social benefit equals marginal private cost. d. Marginal private benefit equals marginal private cost.

ANSWER: a 9. Someone down the hall playing music loudly in a dormitory while a student tried to study for a big economics exam the next day is an example of which of these? a. negative production externality b. positive production externality c. positive consumption externality d. negative consumption externality ANSWER: d 10. Suppose that a market is in equilibrium and that there is no government intervention in the market. If the private marginal cost of producing an item is $4 and the social marginal cost of production is $6, what is the private marginal benefit of the item? a. $2 b. $4 c. $10 d. $6 ANSWER: b 11. Without government intervention, it is _____ true that _____ in equilibrium. a. always; private marginal benefit equals private marginal cost b. sometimes; private marginal benefit equals private marginal cost c. always; private costs equal private benefits d. always; social marginal benefit equals social marginal cost Copyright Macmillan Learning. Powered by Cognero.

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Chapter 5 ANSWER: a 12. To maximize social welfare when there are no externalities, marginal private costs must be: a. equal to marginal social costs. b. less than marginal private benefits. c. equal to marginal private benefits d. greater than marginal private benefits.

ANSWER: c 13. In a free market in which there is pollution, the optimal amount of pollution reduction occurs when: a. social marginal benefits of reduction equal its total social costs. b. social total benefits of reduction are maximized. c. social marginal benefits of reduction equal its social marginal costs. d. social marginal benefits of reduction equal zero.

ANSWER: c 14. To maximize total welfare, one must equate _____ with _____. a. total social benefit; total social cost b. marginal social benefit; total social cost c. total social benefit; marginal social cost d. marginal social benefit; marginal social cost ANSWER: d 15. The _____ is the direct benefit to consumers of consuming an additional unit of a good. a. private total benefit b. private marginal benefit c. social total benefit d. social marginal benefit ANSWER: b 16. Which of these activities is MOST likely to impose a negative externality? a. smoking b. drinking coffee c. going to a movie d. riding a bicycle ANSWER: a 17. Suppose Anxo enjoys letting the grass in his yard grow wild and free, a practice with which his neighbor disagrees. This is an example of a: a. negative production externality. b. positive production externality.

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Chapter 5 c. positive consumption externality. d. negative consumption externality.

ANSWER: d 18. Suppose Mira’s neighbor decides to secure their single-room air conditioner with duct tape and black plastic, creating a view from Mira’s house that she considers visually unappealing. The duct tape and black plastic are an example of: a. a negative production externality. b. a positive production externality. c. a positive consumption externality. d. a negative consumption externality.

ANSWER: d 19. In private equilibrium, a positive production externality will lead to _____; a negative consumption externality will lead to _____. a. SMC less than PMC; SMC greater than PMC b. SMC less than PMC; SMC less than PMC c. SMB less than PMB; SMC greater than PMC d. SMC less than PMC; SMB less than PMB ANSWER: d 20. Lex’s neighbor's dog has been using his lawn in an unwanted way. If the dog's owner agrees to compensate Lex for the dog's use of his yard, this is an example of: a. a tax. b. a subsidy. c. private bargaining. d. a government solution to an external cost.

ANSWER: c 21. Assigning property rights so that a previously existing externality is now fully accounted for in a market transaction will solve the: a. holdout problem. b. assignment problem. c. free rider problem. d. problem of internalizing the externality.

ANSWER: d 22. Part I of the Coase theorem states that when there are well-defined property rights and costless bargaining, then, in a market in which there is an externality, which statement is TRUE? a. The socially optimal level of consumption can be achieved through the use of taxes and subsidies by the government. b. The socially optimal level of consumption can be achieved through the use of quantity restrictions by Copyright Macmillan Learning. Powered by Cognero.

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Chapter 5 the government. c. The socially optimal level of consumption can be achieved through negotiations between the affected parties. d. The socially optimal level of consumption cannot be achieved without mediation by the government.

ANSWER: c 23. Ismail’s roommate smokes in their apartment, imposing a cost on Ismail. The Coase theorem suggests that one solution would involve: a. the government establishing that the roommate owns the air in their apartment. b. recognizing the fact that no one can own the air in their apartment. c. the government establishing that it owns the air in their apartment. d. a government ban against the production of tobacco products.

ANSWER: a 24. Suppose Aitor often come home and find that an uninvited dog has left a calling card in his yard.

Determining whose dog is responsible is an example of which of these? a. holdout problem b. assignment problem c. free rider problem d. the problem of internalizing the externality ANSWER: b 25. An implication of Part I of the Coase theorem is that in the presence of externalities, government: a. should primarily establish property rights to prevent market failure. b. should primarily use taxes to prevent market failure. c. should primarily use subsidies to prevent market failure. d. can do nothing to prevent market failure.

ANSWER: a 26. According to Part II of the Coase theorem, to achieve the efficient solution to an externality: a. the party imposing the externality must be assigned the property rights. b. property rights must be periodically switched between the parties. c. the government must impose taxes or subsidies. d. property rights must be assigned to one party or the other.

ANSWER: d 27. The success of the Coase theorem depends crucially on: a. one party internalizing the externality. b. the ability of at least one party to make a credible threat. c. negotiation between the parties. d. one party internalizing the externality and negotiation between the parties.

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Chapter 5 ANSWER: d 28. With respect to solving a problem of a negative externality, the assignment problem refers to the difficulty in determining who: a. to tax or subsidize. b. is to blame for an externality. c. bears the damage caused by an externality. d. is not affected by an externality.

ANSWER: b 29. Which of these results when shared ownership of property rights gives each owner power over all the others? a. the holdout problem b. the assignment problem c. the free rider problem d. the problem of internalizing an externality ANSWER: a 30. A club next door plays loud music that irritates the whole neighborhood. The club agrees to turn down the music by 5 decibels for every $25 it collectively receives from its neighbors, and even though the neighbors collectively value reductions of 5 decibels at more than $25 per person, no one pays. This is an example of: a. the holdout problem. b. the assignment problem. c. the free rider problem. d. the problem of internalizing an externality.

ANSWER: c 31. Suppose that factories in Chicago, Illinois, and Gary, Indiana, produce pollution that affects people living in western Michigan. Even though the polluting plants and affected individuals can be identified, the externality cannot be resolved privately because of the large number of both polluters and affected individuals. This is an example of: a. the assignment problem. b. the free rider problem. c. the problem of internalizing an externality. d. transaction costs and negotiating problems.

ANSWER: d 32. Which of these suggests that when an investment has a personal cost but a common benefit, individuals will invest too little? a. holdout problem b. assignment problem c. free rider problem Copyright Macmillan Learning. Powered by Cognero.

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Chapter 5 d. the problem of internalizing an externality ANSWER: c 33. Corrective taxation is BEST used when: a. it is difficult to internalize the externality. b. the government can easily allocate property rights. c. there are well-defined property rights and costless bargaining. d. there are no external costs or benefits.

ANSWER: a 34. Taxing the producer of an externality based on the amount of the externality produced is equivalent to which of these? a. subsidizing the consumer b. subsidizing those outside the market c. increasing the producer's input costs d. increasing the benefits of the consumers in the market ANSWER: c 35. Which type of approach does the Environmental Protection Agency (EPA) take toward resolving externality problems? a. public-sector solutions b. Coasian bargaining c. military action d. free market solutions ANSWER: a 36. If SUVs produce a negative externality, taxing the buyers of SUVs would do which of these? a. shift the private demand curve to the left b. shift the private demand curve to the right c. shift the private supply curve to the right d. shift the private supply curve to the left ANSWER: a 37. Complete the following sentence so that it ALWAYS holds true: In the presence of a positive production externality, _____ is produced relative to the optimal level. a. too much b. too little c. the right amount d. any of the above ANSWER: b 38. For a tax to lead to the optimal amount of pollution, it should be set: Copyright Macmillan Learning. Powered by Cognero.

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Chapter 5 a. greater than social marginal damage. b. equal to social marginal damage. c. greater than social marginal cost. d. equal to social marginal cost.

ANSWER: b 39. If utilities pollute the air too much in private equilibrium, corrective taxation of the utilities would: a. increase pollution and shift the private marginal cost curve downward. b. increase pollution and shift the private marginal cost curve upward. c. reduce pollution and shift the private marginal cost curve downward. d. reduce pollution and shift the private marginal cost curve upward.

ANSWER: d 40. Under an optimal tax system, polluting producers have the incentive to reduce pollution up to the point at which the cost of the reduction is: a. twice the tax imposed. b. equal to the tax imposed. c. equal to the total benefit of the reduction. d. twice the total benefit of the reduction.

ANSWER: b 41. Government subsidizes producers of education in part because education is believed to produce a positive externality. The subsidy shifts the private: a. demand curve to the left. b. demand curve to the right. c. supply curve to the right. d. supply curve to the left.

ANSWER: c 42. Suppose government subsidized the consumption of education by giving education vouchers to parents to spend at the school of their choice. The subsidy would shift the private: a. demand curve to the left. b. demand curve to the right. c. supply curve to the right. d. supply curve to the left.

ANSWER: b 43. A subsidy on the production of education to change its equilibrium price and quantity would: a. increase price and quantity. b. increase price and decrease quantity. c. decrease price and quantity.

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Chapter 5 d. decrease price and increase quantity.

ANSWER: d 44. In a free market with pollution and no government intervention, the market equilibrium quantity of pollution reduction is reached when: a. pollution reduction is zero. (No pollution is reduced.) b. the social marginal cost of reduction equals twice the marginal benefit of reduction. c. the social marginal benefits of reduction equal its social costs. d. the social marginal benefits of reduction equal its social marginal costs.

ANSWER: a 45. When firms in a polluting industry have different costs for the technology to reduce pollution, which of these is efficient? a. mandating equivalent reductions in the quantity of pollution emitted from all firms b. mandating that each firm reduce pollution up to the point at which the marginal cost of reducing pollution is equal to the total social benefit of the reductions for each firm c. mandating that each firm reduce pollution up to the point at which the marginal cost of reducing pollution for each firm is equal to the marginal social benefit of the reductions d. mandating that each firm reduce pollution up to the point at which the marginal benefit of doing so is zero ANSWER: c 46. If government knows the private and social benefit and cost curves associated with reducing pollution, which type of instrument for intervention should the government choose? a. either price or quantity interventions b. neither price nor quantity interventions c. direct government provision of the product in question d. no action because the free market level of pollution is efficient ANSWER: a 47. A government payment to an individual or firm that lowers the cost of consumption or production, respectively, is referred to as which of these? a. Coasian compensation b. subsidy c. tax d. free rider problem ANSWER: b 48. If the social marginal benefit curve of reducing pollution is locally flat, which statement must be TRUE? a. The benefit to society pollution reduction is larger than if the curve is steep. b. The marginal damage curve of pollution is steep. c. The marginal damage curve of pollution is flat.

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Chapter 5 d. The marginal damage associated with reducing pollution is very large.

ANSWER: c 49. When the social marginal benefit curve of reduction of pollution is locally flat and the costs of reduction are uncertain, which of these generally makes sense? a. quantity intervention b. price (tax) intervention c. direct government provision of the product in question d. no action ANSWER: b 50. Suppose government wants to get the amount of pollution right. Which instrument for intervention should the government choose? a. quantity intervention b. price (tax) intervention c. direct government provision of the product in question d. no action ANSWER: a 51. The private marginal benefit of a product's consumption is PMB = 200 − 2Q, and the private marginal cost of its production is PMC = 2Q. The marginal external damage of this good's production is MD = 4Q. The government imposes a tax on each unit sold in an effort to internalize the externality. How high should the tax be set in order to achieve the social optimum? a. $50 b. $100 c. $200 d. $400 ANSWER: b 52. The private marginal benefit of a product's consumption is PMB = 200 − 2Q, and the private marginal cost of its production is PMC = 2Q. The production causes a negative externality, and the government imposes a $400 tax in an effort to internalize the externality. What is the marginal external damage of this good's production? a. $50 b. $100 c. $200 d. $400 ANSWER: d 53. The demand for a product is given by Q = 120 − P, where quantity is measured in pounds. The market supply is given by MC = 10. The production of this product causes toxins to be emitted into the air. The marginal external damage of this product is $2 per unit. What is the equilibrium price and quantity of this good without government intervention?

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Chapter 5 a. $50, 50 b. $10, 50 c. $10, 110 d. $40, 120 ANSWER: c 54. The demand for a product is given by Q = 120 − P, where quantity is measured in pounds. The market supply is given by MC = 10. The production of this product causes toxins to be emitted into the air. The marginal external damage of this product is $2 per unit. What level of taxation would generate the socially efficient level of the good? a. $0 b. $2 c. $10 d. $20 ANSWER: b 55. The demand for a product is given by Q = 120 − P, where quantity is measured in pounds. The market supply is given by MC = 10. The production of this product causes toxins to be emitted into the air. The marginal external damage of this product is $2 per unit. What is the socially efficient production of the good? a. 0 b. 50 c. 108 d. 120 ANSWER: c 56. According to a 2019 study, the costs associated with traffic congestion: a. are expected to decline. b. will include only carbon emissions and lost time. c. will be over $150 billion annually in the United States. d. will not exist because of the increase in public transportation usage.

ANSWER: c 57. Which of these is an example of congestion pricing? a. A state increases the property tax rate. b. A city charges a toll for cars that enter the downtown area between 8 a.m. and 5 p.m. c. A parking service builds additional parking garages in the downtown area. d. The minimum driving age increases from 16 years of age to 18 years of age.

ANSWER: b 58. Which city implemented a congestion tax and realized that the number of private cars that enter the city during enforced hours decreased by 39%? a. Austin Copyright Macmillan Learning. Powered by Cognero.

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Chapter 5 b. London c. Stockholm d. New York ANSWER: b 59. Which of these is one of the reasons congestion pricing was successful in London? a. The government stopped issuing driver's licenses. b. Gasoline taxes tripled. c. Additional buses were added to the public transportation system. d. The government subsidized bicycle purchases.

ANSWER: c 60. Why isn't congestion pricing popular in the United States? a. The United States doesn't have a congestion problem. b. It is too difficult to implement such a tax. c. It would not deter U.S. drivers. d. It is not politically wise.

ANSWER: d 61. Which of these is a reason why research and development, R&D, is considered a positive production externality? a. Innovations by a given firm produce goods and services that are consumed by everyone. b. R&D by a given firm increases the knowledge and technology capacity of other firms. c. Innovations by a given firm are kept secret from other firms in related industries. d. R&D by all firms creates pollution that impacts other firms in related industries.

ANSWER: b 62. According to recent research, what are the social returns to research and development, R&D, compared to private returns? a. Private returns are about three times as large as social returns. b. Social returns are about half of the private returns. c. Social returns are about three times as large as private returns. d. Private and social returns are about the same.

ANSWER: c 63. Knowledge spillovers result in positive production externalities. Which of these is an example of a knowledge spillover? a. A pharmaceutical company develops a new technology that increases the efficiency of manufacturing a new drug as well as increases the risk of cancer in patients. b. SUVs provide a feeling of security because they are so much larger than other cars on the road; however, they increase the insecurity of other cars on the road. c. Mervi improves the landscaping around her house and her neighbor get to enjoy her beautiful yard Copyright Macmillan Learning. Powered by Cognero.

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Chapter 5 every morning from their front door. d. A pharmaceutical company develops a new technology that increases the efficiency of manufacturing a new drug, and other similar companies adopt the new development.

ANSWER: d 64. Vaccination is an example of a positive consumption externality because: a. when individuals vaccinate, they protect themselves and others who may not be vaccinated. b. pharmaceutical companies that did not develop the vaccine benefit from the company that developed it. c. those that get vaccinated have a greater likelihood of developing negative side effects. d. those vaccinated are the only ones to be fully protected.

ANSWER: a 65. Operation Warp Speed (OWS) created incentives to speed the rapid development of vaccines against Covid19. The _____ incentives included grants to offset the enormous cost of research and development. The _____ incentives included advance purchase commitments that ensure that vaccines would be ready to be distributed quickly once developed. a. subsidy; tax b. push; pull c. pull; push d. tax; subsidy ANSWER: b 66. According to climate experts, which country will lose about 17% of the nation's land due to sea-level rise? a. France b. United States c. Bangladesh d. England ANSWER: c 67. Which of these is an example of an environmental externality? a. The contribution of driving to wear and tear on roads is directly proportional to the vehicle's weight. b. The odds of having a fatal accident are directly proportional to the size and weight of the vehicles. c. The odds of a fatal accident in pedestrians and cyclists are directly proportional to the size and weight of the vehicles. d. The contribution of driving to climate change is proportional to the amount of fossil fuel a vehicle requires to travel a mile.

ANSWER: d 68. Suppose a town wishes to build a dam to protect itself from the risk of flooding. Despite the fact that each family in the town is willing and able to pay up to $200 to have the dam built and it will cost only $150 per family, a voluntary contribution campaign is unable to raise enough funds to build the dam. Why? What type of Copyright Macmillan Learning. Powered by Cognero.

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Chapter 5 problem is this, and what solution would work in this case?

ANSWER: This is an example of the free rider problem. Since one family benefits if the other families invest in the dam and since the effect of one family's contribution is quite small, each family will want to free ride off the other families' contributions. One solution to the free rider problem would be to have the local government levy a tax and coerce everyone to pay the $150 per family.

69. Suppose Gwen enjoys riding around her yard on a rather loud dirt bike. What kind of externality is this (positive or negative, consumption or production)? What would the government have to do, if anything, to facilitate a Coasian solution to this externality? Would the result be socially optimal? Explain.

ANSWER: This is a negative consumption externality. To facilitate a Coasian solution, the government would need to establish clear property rights—either Gwen should have the right to ride around on the dirt bike or her neighbors should have the right to quiet. The result would likely be socially optimal: Bargaining costs between Gwen and her neighbor are low, there is no assignment problem, and because there are only two parties, there is no free rider or holdout problem.

70. People who live on the edge of small lakes sometimes have break walls constructed on their property by the shore. A break wall is typically a vertical column of wood or concrete that prevents high water levels from covering part of the owner's property, reducing the size of the beach, and/or eroding the yard. However, several communities have restricted property owners from building break walls. What is one reason for that? Hint: Think about potential externalities of building a break wall.

ANSWER: If one person builds a break wall, the water that ordinarily would have covered a bit more of that person's property now goes to the next lowest spot around the lake. Consequently, by building a break wall, a property owner increases the benefit to another lakefront property owner of building a break wall to protect against the somewhat higher water levels. That is, building a break wall imposes a negative externality on other lakefront property owners. As a result, some lakefront communities have imposed the rule that no one may build a break wall.

71. Suppose that the demand for a chemical is given by Q = 100 − 2P, where quantity is measured in pounds.

The market supply is given by MC = 5. Assume that the marginal external damage of this product is $3 per unit. (a) What is the equilibrium price and quantity of this good without government intervention? (b) What level of taxation would generate the socially efficient level of the good?

ANSWER: (a) Solving P in terms of Q from the demand curve, we get that inverse demand is given by P = 50 − 0.5Q. Setting that equal to the supply, we get 5 = 50 − 0.5Q, which implies that Q = 90. Find the price by plugging 90 in for Q in the inverse demand, and we find that P = 5. (b) Suppose we tax the producer of this product $3 per pound for every pound it makes. This tax would shift up the private marginal cost curve so that it equals the social marginal cost curve. Then we find that 8 = 50 − 0.5Q, which means that Q = 84 and P = $8. Thus, 84 pounds is the socially optimal amount to produce, the amount at which social marginal benefit equals social marginal cost.

72. When are quantity restrictions not the same as price restrictions (via taxes)? Describe one situation in which the government would be better off imposing quantity restrictions than setting a tax and explain why quantity restrictions are better in that case.

ANSWER: If the government knows the relevant marginal cost and marginal damage functions, quantity and price regulation are equivalent. However, when there is uncertainty regarding the marginal cost of reducing the negative externality, one approach may be better than the other. Quantity restriction will be better when the social marginal damage curve is steep—when small amounts of additional Copyright Macmillan Learning. Powered by Cognero.

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Chapter 5 production make society significantly worse off. The example given in the text is that of forest fires, where very small difference in the amount of fires that spreads can make a huge difference in terms of lives saved.

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Chapter 6 1. Which of these can be said about the Obama administration's 2014 Clean Power Plan? a. Coal-fired power plants easily met the new carbon standards. b. The regulation restricted carbon emissions only for coal producers. c. Different states had dramatically different targets for reducing carbon emissions. d. It was embraced by the Trump administration and is now fully in place.

ANSWER: c 2. The Obama administration's Clean Power Plan called for: a. reductions in carbon dioxide emissions from newly constructed power plants only. b. reductions in carbon dioxide emissions from existing power plants. c. uniform reductions in every state, regardless of differences between states. d. closing all coal-fired power plants by the year 2030.

ANSWER: b 3. Major differences between the EPA's estimate of "the social cost of carbon" in the Trump Administration and in the Obama administration include all of these EXCEPT: a. the use of a higher discount rate. b. the focus on domestic benefits. c. the exclusion of global benefits. d. an increase in the statistical value of a human life.

ANSWER: d 4. A similarity between the ACE Rule of the Trump Administration and the CPP of the Obama Administration is that: a. neither passed scrutiny by the courts. b. both required fuel switching from fossil fuels to clean energy. c. both offered quantitative guidelines for emission reductions. d. neither focused on guidelines for individual coal plants.

ANSWER: a 5. Particulate matter is created when _____ are released into the atmosphere. a. sulfur dioxide and carbon dioxide b. carbon monoxide and nitrogen oxides c. sulfur dioxide and nitrogen oxides d. carbon monoxide and carbon dioxide ANSWER: c 6. The MOST significant negative impact of particulates is: a. damage to property. b. reduced visibility. c. adverse health outcomes.

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Chapter 6 d. climate change.

ANSWER: c 7. Which of these statements is TRUE about the early 1980s? a. Total emissions were higher than they were before the Clean Air Act of 1970. b. Total emissions were lower than they were before the Clean Air Act of 1970. c. Most emissions were due to the construction of new (post-1970) coal-burning plants. d. The requirements of the Clean Air Act of 1970 had proven too burdensome.

ANSWER: b 8. The release of particulates into the air by coal-fired power plants is a: a. positive production externality. b. positive consumption externality. c. negative production externality. d. negative consumption externality.

ANSWER: c 9. The health costs associated with particulates: a. can be observed by comparing outcomes in areas with high levels of particulates to outcomes in areas with low levels of particulates. b. are not significant because economic costs only relate to property damage. c. cannot be estimated because there is no way to determine the cause of differential health outcomes. d. can best be estimated based on quasi-experiments with treatment and control groups.

ANSWER: d 10. The Clean Air Act of 1970 was intended to reduce emissions that cause acid rain by: a. setting standards for new coal-fired power plants. b. setting standards for existing coal-fired power plants. c. imposing a tax on energy produced by coal-fired power plants. d. requiring that existing coal-fired power plants install scrubbers.

ANSWER: a 11. The Clean Air Act of 1970 forced utilities to: a. install scrubbers on power plants built before 1970. b. install scrubbers on power plants built after 1970. c. relocate large numbers of power plants to Mexico. d. immediately replace older, dirtier power plants with new plants equipped with scrubbers.

ANSWER: b 12. Which of these is an unintended consequence of the 1970 Clean Air Act? a. Utilities relocated large numbers of power plants to Mexico.

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Chapter 6 b. Utilities began operating more nuclear power plants. c. Utilities ran plants built prior to 1970 longer than they would have otherwise. d. The coal mining industry suffered massive job losses.

ANSWER: c 13. The 1990 amendments to the Clean Air Act included a regulation that mandated: a. significant reductions in sulfur dioxide emissions by all plants, even older ones. b. significant reductions in sulfur dioxide emissions by newly constructed plants only. c. replacement of all older power plants with new plants utilizing cleaner technology. d. no further reductions in sulfur dioxide emissions, since the goals established in 1970 had been achieved.

ANSWER: a 14. Which of these was a source of opposition to the 1990 amendments to the Clean Air Act? a. An industry study conducted in 1989 predicted the loss of up to 4 million jobs. b. The nuclear power plants that would be built as a result were unwanted in most communities. c. The changes did not allow older plants to purchase emission allowances from newer plants. d. Environmentalists favored an allowance and trading system.

ANSWER: a 15. The 1990 amendments to the CAA created an SO2 emissions trading system. Under this system: a. the government forced closures of coal-fired power plants. b. firms could trade permits to emit limited quantities of SO2. c. taxes were imposed on carbon. d. firms could purchase rights to dump pollution in developing countries.

ANSWER: b 16. In comparing the health outcomes of communities in attainment and nonattainment areas before and after the Clean Air Act of 1970, Chay and Greenstone (2003) used a: a. time series analysis. b. cross-sectional regression analysis. c. randomized trial. d. quasi-experiment.

ANSWER: d 17. Chay and Greenstone (2003) estimated the effect of the Clean Air Act of 1970 by comparing the health outcomes of people in attainment areas with those of people in nonattainment areas both before and after the law was passed. They found that: a. reduced emissions led to a decrease in infant mortality. b. reduced emissions did not affect infant mortality. c. the Clean Air Act of 1970 did not affect emissions in any state.

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Chapter 6 d. the Clean Air Act of 1970 affected different regions of the country in the same way.

ANSWER: a 18. Which of these statements regarding the effects of amendments to the Clean Air Act passed in 1990 is accurate? a. The amendments encouraged utilities to operate older power plants longer than they would have otherwise. b. The amendments had little effect on emissions overall, although they did affect local areas. c. The tradable permit system established by the amendments worked well. d. The tradable permit system established by the amendments did not work well.

ANSWER: c 19. The Clean Air Act of 1970 and the 1990 amendments to the act can be judged a success if the: a. benefits of the regulations resulted in improved health outcomes. b. costs of the regulations did not include significant job loss. c. benefits of lowering particulate emissions are greater than the economic costs. d. regulations result in a reduction in greenhouse gas emissions and acid rain.

ANSWER: c 20. Evidence that, despite the successes of the CAA, efforts to curb emissions have not gone far enough includes all of these EXCEPT: a. decreased enforcement of the CAA provisions. b. increases in particulate matter in the air. c. increases in the number of coal-fired plants in the United States. d. estimates that the marginal costs of reducing emissions are below the estimated marginal benefits.

ANSWER: c 21. According to our best estimates, the surface temperature of the Earth will rise by at least _____ degrees Fahrenheit by the end of the century. a. 5.4 b. 3.2 c. 2.1 d. 9.7 ANSWER: b 22. The 1997 global meeting on climate change in Kyoto, Japan, addressed: a. acid rain only. b. wastewater disposal. c. melting of the polar ice caps. d. greenhouse gas emissions.

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Chapter 6 23. A rise in the Earth's surface temperature of 6 degrees Fahrenheit would be expected to lower global GDP by _____% by the year 2100. a. 10 b. 20 c. 30 d. 40 ANSWER: a 24. In 2017, approximately how much was spent on climate-related disaster funding per U.S. taxpayer? a. $100 b. $500 c. $1,000 d. $5,000 ANSWER: c 25. In the United States in 2019, fossil fuels accounted for _____% of all the energy used. a. 63 b. 98 c. 78 d. 12 ANSWER: a 26. The negative externality that potentially poses the greatest harm to humans is: a. rising health care costs caused by smoking. b. climate change caused by greenhouse emissions. c. the increasing acidity of lakes and streams caused by sulfur dioxide and nitrogen oxide emissions. d. the corrosion of metals and the deterioration of stone caused by acid rain.

ANSWER: b 27. What was the main achievement of the Montreal Protocols of 1987? a. banning overfishing in endangered areas b. phasing out the use of hydrofluorocarbons c. increasing funding to developing countries to decrease dependence on fossil fuels d. banning the use of chlorofluorocarbons ANSWER: d 28. The goal of the 1997 Kyoto treaty was to combat global warming by: a. cutting greenhouse emissions below 1970 levels by 2010. b. cutting greenhouse emissions below 1990 levels by 2010. c. relocating coal-fired power plants to areas of the planet with the highest concentrations of greenhouse gases.

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Chapter 6 d. relocating coal-fired power plants to areas of the planet with the lowest concentrations of greenhouse gases.

ANSWER: b 29. Which country was the top carbon dioxide emitter in 2019? a. United States b. Russia c. Germany d. China ANSWER: d 30. Climate change is primarily caused by an increase in what gas? a. carbon monoxide b. nitric oxide c. sulfur dioxide d. carbon dioxide ANSWER: d 31. Scientists discovered a hole opening up in the ozone layer in the 1980s. As a result, the international community adopted the _____ in September 1987. a. Kyoto Treaty b. Clean Air Act c. Montreal Protocol d. Antarctica Accord ANSWER: c 32. Under the 1997 Kyoto treaty, the industrialized signatories: a. are not allowed to trade emissions rights. b. are allowed to trade emissions rights among themselves, provided that overall emissions goals are achieved. c. must reduce emissions in the most cost-effective way, leading most industrialized countries to refuse to sign the treaty. d. must reduce emissions only when it is cost-effective, resulting in participation by such countries as the United States.

ANSWER: b 33. Which country, in 2014, launched a campaign to curb pollution, resulting in 32% less particulate matter in the air just four years later? a. China b. Russia c. United States d. Canada Copyright Macmillan Learning. Powered by Cognero.

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Chapter 6 ANSWER: a 34. The American Clean Energy and Security Act (2009), which set a target for reducing carbon emissions, was: a. approved by the Senate but not the House of Representatives. b. approved by the House of Representatives but not the Senate. c. passed by Congress and signed into law by the President. d. passed by Congress but vetoed by the President.

ANSWER: b 35. The American Clean Energy and Security Act (2009) sought to decrease greenhouse gas emissions by: a. enacting a carbon tax. b. setting limits on emissions produced by firms. c. providing subsidies to firms that decrease their emissions over time. d. creating a system of tradable emissions permits.

ANSWER: d 36. Criticisms of the American Clean Energy and Security Act (ACES) of 2009 included all of these EXCEPT that: a. it would lead to higher prices and fewer jobs. b. the value of the emission allowances would be rebated to industry rather than consumers. c. carbon dioxide was not included as an emission in the tradable permit system. d. the government would have initially given most permits away rather than auctioning them to polluting firms.

ANSWER: c 37. Which of these was an unintended consequence of banning chlorofluorocarbons? a. The world found a substitute in hydrofluorocarbons. b. Developed countries started producing less of all pollutants. c. All countries stopped producing products that emitted hydrofluorocarbons. d. Less developed countries stopped producing products that emitted chlorofluorocarbons.

ANSWER: a 38. Which of these was a concern for developing countries about a hydrofluorocarbon (HFC) ban? a. The damage already done was irreversible. b. The ban would eliminate millions of jobs. c. Expensive alternatives would make air conditioners unaffordable for millions. d. The ban would reduce economic growth in developed countries by about 0.5% annually.

ANSWER: c 39. Which of these was an outcome of the Paris Agreement? a. The countries agreed to keep the rise in the average global temperature 2 degrees Celsius above Copyright Macmillan Learning. Powered by Cognero.

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Chapter 6 preindustrial levels. b. The countries agreed to stop production of products that emit hydrofluorocarbons. c. A global progress report will evaluate progress every ten years. d. Less developed countries will stop producing products that emit chlorofluorocarbons.

ANSWER: a 40. The United States was the first country to withdraw from the Paris Agreement under the _____ administration; however, it reentered the agreement on the first day of the _____ administration. a. Trump; Biden b. Obama; Trump c. Bush; Obama d. Obama; Biden ANSWER: a 41. Currently, what proportion of Americans smoke? a. less than 3% b. approximately 14% c. nearly 19% d. more than 30% ANSWER: b 42. The damage people do to themselves through adverse health (or other) behavior is referred to as a(n): a. actuarial adjustment. b. externality. c. internality. d. self-control problem.

ANSWER: c 43. If smokers are less productive in the workplace and the laws were to prohibit differential pay on the basis of smoking behavior, then smoking would: a. exert a positive externality. b. exert a negative externality. c. not exert an externality. d. internalize the externality associated with smoking.

ANSWER: b 44. In the standard utility maximization model, smoking results from: a. an irrational choice. b. a miscalculation of the benefits and costs of smoking. c. a rational choice. d. perfect information about the costs of smoking.

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Chapter 6 ANSWER: c 45. According to economists Becker and Murphy (1998), "rational" cigarette addicts: a. do not consider the potential costs associated with smoking. b. are not capable of making rational choices, so government action is needed. c. do not understand that smoking today increases their addiction in the future. d. understand that smoking today increases their addiction in the future.

ANSWER: d 46. Which statement implies that smoking produces a negative externality? a. Employers lower all wages to account for less productive workers. b. Smokers die too early to collect Social Security benefits. c. Insurance companies adjust insurance premiums for smoking status. d. Income earned by smokers is lower because they tend to be less productive.

ANSWER: a 47. Potential negative externalities of smoking include all of these EXCEPT that smokers: a. are less likely to collect social security due to premature death. b. cause higher health insurance premiums for everyone. c. are less productive than other workers, resulting in lower pay for all workers. d. are more likely to start fires, increasing costs for local fire departments.

ANSWER: a 48. Which statement implies that smoking yields a positive externality? a. Employers lower all wages to account for less productive workers. b. Smokers die too early to collect Social Security benefits. c. Insurance companies adjust insurance premiums for smoking status. d. Income earned by smokers is lower because smokers tend to be less productive.

ANSWER: b 49. Which statement does not imply that smoking yields a negative externality? a. The health care costs of the uninsured are passed on to others. b. Secondhand smoke has serious effects not considered by smokers when they decide to smoke. c. Fire damages nonsmokers' property, and smokers are more likely to start fires. d. Since smokers die early, they won't have high nursing home costs.

ANSWER: d 50. Suppose smoking increases health care costs in a society in which everyone has health insurance. If smokers are charged higher prices for health insurance, the smoking externality is: a. internalized through actuarial adjustments. b. internalized through compensating differentials.

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Chapter 6 c. positive instead of negative. d. not internalized.

ANSWER: a 51. By most estimates, the _____ due to smoking (excluding secondhand smoke) are _____ the level of taxation. a. externalities; greater than b. externalities; less than c. internalities; greater than d. internalities; less than ANSWER: b 52. An estimate of the external costs of smoking (excluding those associated with secondhand smoke) is approximately _____ per pack in 2020 dollars. a. 56¢ b. $3 c. $20 d. 89¢ ANSWER: a 53. Externalities associated with secondhand smoke are difficult to estimate for all of these reasons EXCEPT that: a. there is considerable medical uncertainty about the damage done by secondhand smoke. b. rational smokers have already internalized the potential harm to nearby individuals in their utility calculations. c. nearby individuals may receive utility from secondhand smoke. d. most of the damage of secondhand smoke is inflicted on household members.

ANSWER: c 54. The fact that 80% of smokers wish to quit but fewer than the 80% do is evidence of a: a. compensating differential. b. commitment device. c. financial externality. d. self-control problem.

ANSWER: d 55. Colin making a $200 bet that he will quit smoking by the end of the month is an example of a(n): a. actuarial adjustment. b. commitment device. c. financial externality. d. self-control problem.

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Chapter 6 ANSWER: b 56. If cigarette taxes were increased to completely internalize the negative effects of secondhand smoke, the price that smokers actually pay for cigarettes would: a. stay about the same. b. fall. c. increase. d. be the same amount as sellers receive.

ANSWER: c 57. If cigarette taxes were increased to completely internalize the negative effects of secondhand smoke, the volume of cigarettes bought and sold in the market would: a. stay about the same. b. fall. c. increase. d. decrease to zero.

ANSWER: b 58. Which of these is a finding of the research on setting the legal drinking age? a. Lowering the drinking age to 18 led to 6%–17% less drinking among 18- to 20-year-olds. b. Those who start drinking earlier are less likely to drink later in life. c. A lower drinking age is associated with a 17% increase in the rate of motor vehicle deaths for 18- to 20-year-olds. d. Lowering the drinking age has no adverse effects on those aged 18 to 20.

ANSWER: c 59. An estimate of the external cost of consuming one alcoholic beverage is: a. about the same as the per-ounce tax. b. much higher than the per-ounce tax. c. much lower than the per-ounce tax. d. zero.

ANSWER: b 60. The internalities from alcohol consumption are: a. about the same as the internalities from smoking. b. much higher than the internalities from smoking. c. much lower than the internalities from smoking. d. zero.

ANSWER: c 61. Higher alcohol taxes would: a. raise social welfare.

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Chapter 6 b. decrease alcohol consumption to zero. c. decrease social welfare. d. harm those who drink little disproportionately.

ANSWER: a 62. What is the recommended way to manage the high externalities of alcohol use? a. increase taxes on alcohol b. further regulate the times, days, and stores that can sell alcohol c. raise the drinking age to 25 d. regulate the percentage of alcohol allowed in beer, wine, and liquor ANSWER: a 63. Beginning in the late 1990s, a rapid increase in drug overdose deaths was primarily caused by: a. a decrease in the cost of crack cocaine. b. the legalization of medical marijuana in many states. c. the oversubscribing of opioid pain medications such as Oxycontin. d. the increased availability of methamphetamines.

ANSWER: c 64. The fastest growing public health problem in the United States today is: a. drug-related accidents. b. diabetes, which is linked to rising obesity rates. c. sexually transmitted diseases. d. smoking-related diseases.

ANSWER: b 65. Causes of obesity include all of these EXCEPT: a. a decrease in the number of jobs that require physical activity. b. the rising opportunity costs of exercise. c. a lack of access to nutritious food in "food deserts" of low-income neighborhoods. d. the increased use of genetically modified organisms in food products.

ANSWER: d 66. Public policy initiatives to reduce obesity: a. have not been proposed but hold a lot of promise. b. have been highly effective. c. have not proven highly successful. d. are not within the jurisdiction of economic policy.

ANSWER: c 67. A 2016 study examined the effects of short-term variation in particulate matter on mortality. What caused Copyright Macmillan Learning. Powered by Cognero.

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Chapter 6 that short-term variation in particulate matter? a. temperature b. wind c. precipitation d. traffic ANSWER: b 68. Which of these was a result of the sugar tax in Philadelphia? a. Residents were more likely to consume energy drinks than bottled water. b. Residents were less likely to consume soda. c. Residents were less likely to consume bottled water. d. Residents were more likely to consume foods high in sugar than drinks high in sugar.

ANSWER: b 69. One of the MOST effective methods of internalizing externalities associated with obesity is: a. taxing sugary drinks. b. banning fast food restaurants. c. regulating the amount of genetically modified organisms in the food supply. d. subsidizing organic farms and cooperatives.

ANSWER: a 70. Contrast the views of supporters and opponents of the 2014 Clean Power Plan.

ANSWER: Supporters praised the flexibility the plan affords states in determining how they will meet the standard set by the law in ways most suited to their own circumstances. The EPA estimated that the rule would cut air pollutants such as sulfur dioxide, nitrogen oxide, and soot by 25% by 2030, yielding a positive externality of between $55 and $93 billion per year until 2030. This would far outweigh the expected costs of implementing the plan of between $7 and $9 billion per year.

Opponents argued that the proposed emissions cuts were not feasible, given current technology, and that they would therefore drive companies and jobs overseas, pushing up energy costs and lowering incomes.

71. Evaluate the success of the Clean Air Act (CAA) of 1970 and the 1990 amendments. What are the important issues that should be considered in order to analyze these regulations accurately?

ANSWER: Regulations are considered successful if the benefits exceed the economic costs, that is, if the net benefits are positive. Benefits include reduced property damage and the prevention of harmful health effects. It is hard to determine whether the net economic costs from the CAA program are smaller than its benefits. Greenstone (2002) estimates that in its first 15 years, the CAA cost almost 600,000 jobs and $75 billion in output in pollution-intensive industries. On the other hand, the health improvements are very important, especially given that they create long-term gains. Burtraw et al. (1997) estimate that the health benefits alone from reducing emissions exceeded by seven times the cost of reduction once the lower-cost trading regime was in place.

72. A grandfather clause in a regulation typically exempts existing facilities or operations from the new regulation. For example, the Clean Air Act of 1970 exempted existing plants from the regulation, which Copyright Macmillan Learning. Powered by Cognero.

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Chapter 6 affected only new plants. What was the rationale for including a grandfather clause in something like the Clean Air Act of 1970? Describe a negative result of the grandfather clause used in the 1970 act?

ANSWER: Grandfather clauses are typically used to ensure that new regulation does not impose significant costs on companies that made decisions to invest before the new regulation was passed. In the case of the Clean Air Act, it is much more costly to upgrade existing power plants to meet new requirements than it is to make a new plant meet those same requirements. Grandfather clauses take the approach that, for this reason, only new plants will be subject to the regulation, with the thought that the regulation will gradually take place in the least costly way possible as the old plants are closed. However, the perverse incentive of the grandfather clause on the Clean Air Act of 1970 was to encourage utilities to keep operating the old, dirty plants far longer than they would have without the regulation.

73. Discuss the difference between the problem of climate change and the problem of ozone depletion, including how these differences have affected resolutions to the underlying problems.

ANSWER: Ozone depletion is caused primarily by the release of chlorofluorocarbons (CFCs), and by 1987, the problem was rapidly getting worse. As the effects of the release of CFCs (a 25-million-squarekilometer hole in the ozone layer over Antarctica) showed themselves immediately and urgently, the international community met and adopted the Montreal Protocol. In contrast, the problems that arise from climate change are not immediately apparent but appear gradually. As a result, the international community took a considerable amount of time to become sufficiently alarmed to act, as it finally did in the form of the Kyoto protocol and later the Paris agreement. Further complicating the issue is how to include developing countries in an agreement in a way viewed as fair to both developed and developing countries.

74. If all the effects of secondhand smoke occurred among a person's family in their home, is there any alternative to a public-sector approach of taxes, subsidies, or regulation to resolving this externality? Explain.

ANSWER: In this case, a Coasian solution may be in order. If one person in the family is assigned the property rights to the air in the household, then one of two Coasian solutions could occur. If the property rights were allocated to the smoker, the nonsmokers could compensate the smoker for not smoking in the house. Alternatively, if the property rights were allocated to a nonsmoker, the nonsmoker could charge the smoker for the right to smoke in the house. By part II of the Coase theorem, either approach would resolve the externality.

75. How might the externality of smoking be different in a state in which unions negotiate common wages for all employees in similar positions in a company versus a state in which there are no labor unions and wages are negotiated by each employee? Assume that all other aspects of these two states are identical.

ANSWER: One possible externality works through less productive workers who smoke. If wages are individually adjusted according to productivity, smoking may not lead to a negative externality.

However, if wages are not adjusted for productivity at the individual level, wages may have to be lowered for all workers to offset the productivity loss. Consequently, smoking is likely to cause a larger externality in the state in which there are labor unions than in the state without them.

76. The average weight of American adults increased by about 10 pounds in the 1990s. In November 2004, it was reported that U.S. airlines spent $275 million more in fuel costs to transport this additional weight. Under what circumstances would this increased cost be an externality of obesity, and under what circumstances would it not be an externality?

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Chapter 6 ANSWER: If airlines can pass along the costs of carrying an obese passenger to that particular passenger, then there is no externality. However, if airlines must spread the costs of transporting obese people over all passengers, including those who are slim, obesity causes a negative externality for slimmer airline passengers.

77. In recent years, there have been a number of different efforts to use public policy tools to reduce obesity.

Summarize at least three of these new approaches.

ANSWER: One approach is to make healthier foods more readily available, particularly in low-income neighborhoods where traditional grocery stores are scarce. Another approach is to tax or even ban unhealthy foods. In some cases, the focus is on information; for example, a regulation may require restaurants to display calories on their menus. Some public schools have banned soda and junk foods from their cafeterias and required more physical activity. Some countries have even decided to impose costs on individuals who are obese.

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Chapter 7 1. Public goods: a. are likely to be underprovided by the private sector due to the free rider problem. b. are likely to be overprovided by the private sector due to the free rider problem. c. can be provided only by the public sector, while private goods can be provided only by the private sector. d. cannot be provided by the private sector because they are rival in consumption.

ANSWER: a 2. Government may not be able to determine the optimal amount of a public good because: a. it is easier to determine the costs and benefits associated with public goods than those associated with private goods. b. it is easier to determine the costs and benefits associated with private goods than those associated with public goods. c. the quantity of public goods provided by private parties is zero. d. there is no optimal mix of public and private goods.

ANSWER: b 3. National defense is: a. excludable but not rival. b. rival but not excludable. c. both rival and excludable. d. neither rival nor excludable.

ANSWER: d 4. If one person consumes a good so that no other person can consume it at all, then that good is: a. excludable. b. non-excludable. c. purely rival. d. partially rival.

ANSWER: c 5. What property must a good satisfy to be a pure public good? a. It must be non-rival in consumption. b. It must be rival in consumption. c. It must be non-rival in production. d. It must be rival in production.

ANSWER: a 6. A road that is non-excludable and rival in consumption is a(n): a. pure private good. b. pure public good.

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Chapter 7 c. impure public good. d. altruistic good.

ANSWER: c 7. Which of these is excludable but non-rival in consumption? a. a road b. cable television c. a lighthouse d. public radio ANSWER: b 8. A painting by Monet displayed in a museum is: a. excludable but not rival. b. rival but not excludable. c. both rival and excludable. d. neither rival nor excludable.

ANSWER: a 9. If a good becomes less valuable as a result of one consumer's use of the good but does not become worthless to other consumers, that good is: a. purely excludable. b. partially excludable. c. purely rival. d. partially rival.

ANSWER: d 10. Which is a property of a private good such as a sandwich? a. non-rival in consumption b. rival in consumption c. non-excludable d. subject to the free rider problem ANSWER: b 11. Which statement is generally TRUE? a. Private markets overprovide public goods. b. Private markets underprovide public goods. c. Private markets provide the socially optimal amount of public goods. d. Private markets do not provide public goods.

ANSWER: b 12. Economists refer to individuals who care about outcomes for other people as: Copyright Macmillan Learning. Powered by Cognero.

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Chapter 7 a. free riders. b. irrational. c. actuarially adjusted. d. altruistic.

ANSWER: d 13. Which activity is considered altruistic? a. planting flowers in one’s own yard b. donating money to the Red Cross c. going to college d. saving for retirement ANSWER: b 14. Suppose many potential donors reduce their annual gifts in response to government grants to local medical research projects. This is an example of: a. the difficulty of determining the public's preferences for public goods. b. crowd-out of the private provision of public goods. c. the difficulty of measuring the costs and benefits of public goods. d. crowd-in of the public provision of private goods.

ANSWER: b 15. If it is not possible to prevent potential users from consuming or having access to the benefits of a good, that good is: a. excludable. b. non-excludable. c. purely rival. d. partially rival.

ANSWER: b 16. A good for which the price is set at $1 to model choice between goods is a(n): a. pure public good. b. numeraire good. c. impure public good. d. pure private good.

ANSWER: b 17. Which of these is TRUE when the socially optimal amount of a private good is produced? a. The private benefit equals the private cost. b. The social marginal benefit equals the private marginal cost. c. The consumer surplus equals the producer surplus. d. The social marginal benefit exceeds the social marginal cost.

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Chapter 7 ANSWER: b 18. Which of these is TRUE when the provision of a public good is optimal? a. The marginal cost equals the marginal rate of substitution for each consumer. b. Each consumer's surplus equals the marginal cost. c. Total consumer surplus equals the marginal cost. d. The sum of the marginal rates of substitution across all consumers equals the marginal cost.

ANSWER: d 19. The underprovision of public goods by the private market results from the: a. holdout problem. b. assignment problem. c. free rider problem. d. irrationality problem.

ANSWER: c 20. Suppose a downtown business owner tries to convince the owners of nearby businesses to renovate their buildings to make the downtown area more attractive to shoppers. The problem that is likely to prevent this plan from going forward is the: a. free rider problem. b. assignment problem. c. crowding-out problem. d. irrationality problem.

ANSWER: a 21. Business improvement districts have tended to be effective in overcoming the free rider problem when: a. laws force businesses to pay necessary fees. b. business owners are altruistic. c. there is substantial social capital in the business district. d. local businesses merge, aligning their interests.

ANSWER: a 22. Ronald Coase argued that British lighthouses were provided and maintained by private interests long before the government took them over. Given the seemingly non-rival and non-excludable nature of lighthouses, how might this have been possible? a. Lighthouses are not excludable, but port access is; and port fees could have been assessed on the number of lighthouses a ship must pass en route to a given port. b. The historical period in question predated the rise of capitalism; thus, sea captains may have been willing to help pay for lighthouses out of altruism. c. Lighthouses were built and maintained by a consortium of shipping companies; since every shipping company was in the consortium, there would have been no free riders. d. It wasn't in fact possible for private interests to provide and maintain lighthouses; so contrary to Copyright Macmillan Learning. Powered by Cognero.

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Chapter 7 Coase, lighthouses were government-provided.

ANSWER: a 23. Suppose the local public radio station, supported partly by voluntary contributions, reaches eight towns.

Also suppose that the station has vowed not to report on the local news events of any town whose residents have not made a minimum level of contributions to the station. This could be BEST characterized as a: a. private-sector approach to providing a public good. b. private-sector approach to providing a private good. c. government solution to the free rider problem. d. public-sector approach to providing a public good.

ANSWER: a 24. Which factor is likely to prevent private market forces from providing the optimal amount of a public good? a. non-satiated preferences b. large differences among individuals in their demand for the public good c. little or no difference among individuals in their demand for the public good d. the free rider problem ANSWER: d 25. Which of these is a reason to be cautious about interpreting results from laboratory experiments in economics? a. The experiments do not typically allow subjects to keep real money. b. Typical subjects in these experiments may not be representative of the entire population. c. The stakes are typically greater in experiments than in the real world. d. Laboratory experiments cannot really be conducted in economics, since it is a social science.

ANSWER: b 26. Which activity is MOST consistent with altruism? a. buying more of a good as its price rises, other things equal b. volunteering to pick up trash in the community c. taxing individuals to pay for a new park d. taxing businesses to pay for a new park ANSWER: b 27. Which factor is likely to encourage the private provision of a public good? a. large differences among individuals in their demand for the public good b. little or no difference among individuals in their demand for the public good c. the existence of free riders who enjoy the benefits but refuse to pay the cost of the public good d. the fact that the benefits of the public good are available to everyone ANSWER: a 28. Sally and Roger live next door to each other and share a large backyard space that contains an elaborate Copyright Macmillan Learning. Powered by Cognero.

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Chapter 7 garden requiring costly upkeep. If Sally and Roger have identical incomes, but Sally values the garden more than Roger, then Sally will likely: a. free ride off Roger and not pay anything towards upkeep of the garden. b. cover a larger share of the upkeep of the garden than Roger out of altruism. c. cover a larger share of the upkeep of the garden than Roger out of self-interest. d. pay for the socially optimal level of upkeep of the garden.

ANSWER: c 29. Nora, a wealthy businesswoman, and Ravi, a poor production worker, share a 10-acre plot on which each owns a home—Nora a mansion and Ravi a bungalow. Though Nora and Ravi value the property equally, only Nora pays for upkeep, reflecting her less stringent budget constraint. Assuming neither party is altruistic or susceptible to the warm glow phenomenon, Nora and Ravi will fail to achieve a social optimum because: a. each will free ride on the other. b. Nora, in her expenditures on upkeep, will not take into account Ravi's interests. c. in the absence of altruism, social optima are unobtainable in the private market. d. Ravi fails to contribute his fair share.

ANSWER: b 30. Which of these is LEAST likely to characterize a society with a high level of social capital? a. strong interconnections among individuals and groups b. a high level of trust c. an ethic of individualism d. an affiliative culture ANSWER: c 31. Which action is BEST described by the warm glow model? a. making a donation to a charitable organization to reduce one's tax obligations b. using a national park without contributing to its upkeep c. making a large donation to a charitable organization to gain acceptance from friends d. not being able to consume a private good and blaming the government for it ANSWER: c 32. The extent of crowd-out associated with the government provision of public goods rises: a. as people derive more utility from contributing themselves to the provision of public goods. b. as differences in preferences among the beneficiaries of public goods increase. c. with the robustness of the initial equilibrium. d. as differences in income among the beneficiaries of public goods increase.

ANSWER: c 33. If government provision of a public good results in an equal reduction in the provision of the good by market forces, then: a. private provision is partially crowded out.

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Chapter 7 b. private provision is not crowded out. c. the warm glow effect caused an increase in the net amount of the public good. d. private provision is fully crowded out.

ANSWER: d 34. Suppose Mahindra and Kyoko—who live in a high-crime neighborhood—each provide 8 hours of guard service per day, so that the total private provision of guard service—which costs $2.50 per hour or $20 per 8hour shift—is 16 hours per day. The government then tries to achieve the social optimum of 24 hours of guard service per day by taking $10 from both Mahindra and Kyoko and using the $20 it acquires to provide 8 more hours of guard service per day. If Mahindra's and Kyoko's willingness to pay for guard service remains unchanged, what will be the result? a. partial crowd-out b. full crowd-out c. partial crowd-in d. a social optimum ANSWER: b 35. Suppose that Mahindra has a stronger preference for guard service than Kyoko and consequently pays $40 for 16 hours of guard service per day, while Kyoko pays nothing. The government then tries to achieve the social optimum of 24 hours of guard service per day by charging $10 each to Mahindra and Kyoko and using its additional $20 to provide 8 more hours of guard service. In this situation, a. Mahindra will lower his provision of guard service by 8 hours, so there will be full crowd-out. b. Mahindra will lower his provision of guard service by less than 8 hours, so there will be partial crowd-out. c. Mahindra will increase his provision of guard service, so there will be crowd-in. d. Mahindra will decrease his provision of guard service, while Kyoko will increase hers, leading to crowd-out or crowd-in, depending on which change is larger.

ANSWER: b 36. Assume that private firms already provide some quantity of a public good in the absence of government intervention. If the government begins to provide the public good, it is likely that: a. private provision of the good will be unaffected, and the overall provision of the good will increase. b. taxpayers will refuse to support public provision of a good that is already privately provided. c. private provision of the good will be crowded out by its public provision. d. private provision of the good will be crowded in by its public provision.

ANSWER: c 37. In what sense is the problem of the public provision of public goods an externality problem? a. Public goods generate negative externalities and so tend to be overproduced. b. Public goods must be purchased by the government, leading to increased government debt. c. Public goods must be funded through taxes, which distort market signals. d. Public goods generate positive externalities and so tend to be underproduced.

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Chapter 7 ANSWER: d 38. In 1996, legal changes reduced the eligibility of noncitizens for cash welfare programs. Evidence on the resulting changes in charitable support by churches suggests that crowd-out is: a. insignificant, since churches in high-immigrant areas increased their charitable spending much more than churches in low-immigrant areas. b. significant, since churches in high-immigrant areas increased their charitable spending much more than churches in low-immigrant areas. c. insignificant, since there was no difference in the charitable spending of churches in high-immigrant areas and those in low-immigrant areas. d. significant, since there was no difference in the charitable spending of churches in high-immigrant areas and those in low-immigrant areas.

ANSWER: b 39. Which is NOT a barrier to solving the free rider problem in the provision of public goods? a. Individuals may not know their valuations of public goods. b. Individuals may not reveal their valuations of public goods to the government. c. The government may not be able to aggregate the preferences of millions of citizens. d. Some individuals may voluntarily choose to pay for a public good.

ANSWER: d 40. Which is generally TRUE of the empirical evidence on the crowding out of individual contributions by government spending? a. The crowd-out effect is close to zero in both empirical and experimental studies. b. The crowd-out effect is approximately 50% in both empirical and experimental studies. c. The crowd-out effect is substantially larger in empirical studies than in experimental studies. d. The crowd-out effect is substantially smaller in empirical studies than in experimental studies.

ANSWER: d 41. Contracting out is an approach through which the government: a. is responsible for public goods but hires private-sector firms to produce them. b. mandates that individuals buy public goods in the private sector. c. holds private business firms financially responsible for the provision of public goods. d. is responsible for private goods but uses taxpayer money to produce them.

ANSWER: a 42. Health care reform implemented in Massachusetts in 2006 provides an example of: a. unsuccessful contracting out. b. successful contracting out. c. a private-sector solution to the free rider problem. d. awarding government contracts without competitive bidding.

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Chapter 7 43. Which of these is LEAST likely to be problematic in the provisioning of public goods through contracting out? a. higher unit costs of production b. a misalignment between the public interest and those of the private producer of the public good c. misreporting by contractors of the results of their work d. cost-cutting leading to lower quality ANSWER: a 44. Suppose a city manager finds that residents lied about the value to them of a proposed city project. This illustrates the problem of: a. preference revelation. b. altruism. c. preference knowledge. d. the warm glow effect.

ANSWER: a 45. The three problems facing a government trying to determine the optimal quantity of a public good include all of these EXCEPT: a. preference revelation because individuals may not tell the government their true valuations of the public good. b. preference knowledge because individuals may not know their true valuations of the public good. c. preference implementation because it is hard to produce public goods in practice. d. preference aggregation because it is difficult to add up the preferences of millions of citizens.

ANSWER: c 46. The outcome in which each actor pursues their optimal strategy, given the strategies of the other actors, is the: a. altruistic equilibrium. b. Nash equilibrium. c. general equilibrium. d. dominant strategy.

ANSWER: b 47. The waste management system in Lebanon suffers from which of these? a. the free rider problem b. a Nash equilibrium c. crowding out d. contracting out ANSWER: a 48. The demand for clean parks is Q = 100 − P. The marginal cost of cleaning a park is constant at $75. What is Copyright Macmillan Learning. Powered by Cognero.

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Chapter 7 the socially optimal number of clean parks? a. 0 b. 25 c. 100 d. 175 ANSWER: b 49. Suppose Margaret and Thomas are the only two homeowners in the neighborhood. Margaret's demand for clean streets is given by Q = 50 − 2P. Thomas's demand for clean streets is given by Q = 40 − P. What is the social marginal benefit curve for clean streets? a. P = 10 b. Q = 90 − 3P c. P = 65 − 1.5Q d. Q = 30 ANSWER: c 50. Suppose Margaret and Thomas are the only two homeowners in the neighborhood. Margaret's demand for clean streets is given by Q = 50 − 2P. Thomas's demand for clean streets is given by Q = 40 − P. What is the socially optimal number of clean streets if the marginal cost of cleaning them is $35? a. 5 b. 10 c. 20 d. 35 ANSWER: c 51. How would neighborhood private trash collection be financed? a. voluntary fees paid by neighborhood residents b. payroll taxes paid by both employer and employee c. property taxes paid by landowners d. government subsidies and grants to developers ANSWER: a 52. In right-to-work states, the law allows people to opt out of joining a labor union and paying membership dues while still benefiting from collective bargaining agreements negotiated by the union. If the benefits of collective bargaining agreements are public goods, are these benefits likely to be underprovided in right-to-work states? Explain why or why not.

ANSWER: Yes, there might be a free rider problem if workers can enjoy the benefits of collective bargaining agreements (such as better pay, improved working conditions, or more benefits) without having to pay the costs associated with achieving the agreements.

53. Roads are typically viewed as a public good. However, some highways are financed by tolls levied on drivers instead of through taxes. Discuss why this model works for some roads and not others in terms of the properties of public goods.

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Chapter 7 ANSWER: Roads are non-rival—the first characteristic of a public good—to the extent that one person driving on a road does not diminish the value of driving on it for someone else. (Of course, this property declines as traffic becomes more congested.) The key difference between toll roads and, say, residential roads is the ease and cost-effectiveness with which toll roads can be made excludable.

For toll roads with heavy traffic and long stretches of highway without many exits or entrances, limiting access is feasible, and constructing toll booths is economically viable. By contrast, making residential roads excludable is prohibitively costly, given the small amount of traffic on such roads and the difficulty in preventing people from accessing them without paying. Consequently, financing residential and city roads with tolls is not economically feasible.

54. Suppose Scott and Bob live on the same street. In the winter, both of them like their street plowed. Bob's demand is given by Q = 40 − P, and Scott's demand is given by Q = 30 − 2P. Suppose the marginal cost of plowing the snow is constant at $35. (a) What is the social marginal benefit curve? (b) What is the socially efficient amount of plowing? (c) What would be the socially efficient amount of plowing if the marginal cost of plowing were $5?

ANSWER: (a) We must sum the demands of Scott and Bob vertically. Solving for both inverse demand curves, we have P = 40 − Q and P = 15 − 0.5Q. Adding these together, we find that the social marginal benefit curve over the range 0 ≤ Q ≤ 30 is given by P = 55 − 1.5Q. Scott is unwilling to pay anything when Q exceeds 30, so at Q ≥ 30, the social marginal benefit curve is given by P = 40 − Q. (b) Find the quantity at which the social marginal benefit equals the social marginal cost, which is $35. So 35 = 55 − 1.5Q → Q = 13.33. Since this is less than 30, we are using the correct segment of the social marginal benefit curve. (c) The trick here is to recognize which segment of the social marginal benefit curve the marginal cost curve intersects. If we set 55 − 1.5Q = 5, we'd find that Q = 33.33, but that segment is only defined where Q < 30. So we set the marginal cost of 5 equal to 40 − Q and find that Q = 35.

55. Suppose that an observer, finding that people in areas where residents have more education tend to donate more money for local parks than do people in areas where residents are less well educated, concludes that education increases altruism. Use what the material covered in this course to evaluate the validity of this conclusion.

ANSWER: It may be that becoming educated causes people to become more altruistic. However, that need not be the case, since there are several other possible explanations for the observed phenomenon. It may be that people who tend to become more educated also tend to be more altruistic. Alternatively, people who are more educated may have higher incomes and thus stronger preferences for local parks, a normal good. Finally, it may be that local governments in areas with less well-educated people are more effective in providing local parks than are local governments in areas with bettereducated people. Indeed, there is no shortage of alternative explanations for this observation. It may even be, as implied by the types of problems discussed in Chapter 3, that more education makes Copyright Macmillan Learning. Powered by Cognero.

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Chapter 7 people less altruistic!

56. What are the options available to a government when deciding whether to rely on the private sector or the public sector in providing public goods? Use the example of prisons as an illustration.

ANSWER: At one extreme, public goods may be produced by public-sector employees and paid for with government revenue. At the other extreme, the government may subsidize or mandate the private provision of public goods. Between these extremes, there are various approaches involving contracting out. The government can, for example, build prisons and hire guards, or hire private security companies to incarcerate offenders, or contract with private companies to manage prisons.

57. Suppose two individuals, Jon and David, form a community and would like to construct a communal fort that would protect them from attack. They both consume good X, a private good, and the protection of the fort, P. One unit of good X costs 1 unit of currency, and one unit of P costs 2 units of currency. Both Jon and David have incomes of 100 and a utility function of the form: U = log(Xi) + 2 × log(PJ + PD) The budget constraint for each is given by: Xi + 2 × Pi = 100 (a) Find the amount of protection Jon will provide as a function of how much David provides, and explain why the relationship is the way it is. (b) How much protection P will be privately provided in this case? (c) Explain the economic intuition behind this amount, and compare it to the socially optimal amount without solving for the socially optimal amount.

ANSWER: (a) Since both Jon and David will spend all their income, substitute from the budget constraint into the utility function, so that everything is in terms of P. Jon solves the following problem: Max U = log(100 − 2PJ) + log(PJ + PD).

The first-order condition from this maximization problem is given by: −2/(100 − 2PJ) + 1/(PJ + PD) = 0.

Solving this for PJ: PJ = 25 − 0.5PD This implies that as David provides more protection, Jon provides less, reflecting the free rider problem. Solving a similar problem for David, we find that PD = 25 − 0.5PJ. (b) Solving these two equations for the two unknowns, we find that PD = PJ = 16.67. So the total amount of protection P provided is 33.33 units. (c) This amount of protection is less than the socially optimal amount. The free rider problem leads to an underprovision of the public good.

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Chapter 8 1. The benefits of a high-speed rail system from Sacramento to San Diego do NOT include: a. improved productivity resulting when commuters are able to work on the train. b. lower medical expenses resulting from fewer automobile accidents. c. the value of the land needed for the project. d. less traffic and reduced use of fuel.

ANSWER: c 2. _____ analysis consists of a comparison of the projected expenses and benefits of public goods projects to decide if they should be undertaken. a. Contingent valuation b. Cash flow c. Cost-benefit d. Social discounting ANSWER: c 3. The accounting method that calculates costs solely by adding up what the government pays for inputs to a project and calculates benefits solely by adding up government revenues generated by the project is called the _____ accounting approach. a. contingent valuation b. cash flow c. opportunity cost d. social discounting ANSWER: b 4. The value of an input in its next BEST use is the: a. cost-benefit ratio. b. explicit cost. c. marginal benefit. d. opportunity cost.

ANSWER: d 5. If an input is sold in a perfectly competitive market, its price is equal to its: a. average cost. b. opportunity cost. c. cost-benefit ratio. d. cash flow premium.

ANSWER: b 6. The opportunity cost of an input that is sold in a perfectly competitive market is: a. greater than the price of the input. b. less than the price of the input.

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Chapter 8 c. equal to the price of the input. d. not related to the price of the input.

ANSWER: c 7. When there are imperfect markets, the total costs of the project are equal to: a. opportunity costs plus the transfer of rents. b. the transfer of rents. c. opportunity costs. d. opportunity costs plus interest payments.

ANSWER: a 8. Under imperfect markets, total costs are greater than economic costs because: a. total costs include the costs of externalities. b. economic costs do not consider wages. c. opportunity costs are included in total costs but not economic costs. d. total costs include the transfer of rents.

ANSWER: d 9. If the present discounted value of $85 next year is $80 this year, what is the implied annual rate of interest? a. 3.03% b. 5% c. 5.88% d. 6.25% ANSWER: d 10. If the present discounted value of $134 next year is $115 this year, what is the implied annual rate of interest? a. 7.63% b. 9.5% c. 13.34% d. 16.52% ANSWER: d 11. In a perfectly competitive labor market with freely adjusting hours, what is the value of an hour? a. the value of additional health benefits received at work b. the hourly wage c. less than the hourly wage d. more than the hourly wage ANSWER: b 12. What is the present discounted value of $400 a year from now and $500 two years from now if the interest Copyright Macmillan Learning. Powered by Cognero.

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Chapter 8 rate is 10%? a. $676.18 b. $743.80 c. $818.18 d. $776.86 ANSWER: d 13. If the present discounted value of $400 next year is $380 this year, what is the implied rate of interest? a. 5.26% b. 5% c. 2.56% d. 2.60% ANSWER: a 14. Suppose Catharina has three years to live. She values each year of life at $7 million but has a discount rate of 5%. How much does she value the rest of her life in today's dollars? a. $20 million b. $19.06 million c. $21 million d. $18.14 million ANSWER: b 15. If the maintenance costs of a project are estimated at $800,000 per year, what is the total maintenance cost over time assuming a 6% discount rate? a. about $4.8 million b. about $8.5 million c. about $13.3 million d. about $48.1 million ANSWER: c 16. The construction materials and labor costs for a new city hall will cost $14 million. The maintenance costs are estimated at $30,000 per year. What is the total cost over time assuming 6% discount rate? a. $500,000 b. $14.5 million c. $280 million d. $233.8 million ANSWER: b 17. The construction materials and labor costs for a new city hall will cost $14 million. The maintenance costs are estimated at $30,000 per year. What is the first-year cost, assuming 6% discount rate? a. $30,000 b. $14 million Copyright Macmillan Learning. Powered by Cognero.

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Chapter 8 c. $14.5 million d. $233.8 million ANSWER: b 18. The hourly wage for construction workers completing a federal highway project is $17.50 per hour. These workers could have earned $12.75 in other jobs in the community. What is the opportunity cost per hour for each worker? a. $4.75 b. $12.75 c. $17.50 d. $30.25 ANSWER: b 19. The hourly wage for construction workers completing a federal highway project is $17.50 per hour. These workers could have earned $12.75 in other jobs in the community. What is the transfer of rents per hour for each worker? a. $4.75 b. $12.75 c. $17.50 d. $30.25 ANSWER: a 20. The Federal Highway Administration is conducting a cost-benefit analysis for a federal highway project.

The hourly wage for construction workers on this project is $17.50 per hour. These workers could have earned $12.75 in other jobs in the community and will spend 1 million hours completing the highway project. What is the total opportunity cost of labor associated with this project? a. $4.75 million b. $12.75 million c. $17.5 million d. $30.25 million ANSWER: b 21. The Federal Highway Administration is conducting a cost-benefit analysis for a federal highway project.

The hourly wage for construction workers on this project is $17.50 per hour. If the labor market is perfectly competitive, what is the market wage rate? a. $4.75 b. $12.75 c. $17.50 d. $30.25 ANSWER: c 22. The Federal Highway Administration is conducting a cost-benefit analysis for a federal highway project.

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Chapter 8 The total labor cost for the project is $12.75 million. The hourly wage for construction workers on this project is $17.50 per hour. These workers could have earned $12.75 in other jobs in the community. How many labor hours will it take to complete this project? a. 0.4 million b. 0.7 million c. 1 million d. 2.7 million ANSWER: c 23. The after-tax return to a firm is 7%, but the discount rate used in analyzing a government project in the community is 14%. What is the firm's tax rate? a. 7% b. 14% c. 21% d. 50% ANSWER: d 24. The construction materials and labor costs for a new city hall will cost $14 million. The maintenance costs are estimated at $30,000 per year. The after-tax return for a typical firm is 3%, and a typical firm's tax rate is 50%. What is the total cost over time? a. $500,000 b. $14.5 million c. $280 million d. $233.8 million ANSWER: b 25. The after-tax return to a firm is 7%, and the firm's tax rate is 50%. What is the discount rate that should be used when analyzing a government project in the community? a. 7% b. 14% c. 21% d. 50% ANSWER: b 26. The discount rate used in analyzing a government project in the community is 14%, and a typical firm's tax rate is 50%. What is the typical firm's after-tax return? a. 7% b. 14% c. 21% d. 50% ANSWER: a Copyright Macmillan Learning. Powered by Cognero.

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Chapter 8 27. The value to producers from a road infrastructure project could be estimated by: a. the value of the new markets now available to the producer. b. asking the producers how much they would be willing to pay in increased taxes for the project. c. the reduction in costs of supplying the good. d. the amount of user fees that can be collected from producers.

ANSWER: c 28. In a perfectly competitive labor market, the benefits to consumers of a road infrastructure project could be measured by: a. adding up hours saved commuting and multiplying by the average wage. b. adding up hours saved commuting and multiplying by the highest wage. c. adding the value of the new jobs created by the infrastructure project. d. calculating the increase in incomes of the workers involved in the project construction.

ANSWER: a 29. In a competitive market, we can calculate the value of leisure by: a. analyzing the amount that the government spends on parks and recreation, and dividing by population. b. equating it to the average wage rate. c. calculating the amount spent by consumers on entertainment in a period of time. d. the land value of commercial properties plus the land value of all state and national parks in a given area.

ANSWER: b 30. Asking someone to quantify how much they would benefit from a new highway is an example of: a. contingent valuation. b. revealed preference valuation. c. cost-benefit analysis. d. social discounting.

ANSWER: a 31. The county supervisor sends out a survey via U.S. mail asking residents how much they are each willing to pay toward a new community swimming pool. This is an example of: a. contingent valuation. b. revealed preference valuation. c. cost-benefit analysis. d. social discounting.

ANSWER: a 32. The county supervisor is considering building a community pool and has gathered data on how much residents are willing to pay. They sum up the valuations they have received and compare that number to the estimated cost. This is an example of: Copyright Macmillan Learning. Powered by Cognero.

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Chapter 8 a. contingent valuation. b. revealed preference valuation. c. cost-benefit analysis. d. social discounting.

ANSWER: c 33. The county supervisor uses an estimate of how much residents pay to drive to the public swimming pool in the next county as an indication of how much a swimming pool is worth to county residents. This is an example of: a. contingent valuation. b. revealed preference valuation. c. cost-benefit analysis. d. social discounting.

ANSWER: b 34. Which approach asks individuals how they value an option they are now not choosing? a. contingent valuation b. revealed preference c. cost-benefit analysis d. social discounting ANSWER: a 35. In which circumstance is contingent valuation the only option to value a public good? a. the federal government valuing the cost of building a highway b. a local government valuing the additional cost of weekend garbage pickup c. a state government valuing various options to raise revenues d. the federal government valuing the cost of saving bald eagles ANSWER: d 36. When asked how much they would be willing to pay to preserve Yellowstone National Park, respondents were willing to pay ten times more than if that question was placed fourth on a list with other questions. This example shows _____ matters. a. the order of issues b. isolation of issues c. the content of the question d. the embedding effect ANSWER: b 37. When asked how much they would be willing to pay to preserve Yellowstone National Park and Great Smoky Mountains National Park, respondents were willing to pay, on average, $200 more for whichever was named first. This example shows _____ matters. a. the order of issues Copyright Macmillan Learning. Powered by Cognero.

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Chapter 8 b. isolation of issues c. the content of the question d. the embedding effect ANSWER: a 38. In an experiment, some respondents were asked how much they would be willing to pay to preserve 10 acres of land in their town from development, and some were asked how much they would be willing to pay to preserve 100 acres of land. Researchers discovered that the willingness to pay for the two groups was similar.

This example shows _____ matters. a. the order of issues b. isolation of issues c. the content of the question d. the embedding effect ANSWER: d 39. Which is NOT a problem with using contingent valuations? a. Valuations depend on isolation of the issue. b. Valuations depend on the order in which the issues are given. c. Valuations are not consistent with respect to the size of the task. d. Valuations are based only on options individuals are currently choosing.

ANSWER: d 40. Which approach estimates how individuals value an option by looking at their actions? a. contingent valuation b. revealed preference c. cost-benefit analysis d. social discounting ANSWER: b 41. A study by DeAngelo and Hansen (2014) found that a reduction in police enforcement in Oregon led to faster driving, and more traffic fatalities. In fact, paying for 5,445 more trooper-years of service would have saved 2,167 lives. This study is an example of: a. contingent valuation. b. revealed preference. c. cost-benefit analysis. d. cost-effectiveness analysis.

ANSWER: c 42. The method preferred by economists for valuing life is to use: a. contingent valuation. b. revealed preference. c. government preference.

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Chapter 8 d. the present value of lifetime earnings.

ANSWER: b 43. To determine the value of a house, a researcher runs a regression that includes the home's square footage, number of bedrooms, number of bathrooms, and distance to the town center. The researcher is using what kind of methodology? a. contingent valuation b. revealed preference c. government preference d. hedonic market analysis ANSWER: d 44. Based on the revealed preference approach, the consensus value placed on a life is approximately equal to: a. $825,000. b. $3 million. c. $10.5 million. d. $22.3 million.

ANSWER: c 45. Suppose the value of life is estimated by comparing the earnings and probabilities of death from working on a fishing boat in Alaska with the earnings and probabilities of death from working in a fish processing plant in Alaska. The analysis concludes that a year of life is valued at $6 million. If risk-neutral people take the jobs on the boats and risk-averse people take jobs at the processing plants, the estimate will: a. overstate by at least two times the value of a life for the average person. b. overstate by an unknown amount the value of a life for the average person. c. be approximately equal to the value of a life for the average person. d. understate by an unknown amount the value of a life for the average person.

ANSWER: d 46. Cost-benefit analyses of the Covid-19 lockdowns and social distancing measures in the United States show that the benefits were _____ the economic costs. a. greater than b. less than c. equal to d. equal to or less than ANSWER: a 47. The revealed preference approach to valuing a life focuses on: a. survey results. b. actions. c. lost wages. d. medical expenses.

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Chapter 8 ANSWER: b 48. If an individual has the option of spending $10,000 to reduce the probability of death and the individual chooses not to spend $10,000, this implies that the: a. value of life is less than $10,000. b. value of life is exactly $10,000. c. individual does not place an infinite value on life. d. individual places an infinite value on life.

ANSWER: c 49. Because risk-neutral workers are more likely to take risky jobs than risk-averse workers, estimates of a human life based on compensating differentials will usually be: a. overstated. b. understated. c. accurate. d. either overstated or understated.

ANSWER: a 50. The search for the least costly way of providing a desired public good is: a. contingent valuation. b. revealed preference. c. social discounting. d. cost-effectiveness analysis.

ANSWER: d 51. The county supervisor will determine which company should construct the new public swimming pool by collecting bids from various contractors. This is an example of: a. contingent valuation. b. revealed preference valuation. c. cost-benefit analysis. d. cost-effectiveness analysis.

ANSWER: d 52. If the benefits of a project are estimated to be $1.2 million per year, what is the total benefit over time, assuming a 5% discount rate? a. about $1.1 million. b. about $2.4 million c. about $24 million d. about $60 million ANSWER: c 53. James earns $9.50 per hour and works full time, whereas Alice earns $19 per hour but only works part time.

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Chapter 8 Given this information, it must be TRUE that the opportunity cost of each hour of leisure is: a. higher for James. b. lower for Alice because she works part time. c. higher for Alice. d. the same for James and Alice.

ANSWER: c 54. Which person would have the highest value of life if using the wages approach? a. a 36-year-old mother of three young children earning $40,000 per year b. an 18-year-old female earning $7.00 per hour while attending an elite university c. a 62-year-old male, with no plans to retire, earning $62,000 per year d. a 27-year-old male earning $68,000 per year but living in a city with a high cost of living ANSWER: d 55. The _____ is important to determine the long-run value of public projects, as its value determines the total benefits over time. a. federal funds rate b. discount rate c. sales tax rate d. the real interest rate ANSWER: b 56. The Federal Highway Administration is conducting a cost-benefit analysis for a federal highway project.

They are currently trying to determine the value of reduced driving time. The total labor cost for the project is $12.75 million. The hourly wage for construction workers on this project is $17.50 per hour. The average hourly wage in the community is $16.80. Using the wages approach, what value would should be assigned to 100,000 hours of reduced driving time? a. $70,000 b. $1,680,000 c. $1,750,000 d. $34,300,000 ANSWER: b 57. The Federal Highway Administration is conducting a cost-benefit analysis for a federal highway project.

They are currently trying to determine the value of the estimated three lives saved each year due to the highway improvements. The average hourly wage in the community is $21.80, but most workers think they should be paid $23.00 per hour. Workers will work 80,000 hours in a lifetime. In addition, individuals estimate the value of a life at $10.2 million, on average. Using contingent valuation, how would they value the benefit of the lives saved due to highway improvements? a. $1.7 million b. $5.5 million c. $10.2 million Copyright Macmillan Learning. Powered by Cognero.

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Chapter 8 d. $30.6 million ANSWER: d 58. Suppose individuals are willing to pay an additional $50 for a child safety lock on a gate. There is a 1 in 27,000 chance that this lock would save the life of a child. The average life span is 87 years. What is the value of the child's life to those willing to pay for the safety lock? a. $50 b. $4,350 c. $0.4 million d. $1.4 million ANSWER: d 59. What is the value of a worker's life if their compensating differential is $20,000 for a job that has a 2% higher risk of death each year? a. $19,608 b. $20,400 c. $1 million d. $20 million ANSWER: c 60. The county supervisor decides that a new community swimming pool should be constructed based on the projected construction and operating expenses as well as estimates of how much residents would be willing to pay for the pool. This approach reflects: a. contingent valuation. b. revealed preference valuation. c. cost-benefit analysis. d. social discounting.

ANSWER: c 61. All else equal, governments should prefer projects that have _____ but _____ on the gap between costs and benefits. a. high net benefits; less certainty b. low net benefits; less certainty c. low net benefits; more certainty d. high net benefits; zero certainty ANSWER: c 62. All of these are common issues with cost-benefit analyses EXCEPT: a. counting labor as a benefit. b. double counting benefits. c. counting secondary benefits. d. ignoring environmental costs.

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Chapter 8 ANSWER: d 63. The city of Atlantis dredges its harbor, which leads to an 80% increase in shipping activity. Which correctly describes this benefit with respect to a cost-benefit analysis? a. The 80% should be fully counted as a benefit of the project, since it increased economic activity. b. The true benefit is greater than 80% due to the spillover benefits to the wider economy. c. Only the net benefit should be counted, since some of this shipping activity could be taken from nearby city's harbors. d. This 80% increase in shipping activity should not be included at all in the cost-benefit analysis, since it represents only an accounting profit.

ANSWER: c 64. The city of Atlantis dredges its harbor, resulting in the hiring of 200 workers. Which correctly describes these new workers with respect to a cost-benefit analysis? a. The workers' wages are a cost to the project rather than a benefit. b. The true benefit is greater than the wages due to the spillover benefits. c. The workers' wages are as a benefit of the project, since the wages increase economic activity. d. The wages represent a transfer payment and should not be included in the cost-benefit analysis.

ANSWER: a 65. The city of Atlantis dredges its harbor, which leads many ships that once had to travel to harbors farther away to dock instead at Atlantis. This, on average, decreases fuel costs for ships docking at Atlantis by 10%.

Which correctly describes the decrease in fuel costs as part of the cost-benefit analysis? a. The decrease in fuel costs should be included as a benefit to the project, since it decreases shipping costs. b. The true benefit is greater than the cost savings of the decreased fuel costs due to the secondary effects of decreased environmental damage. c. The decreased fuel costs should not be counted as a benefit, because it is double counting benefits already included due to increased shipping activity. d. The decreased fuel costs represent a cost, rather than a benefit, of the project, since fuel sellers will receive less revenue.

ANSWER: c 66. The city of Atlantis dredges its harbor, which increases shipping activity. However, aside from the economic benefits, the increased noise and congestion of the busier harbor bothers nearby residents. This situation represents which concept BEST? a. uncertainty in costs and benefits b. distributional concerns c. common counting mistakes d. discounting future benefits ANSWER: b 67. Suppose the government can pursue one of three projects. The first has benefits of $1,080 and costs of Copyright Macmillan Learning. Powered by Cognero.

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Chapter 8 $1,000, the second has benefits of $1,180 and costs of $1,000, and the third has benefits of $1,230 and costs of $1,000. Suppose that it costs $0.20 for the government to raise a dollar in revenue. Which project should the government pursue? a. the first project b. the second project c. the third project d. None of the answers are correct.

ANSWER: c 68. Suppose the government can pursue one of three projects. The first has benefits of $300 and costs of $270, the second has benefits of $580 and costs of $460, and the third has benefits of $90 and costs of $80. Suppose that it costs $0.15 for the government to raise $1 in revenues. Which project should the government pursue? a. the first project b. the second project c. the third project d. None of the answers are correct.

ANSWER: b 69. Which statement is TRUE of a cost-benefit analysis of a potential government project? a. Both asset value increases to the property owners and income increases to the property owners should be counted. b. Neither asset value increases to the property owners nor income increases to the property owners should be counted. c. The net increase in jobs in a community is a benefit. d. Future costs and benefits should be discounted to present values before being compared.

ANSWER: d 70. Suppose a high-speed rail system is proposed that will save commuters from the suburbs a lot of valuable time. If the high-speed rail system is built, the value of homes in the suburbs will increase because of the easier commute. When estimating the potential benefits of the high-speed rail system: a. it is important not to double count benefits since the rise in home values is caused by the time savings. b. it is important to count both the rise in home values and the value of time saved by commuters. c. neither the rise in home values nor the value of time saved by commuters is considered a benefit of investing in the high-speed rail system. d. the increased value of suburban homes is considered a cost rather than a benefit.

ANSWER: a 71. The city council is conducting a cost-benefit analysis for a new bridge. The construction materials for the bridge will cost $80 million. The maintenance costs are estimated at $7 million per year. The hourly wage for construction workers on this project is $19.50 per hour. These workers could have earned $15.50 in other jobs in the community and will spend 0.5 million hours completing the project. The new bridge is expected to save two lives each year, and individuals estimate the value of a life at $9 million on average. It is also expected that Copyright Macmillan Learning. Powered by Cognero.

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Chapter 8 drivers will save approximately 225,000 hours of driving time each year. The after-tax return to a firm is 7%, and the firm's tax rate is 50%. What is the first-year cost? a. $80 million b. $7.75 million c. $87.75 million d. $187.75 million ANSWER: c 72. The city council is conducting a cost-benefit analysis for a new bridge. The construction materials for the bridge will cost $80 million. The maintenance costs are estimated at $7 million per year. The hourly wage for construction workers on this project is $19.50 per hour. These workers could have earned $15.50 in other jobs in the community and will spend 0.5 million hours completing the project. The new bridge is expected to save two lives each year, and individuals estimate the value of a life at $9 million on average. It is also expected that drivers will save approximately 225,000 hours of driving time each year. The after-tax return to a firm is 7%, and the firm's tax rate is 50%. What is the first-year benefit? a. $3.5 million b. $18 million c. $21.5 million d. $307 million ANSWER: c 73. The Department of Transportation is planning to replace a four-way stop intersection with a round-about.

The Department estimates the replacement will cost $500,000 in material and require 800 labor hours. The annual maintenance budget is $25,000. The hourly wage on this project will be $42.50. The average construction wage in the area is $35.00 per hour. The round-about should save drivers 100,000 hours annually.

The average hourly wage in the area is $24.64. There have been no fatalities or major accidents at the intersection in recent years. What is the first-year cost of the project? a. $528,000 b. $534,000 c. $553,000 d. $559,000 ANSWER: a 74. The Department of Transportation is planning to replace a four-way stop intersection with a round-about.

The Department estimates the replacement will cost $500,000 in material and require 800 labor hours. The annual maintenance budget is $25,000. The hourly wage on this project will be $42.50. The average construction wage in the area is $35.00 per hour. The round-about should save drivers 100,000 hours annually.

The average hourly wage in the area is $24.64. There have been no fatalities or major accidents at the intersection in recent years. What is the approximate first-year benefit of the project? a. $0 b. $2.5 million Copyright Macmillan Learning. Powered by Cognero.

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Chapter 8 c. $3.5 million d. $4.25 million ANSWER: b 75. The Department of Transportation is planning to replace a four-way stop intersection with a round-about.

The Department estimates the replacement will cost $500,000 in material and require 800 labor hours. The annual maintenance budget is $25,000. The hourly wage on this project will be $42.50. The average construction wage in the area is $35.00 per hour. The round-about should save drivers 100,000 hours annually.

The average hourly wage in the area is $24.64. There have been no fatalities or major accidents at the intersection in recent years. What is the approximate present value of the benefits of the project if the appropriate discount rate is 3%? a. $2.5 million b. $82 million c. $117 million d. $142 million ANSWER: b 76. The Department of Transportation is planning to replace a four-way stop intersection with a round-about.

The Department estimates the replacement will cost $500,000 in material and require 800 labor hours. The annual maintenance budget is $25,000. The hourly wage on this project will be $42.50. The average construction wage in the area is $35.00 per hour. The round-about should save drivers 100,000 hours annually.

The average hourly wage in the area is $24.64. There have been no fatalities or major accidents at the intersection in recent years. What is the approximate present value of the costs of the project if the appropriate discount rate is 3%? a. $528,000 b. $833,333 c. $1,361,333 d. $1,367,333 ANSWER: b 77. A firm's tax rate is 20%, and its after-tax return is 4%. What discount rate does the government use for proposed projects? a. 2% b. 4% c. 5% d. 20% ANSWER: a 78. Why is a dollar to be received in the future worth less than a dollar to be received now?

ANSWER: A dollar received today can be used to earn interest. For example, if the annual interest rate is 10%, a person who has $1 today will have $1.10 in one year. Therefore, the value of $1 received now is Copyright Macmillan Learning. Powered by Cognero.

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Chapter 8 equal to $1.10 to be received in one year.

79. Describe the quasi-experiment conducted by Deacon and Sonstelie in 1985 that was designed to reveal the value of time.

ANSWER: During the oil crisis of the 1970s, the government-imposed price ceilings on the large gasoline companies, setting a maximum price that those companies could charge per gallon of gas. These low prices led to consumers waiting in long lines to get gas. The price ceilings did not apply to smaller stations, so lines were shorter there. As a result, the amount of time that individuals were willing to wait at the stations owned by large gas companies (the treatment group) relative to independent stations (the control group) can be compared with the amount of money saved by going to the treatment stations instead of the control stations to form a value of time. Lines formed at large stations for cheaper gas, forcing customers to wait an average of 14.6 minutes more than at competing stations. The mean purchase was 10.5 gallons at a savings of $0.48, suggesting a saving of approximately $20.20 (in 2012 dollars) per hour they waited. That is, individuals revealed themselves to be willing to wait an hour for $20.20—almost exactly equal to the average hourly wage in the United States.

80. Suppose that a city is trying to attract a sports tournament that would entail spending a significant amount of money on marketing of the event and other costs that have no intrinsic value to residents of the city. The city leaders argue that hosting the sports tournament will increase commerce activity around the city because of the visitors who will be in town for the tournament. Consequently, they are lobbying the state governor to give them grants, which they say (credibly) is the only way they can afford to host the tournament. For the governor’s decision, should it matter whether it is a tournament between in-state teams or national teams?

Explain.

ANSWER: It should indeed matter. To look at this project from that state's perspective, compare the net benefits to the state with the costs to the state. To the extent that increased commerce activity in this city is simply people of the state spending money there instead of elsewhere in the state, net commerce activity may not increase. However, if the sports tournament brings in substantial commerce activity from people outside the state or country who would not otherwise spend the money in the state, the net benefits may be positive.

81. Suppose Pankaj can take one of two summer jobs. In the first job as a flight attendant, with a salary of $5,000, Panjaj estimates the probability he will die is 1 in 40,000. Alternatively, he could drive a truck transporting hazardous materials, which pays $12,000, and for which the probability of death is 1 in 10,000.

Suppose that Pankaj is indifferent between the two jobs EXCEPT for the pay and the chance of death. If he chooses the job as a flight attendant, what does this say about the value he places on his life?

ANSWER: He values his life to be worth more than $93.3 million. The additional risk of death is 1/10,000 − 1/40,000 = 3/40,000 = 0.000075. The compensating wage differential is $7,000, so the revealed preference value of his life must be greater than $7,000/0.000075 = $93.3 million, or he would have taken the job transporting the hazardous materials.

82. A city is trying to estimate the most money it should offer to contractors as an incentive for them to finish a disruptive road project early. The transportation project lengthens transport times by 10 hours per week for 40,000 workers. Assume that all workers are paid $10 per hour in a perfectly competitive labor market. What is the MOST that the city should pay to the contractors as an incentive for completing the project four weeks early?

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Chapter 8 ANSWER: If each worker loses 10 hours per week at a rate of $10 per hour, each worker loses $100 per week.

If the project is finished 4 weeks early, each affected worker would be $400 better off. Since there are 40,000 affected workers, the total benefit from completing the project 4 weeks early is 40,000 × $400 = $16 million.

83. A new recreational area in a small town will take 20 full-time (40 hours per week) workers 3 weeks to complete. In addition, the cost of materials is expected to be $75,000. (a) If the labor market is perfectly competitive and the market wage is $20, what are the total opportunity costs of taking on this project? (b) If instead the town had some unemployment, would the opportunity cost of the project change? Explain.

ANSWER: (a) Each of 20 workers has to work 40 hours per week for 3 weeks, so total hours required is equal to 20 × 40 × 3 = 2,400 hours. At $20 per hour, this amount of labor would cost $48,000. Combined with the material costs, the total costs would be $123,000. (b) This would indeed change the total opportunity costs by lowering the opportunity costs of hiring labor. For example, if the town paid 20 formerly unemployed workers to do the labor and these workers valued their leisure time at $10 per hour, the opportunity cost of hiring these workers would only be $10 per hour, even if they were being paid $20 per hour (the extra $10 per hour is a transfer from the town to the formerly unemployed workers). Consequently, the opportunity cost of doing the project would be lower.

84. The city council is conducting a cost-benefit analysis for a new bridge. The construction materials for the bridge will cost $80 million. The maintenance costs are estimated at $7 million per year. The hourly wage for construction workers on this project is $19.50 per hour. These workers could have earned $15.50 in other jobs in the community and will spend 0.5 million hours completing the project. The new bridge is expected to save two lives each year, and individuals estimate the value of a life at $9 million on average. It is also expected that drivers will save approximately 225,000 hours of driving time each year. The after-tax return to a firm is 7%, and the firm's tax rate is 50%.

Determine the net benefit/cost of the project. Should the city council approve the project?

ANSWER: Costs Materials

$ 80,000,000

Labor

$ 7,750,000

Maintenance

$ 100,000,000

First-year costs

$ 87,750,000

Total cost over time

$ 187,750,000

Benefits Driving time saved

$ 3,487,500

Lives saved

$ 18,000,000

First-year benefit

$ 21,487,500

Total benefit over time

$ 306,964,286

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Chapter 8 Net Benefit/Cost $ 119,214,286 The project has a net benefit, so the project should be accepted.

85. The city council is still conducting a cost-benefit analysis for a new bridge, but it is now estimated that drivers will not save any time driving. All other estimates remain unchanged. The construction materials for the bridge will cost $80 million. The maintenance costs are estimated at $7 million per year. The hourly wage for construction workers on this project is $19.50 per hour. These workers could have earned $15.50 in other jobs in the community and will spend 0.5 million hours completing the project. The new bridge is expected to save two lives each year, and individuals estimate the value of a life at $9 million on average. The after-tax return to a firm is 7%, and the firm's tax rate is 50%.

Determine the net benefit/cost of the project. Should the city council approve the project?

ANSWER: Costs Materials

$ 80,000,000

Labor

$ 7,750,000

Maintenance

$ 100,000,000

First-year costs

$ 87,750,000

Total cost over time

$ 187,750,000

Benefits Driving time saved

$-

Lives saved

$ 18,000,000

First-year benefit

$ 18,000,000

Total benefit over time

$ 257,142,857

Net Benefit/Cost $ 69,392,857 Yes, the project should still be accepted as benefits are still higher than costs.

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Chapter 9 1. Federal spending for local projects that serve mostly to transfer federal dollars to politicians' constituents is defined as: a. direct democracy. b. political pork. c. marginal-cost pricing. d. Lindahl pricing.

ANSWER: b 2. Which of these is a system in which individuals report their willingness to pay for the next unit of a public good and the government aggregates those willingnesses to form an overall measure of the social benefit from that next unit of public good? a. access pricing b. voter initiative c. Lindahl pricing d. referendum ANSWER: c 3. Suppose Dexter and Amy are the only members of a community that is trying to determine how much of a public good should be produced. Dexter's (inverse) demand curve is given by P = 50 − 5Q, while Amy's (inverse) demand curve is given by P = 150 − 15Q, where P is price or marginal benefit and Q is the quantity of the good. The marginal cost of producing the public good is constant at $80. The efficient quantity of the public good is equal to: a. 2. b. 6. c. 10. d. 80.

ANSWER: b 4. Suppose Dexter and Amy are the only members of a community that is trying to determine how much of a public good should be produced. Dexter's (inverse) demand curve is given by P = 50 − 5Q, while Amy's (inverse) demand curve is given by P = 150 − 15Q, where P is price or marginal benefit and Q is the quantity of the good. The marginal cost of producing the public good is constant at $80. Dexter will vote for the efficient quantity of the public good if the price to him is: a. $20. b. $40. c. $60. d. $80.

ANSWER: a 5. Suppose Dexter and Amy are the only members of a community that is trying to determine how much of a public good should be produced. Dexter's (inverse) demand curve is given by P = 50 − 5Q, while Amy's (inverse) demand curve is given by P = 150 − 15Q, where P is price or marginal benefit and Q is the quantity of the good. The marginal cost of producing the public good is constant at $80. Amy will vote for the efficient Copyright Macmillan Learning. Powered by Cognero.

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Chapter 9 quantity of the public good if the price to her is: a. $20. b. $40. c. $60. d. $80.

ANSWER: c 6. Pam and Kunal are the only members of a community that is trying to determine how much of a public good should be produced. Suppose that Pam is willing to pay $10 for the fourth unit of the public good, while Kunal is willing to pay $3 for it. What is the community's marginal willingness to pay for the fourth unit of the public good? a. $3 b. $4 c. $10 d. $13 ANSWER: d 7. Pam and Kunal are the only members of a community that is trying to determine how much of a public good should be produced. Suppose that Pam is willing to pay $10 for the fourth unit of the public good and that Kunal is willing to pay $6 for the fourth unit. The marginal cost of producing the public good is constant at $4.

Which is TRUE? a. Fewer than four units of the public good should be produced. b. More than four units of the public good should be produced. c. Exactly four units of the public good should be produced. d. The Lindahl equilibrium is established when the price of the public good is $10.

ANSWER: b 8. The condition for equilibrium in the Lindahl model requires that: a. only those with strong preferences participate in democratic elections. b. each voter accepts an equal share of the overall tax burden. c. each voter selects the same quantity at the announced set of prices. d. each voter's marginal benefit function is the same.

ANSWER: c 9. Which is a problem that must be overcome to achieve the Lindahl solution? a. Individuals always tell the truth about their willingness to pay. b. Individuals tend to overreport their valuation of a public good. c. Individuals tend to underreport their valuation of a public good. d. The tax system may be inefficient.

ANSWER: c 10. Which refers to taxing individuals for a public good according to their valuation of the benefit they receive Copyright Macmillan Learning. Powered by Cognero.

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Chapter 9 from the good? a. efficient-cost taxation b. benefit taxation c. median voter taxation d. mean voter taxation ANSWER: b 11. In a Lindahl equilibrium: a. no one could be made better off by reducing their tax burden, all things equal. b. most but not all individuals are happy to pay their taxes to receive the benefits. c. the government must subsidize the project by using nontax financing schemes. d. everyone is willing to pay the taxes to receive the benefits.

ANSWER: d 12. Which is a problem that must be overcome to achieve the Lindahl solution? a. Individuals tend to overreport their valuation of a public good. b. Individuals may not know their valuation of a public good. c. Individual values cannot be obtained. d. Individuals demand larger quantities of a public good when their tax shares increase.

ANSWER: b 13. Which is a ballot measure that allows citizens to vote on state laws or constitutional amendments that have already been passed by the state legislature? a. recall b. referendum c. voter initiative d. arrow vote ANSWER: b 14. Which is legislation or a constitutional amendment that citizens place on the ballot? a. recall b. referendum c. voter initiative d. arrow vote ANSWER: c 15. Which statement about direct democracy in the United States is NOT true? a. The important feature of a referendum is that it is designed to elicit constituents' reactions to legislation. b. At the local level, the town meeting remains an important venue for decision making in many southern states.

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Chapter 9 c. Voter initiative is widely used in all parts of the United States, especially in West Coast states. d. Referenda and initiatives are used for all kinds of issues, including but not limited to election rules, alcohol rules, animal rights, and so on.

ANSWER: b 16. Which refers to the property of dominance? a. If voters for one choice feel more strongly than do voters for another choice, then the aggregation mechanism must be such that the choices are weighted accordingly. b. If one choice is preferred by all voters, then the aggregation mechanism must be such that this choice is made by society. c. If choice A is preferred to choice B and choice B is preferred to choice C, then A must be preferred to C. d. Choices must satisfy the condition that if one choice is preferred to another, then the introduction of a third choice will not change that ranking.

ANSWER: b 17. Which term defines a preference-aggregation mechanism that satisfies the properties of dominance, transitivity, and independence of irrelevant alternatives? a. socially efficient b. socially inefficient c. inconsistent d. consistent ANSWER: d 18. Majority voting is: a. always consistent. b. sometimes inconsistent. c. a preference-disaggregation mechanism. d. rarely used in political decision making.

ANSWER: b 19. To which does the property of transitivity refer? a. If voters for one choice feel more strongly than do voters who select another choice, then the aggregation mechanism must be such that the choices are weighted accordingly. b. If one choice is preferred by all voters, then the aggregation mechanism must be such that this choice is made by society. c. If choice A is preferred to choice B and choice B is preferred to choice C, then A must be preferred to C. d. Choices must satisfy the condition that if one choice is preferred to another, then the introduction of a third choice will not change that ranking.

ANSWER: c Copyright Macmillan Learning. Powered by Cognero.

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Chapter 9 20. A voting system characterized by the dominance property, the property of transitivity, and independence of irrelevant alternatives would lead to: a. a violation of Arrow's Impossibility Theorem. b. a dictatorship. c. inconsistent aggregation of individual preferences. d. consistent aggregation of individual preferences.

ANSWER: d 21. To what does the property of the independence of irrelevant alternatives refer? a. If voters for one choice feel more strongly than do voters for another choice, then the aggregation mechanism must be such that the choices are weighted accordingly. b. If one choice is preferred by all voters, then the aggregation mechanism must be such that this choice is made by society. c. If choice A is preferred to choice B and choice B is preferred to choice C, then A must be preferred to C. d. Choices must satisfy the condition that if one choice is preferred to another, then the introduction of a third choice will not change that ranking.

ANSWER: d 22. How can a voting model avoid the result of Arrow's Impossibility Theorem? a. impose restrictions on preferences b. remove the irrational voters c. prohibit a dictatorship d. allow individuals to vote according to their personal preferences ANSWER: a 23. Which is necessary for the Median Voter Theorem? a. single-peaked preferences b. double-peaked preferences c. identical preferences for all voters d. unknown preferences ANSWER: a 24. Which is TRUE of median voter outcomes? a. They are socially efficient. b. They are not consistent when voter preferences are single-peaked. c. They do not reflect the intensity of voters' preferences. d. They are the same outcomes that would prevail without government intervention.

ANSWER: c 25. According to the median voter model, what must a politician know to attract the maximum number of votes?

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Chapter 9 a. the preferences of all voters b. the preferences of the median voter c. voters' willingness to pay d. the issue that is most important to all voters ANSWER: b 26. In the town of New Era, Mary, Scott, and Fredo are all running for the same spot on the village council.

New Era residents care only about infrastructure improvements; they know everything about the candidates' positions on that issue but know nothing about their positions on policing. Which assumption of the median voter model is being violated? a. full information b. voter rationality c. the existence of only two candidates d. single-dimensional voting ANSWER: c 27. Which is NOT true about farm policy in the United States? a. Government support to farmers traditionally took two forms: direct subsidy and price supports. b. Farmers growing only 20 of the 400 types of crops grown in the United States are eligible for direct subsidies and price supports. c. The amount of subsidy increases with the amount of crop produced, so larger farms benefit more from the subsidies than do small farms. d. The price supports decrease the average price of food products for American consumers.

ANSWER: d 28. Suppose a state has two senators; one is a Republican, and the other is a Democrat. The median voter model predicts that: a. both will vote like members of their own party from other states, which is consistent with empirical voting records. b. both will vote like members of their own party from other states, which is inconsistent with empirical voting records. c. each will vote the same way as the other, which is consistent with empirical voting records. d. each will vote the same way as the other, which is inconsistent with empirical voting records.

ANSWER: d 29. The approach that emphasizes that the government may not act to maximize the well-being of its citizens is: a. the Samuelson school. b. public choice theory. c. median voter theory. d. bureaucratic theory.

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Chapter 9 30. Suppose the U.S. Department of Agriculture is more interested in preserving itself than in achieving its designated mission. That statement is consistent with: a. goods being provided more efficiently by the private sector than by the public sector. b. government corruption. c. the political business cycle. d. size-maximizing bureaucracy.

ANSWER: d 31. Suppose that a local elected official gives noncompetitive grants to businesses owned by his relatives. This is consistent with: a. goods being provided more efficiently by the private sector than by the public sector. b. government corruption. c. size-maximizing bureaucracy. d. theft.

ANSWER: b 32. One hundred of the voters in a town are willing to pay $100 each to support a public green space, which will cost $10,000 to build and maintain. One hundred and fifty voters in the same town do not value the public green space. What is the social marginal benefit of the public green space? a. $0 b. $100 c. $5,000 d. $10,000 ANSWER: d 33. One hundred of the voters in a town are willing to pay $100 each to support a public green space, which will cost $10,000 to build and maintain. One hundred and fifty voters in the same town do not value the public green space. What is the socially optimal outcome? a. The green space gets built, and all voters are taxed $100. b. The green space does not get built. c. The green space gets built but only those who wanted it will be taxed. d. A more expensive green space gets built.

ANSWER: c 34. One hundred of the voters in a town are willing to pay $100 each to support a public green space, which will cost $10,000 to build and maintain. One hundred and fifty voters in the same town do not value the public green space. What is the outcome according to the median voter model? a. The green space gets built, and all voters are taxed $100. b. The green space does not get built. c. The green space gets built but only those who wanted it will be taxed. d. A less expensive green space gets built.

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Chapter 9 35. One hundred of the voters in a town are willing to pay $100 each to support a public green space, which will cost $10,000 to build and maintain. Fifty voters in the same town do not value the public green space. What is the outcome according to the median voter model? a. The green space gets built, and all voters are taxed. b. The green space does not get built. c. The green space gets built but only those who wanted it will be taxed. d. A less expensive green space gets built.

ANSWER: a 36. Which of these is NOT an assumption of the median voter model? a. single-dimensional voting b. two candidates c. politicians have no ideology d. money impacts elections ANSWER: d 37. Which of these is NOT an assumption of the median voter model? a. single-dimensional voting b. two candidates c. politicians have no ideology d. zero taxation ANSWER: d 38. Which of these is consistent with Leviathan theory? a. Bureaucrats and the government try to maximize the size of the public sector by taking advantage of the electorate's ignorance. b. Voters can trust the government to spend their tax dollars efficiently. c. There is no government greed. d. The government attempts to reduce its size to save tax dollars.

ANSWER: a 39. Which of these is consistent with Leviathan theory? a. Bureaucrats strive to maximize efficiency. b. Voters cannot trust the government to spend their tax dollars efficiently. c. There is no government greed. d. The government attempts to reduce its size to save tax dollars.

ANSWER: b 40. How does redistricting differ from gerrymandering? a. Redistricting reduces bias, while gerrymandering increases it. b. Redistricting increases bias, while gerrymandering decreases it.

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Chapter 9 c. Redistricting is much more likely to favor one political party over the other. d. Gerrymandering ensures that districts are representative.

ANSWER: a 41. The mayoral candidate, Bleak, earned 10,000 votes but ultimately lost the race. His opponent won the race by earning 12,000 votes. What is the efficiency gap in this race? a. 4.5% b. 41% c. 45% d. 56% ANSWER: b 42. What happens to the efficiency gap if districts are redrawn so that Party A loses by a slim margin in all districts? a. It falls to zero. b. It decreases. c. It increases. d. It remains unchanged.

ANSWER: c 43. The accompanying table shows Tom and Ray's total willingness to pay for different amounts of public recreational areas (REC), which is measured in acres. The marginal cost of 1 acre of recreational area is $1,000. (a) What is the socially optimal level of recreational areas? Assume Tom and Ray cannot purchase partial acres.

Explain your answer. (b) What should be the tax burden to Tom and Ray so that their consumer surpluses are equal? Explain.

ANSWER: (a) The first acre costs $1,000 and gives total benefits of $3,000, so it should be purchased. The marginal social benefit of the second acre is $1,800, so it too should be purchased. The marginal social benefit of the third acre is $1,500 ($800 + $700), so it too should be purchased. The marginal social benefit of the fourth acre is $1,100 ($500 + $600), so it too should be purchased. The fifth unit has a marginal social benefit of $600, so it should not be purchased. Consequently, 4 acres should be allocated to public recreational areas. (b) Since the cost of 4 acres is $4,000, total tax receipts must be $4,000. The total social benefit of 3 acres of recreational areas is $7,400 − $4,000 = $3,400. If the goal is to make the consumer surplus of Tom equal to that of Ray, Tom should pay a tax of (4,300 − 1,700) = $2,600 and Ray a tax of (3,100 − 1,700) = $1,400, so each would receive a consumer surplus of $1,700.

44. To Charlie, the marginal benefit (MB) of national defense is MB = 4,500 − 90Q, where Q measures units of national defense. Sally's marginal benefit is MB = 3,000 − 60Q. The marginal cost of providing national defense is constant and equal to $2,700. Calculate the efficient quantity of national defense. Graph aggregates MB and MC to illustrate the efficient quantity of national defense (label functions and include all relevant values in the graph). Assume policy makers are able to choose the efficient level of national defense because they know each voter's marginal benefit function. If tax shares are set to force each person to pay exactly what they think national defense is worth at the optimal level, what is Charlie's tax share, and what is Sally's tax share?

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Chapter 9

The efficient quantity is 32 units of national defense. Plugging this quantity into Charlie's and Sally's MB function shows that Charlie values the 32nd unit at $1,620, which is 60% of the cost, so Charlie's tax share should be 60%. Sally should bear the remaining 40% of the tax for national defense.

45. Suppose that there are 1,000 voters in a city. A total of 400 are willing to pay up to $25 each for the construction of a park, and the other 600 are willing to pay only $10. The construction of the park will cost $12,000. Someone proposes a vote on whether to tax each citizen $12 in order to finance the park. (a) What will be the result according to the median voter model? Is this result socially efficient? Explain. (b) What if instead of being willing to pay up to $25 each, the 400 residents were willing to pay up to $50 each?

ANSWER: (a) The median voter in this case is willing to pay at most $10. Consequently, any proposal for the park that will cost that voter more than $10, including the proposal of the $12 tax, will fail.

However, the residents' total willingness to pay is 400 × $25 + 600 × 10 = $16,000, which exceeds the cost of the park. Consequently, the socially efficient outcome is to construct the park, and so the median voter outcome is socially inefficient. (b) The answer would not change since the median voter did not change.

46. Suppose that three candidates are running for the same office. The only issues the population cares about are policing and criminal rehabilitation programs. There are three types of voters: The first group wants relatively little policing and lots of rehab, the second group wants medium amounts of both, and the third group wants lots of policing and little rehab. The candidate with the highest number of votes wins, and the politicians care only about winning rather than about their personal ideology. Analyze how useful the median voter model will be in this case, specifically focusing on the number of issues in the race and the number of candidates who are running. What problems, if any, would these two things cause in terms of the median voter theory?

ANSWER: The median voter model assumes that there are only two candidates. In this election, there are three.

Consequently, using the median voter model will be problematic since there is no stable equilibrium along the line of preferences. The number of issues is not problematic, however, and does not violate the assumption of single-dimensional voting in the median voter model. Since the voter preferences are exactly correlated between these two issues, the election is essentially a oneCopyright Macmillan Learning. Powered by Cognero.

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Chapter 9 dimensional election.

47. There is an election with three candidates: Lady Left (LL), Carrie Central (CC), and Robert Right (RR). The following are the outcomes in various two- and three-way races: CC, 100%; RR, 0% LL, 0%; CC, 100% RR, 51%; LL, 49% RR, 35%; LL, 33%; CC, 32% The voting system is such that first there is a three-way race. Then, if none of the three candidates wins more than 50% of the votes, there is a two-way runoff election between the two candidates who won the most votes.

Is this voting system consistent? Explain which property of consistency is violated, if any.

ANSWER: Everyone prefers Carrie Central to either of the other candidates. However, the current voting system is inconsistent since Robert Right will win the runoff election against Lady Left. Indeed, the preferred candidate did not even make it to the runoff election! The property of independence of irrelevant alternatives is violated.

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Chapter 10 1. All of these are true statements about the CARES Act EXCEPT: a. It gave immediate relief to states to offset costs during the Covid-19 Crisis. b. The legislation was first introduced by President Trump in 2019. c. The act gave grants to help the education and infrastructure sectors. d. The CARES Act and subsequent acts are at the heart of the debate over optimal fiscal federalism.

ANSWER: b 2. The key questions addressed in this chapter are: I. How does the provision of private goods at the local level impact their optimality?

II. How should different types of spending be shared between different levels of government?

III. What are the impacts of government grants designed to share spending across levels of government? a. I only b. I and II only c. II and III only d. I and III only ANSWER: c 3. Optimal fiscal federalism is the question of: a. which states perform efficiently and which do not. b. how much interstate redistribution of wealth by the federal government is appropriate. c. how much tax revenue should be collected by the federal government and allocated to the state governments. d. which activities should take place at which level of government.

ANSWER: d 4. The share of spending by the federal government was _____% of all government spending in 1902 and _____ significantly over the next 50 years. a. 34; increased b. 34; decreased c. 66; increased d. 66; decreased ANSWER: a 5. All of these are fundamental reasons for the increase in the share of federal government spending in total government spending EXCEPT: a. the Sixteenth Amendment to the Constitution, which allowed the federal government to levy income taxes on individual citizens. b. New Deal programs of the 1930s in response to the Great Depression. c. introduction of large social insurance and welfare programs by the federal government. d. increase in the number of programs mandated by the federal government but funded at the state or local level.

ANSWER: d Copyright Macmillan Learning. Powered by Cognero.

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Chapter 10 6. All of these are large expenditures of the federal government EXCEPT: a. health care. b. education. c. Social Security. d. national defense.

ANSWER: b 7. All of these are large elements of state and local spending EXCEPT: a. health care. b. education. c. Social Security. d. transportation.

ANSWER: c 8. A major source of tax revenue at the local level is: a. income taxes. b. property taxes. c. sales taxes. d. capital gains taxes.

ANSWER: b 9. Fiscal equalization refers to when: a. the national government distributes grants to subnational governments to equalize differences in wealth. b. subnational governments raise money from their citizens, and varying portions of those proceeds are taxed by the national government. c. collectively, spending by subnational governments is equal to spending by the national government. d. collectively, subnational governments collect taxes equal to those collected by the national government.

ANSWER: a 10. In _____, there have been increased efforts to shift control and financing of public programs to subnational governments. a. China b. the United Kingdom c. Greece d. South Korea ANSWER: d 11. Which state spends the MOST per capita on education? a. Wisconsin Copyright Macmillan Learning. Powered by Cognero.

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Chapter 10 b. California c. Wyoming d. Florida ANSWER: c 12. If the federal government gives a grant to a state to spend only on education and total state education spending does not increase at all, which of these is TRUE empirically? Assume that education is a normal good. a. There is a flypaper effect. b. There is a substantial substitution effect. c. There is NO income effect. d. There is both an income effect and a substitution effect.

ANSWER: c 13. If the Tiebout mechanism fails, which of these should be done? a. redistribute income from poor to rich communities b. redistribute from rich to poor communities c. do not redistribute at all d. link local taxes to local spending ANSWER: b 14. Which of these is a conditional block grant? a. $4 million to be spent on education b. up to $4 million to be spent as the state sees fit c. $4 million to the state government to be spent on any state program d. a $1 increase in federal grant money for every $1 spent by the state ANSWER: a 15. According to the Tiebout model, how would someone respond if they didn't like the level of services provided in their community? a. They would use voter initiatives to change the level of services. b. They would vote out the local officials in the next general election. c. They would vote out the local officials by calling a recall election. d. They would move to a different community.

ANSWER: d 16. In the Tiebout model, public goods are provided _____ at the local level due to the preference revelation device of _____. a. inefficiently; general elections b. efficiently; recall elections c. inefficiently; mobility d. efficiently; mobility Copyright Macmillan Learning. Powered by Cognero.

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Chapter 10 ANSWER: d 17. The Tiebout model is MOST likely to apply to: a. the county government. b. the state government. c. the national government. d. the city government.

ANSWER: d 18. Which of these would prevent the Tiebout result? a. rich people paying the same in taxes as poor people b. individuals not being perfectly mobile c. many different communities for individuals to choose from d. variation in public services among communities ANSWER: b 19. An implication of the Tiebout model is that there is _____ similarity in preferences among people living in urban areas than in rural areas and that people in _____ areas are more satisfied with the level of public goods spending. a. less; urban b. more; urban c. less; rural d. more; rural ANSWER: b 20. If the Tiebout model holds perfectly in reality, which of these is TRUE? a. Education should be funded at the local level. b. We should redistribute wealth across communities. c. We should not redistribute wealth within communities. d. Taxes should be the same in all communities.

ANSWER: a 21. Suppose two individuals have identical incomes. One of them has a house worth $100,000, and the other has a house worth $200,000. The local government levies a tax of $500 on each of them, as it does on the homes of the rest of its residents. What kind of tax is this? a. a property tax b. a benefit tax c. an income tax d. a lump-sum tax ANSWER: d 22. Individuals who wish to live in a community with individuals richer than they are but without paying higher Copyright Macmillan Learning. Powered by Cognero.

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Chapter 10 property taxes are hoping to receive the benefits of the: a. free rider effect. b. slum effect. c. neighborhood effect. d. Tiebout effect.

ANSWER: a 23. Which of these is consistent with the assumptions in the Tiebout model? a. Local governments raise money using property taxes. b. Public parks in one town also benefit neighboring towns. c. Policing in one town does not affect criminal behavior in another town. d. Public services are equivalent in every community.

ANSWER: c 24. An implication of the Tiebout model is that comparable houses in a community with a relatively _____ level of taxes, given a level of public goods, will be worth _____. a. low; less b. high; less c. high; more d. low; nothing ANSWER: b 25. Which of these is an implication of the Tiebout model? a. Local government should provide public goods characterized by a weak tax-benefit linkage. b. Local government should provide public goods characterized by a strong tax-benefit linkage. c. Local governments should provide public goods regardless of tax-benefit linkage. d. State or federal governments should provide public goods regardless of tax-benefit linkages.

ANSWER: b 26. The Tiebout model implies that _____ should be financed at the local level and that _____ should be financed at the state and federal levels. a. garbage collection; education programs b. garbage collection; welfare programs c. road repair; education programs d. national defense; snow plows ANSWER: b 27. All of these are limitations of the Tiebout model EXCEPT: a. mobility; many people are not perfectly mobile. b. competition; people may not have perfect information about the benefits and taxes where they live. c. financing; lump-sum taxation is the most popular form of taxation.

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Chapter 10 d. spillover; the Tiebout model assumes that public goods have effects only in a given town, and no spillovers are observed in the neighboring towns.

ANSWER: c 28. Suppose the federal government promises to pay a state $0.50 for every $1 the state spends on health insurance for uninsured children. That transfer can BEST be characterized as a(n): a. interstate transfer. b. block grant. c. matching grant. d. conditional block grant.

ANSWER: c 29. Suppose the federal government pays $5 million into a state's general fund. That transfer can BEST be characterized as which of these? a. an interstate transfer b. a block grant c. a matching grant d. a conditional grant ANSWER: b 30. Suppose the federal government promises to pay a state $5 million to subsidize the loans of college students in that state. That transfer can BEST be characterized as a(n): a. interstate transfer. b. block grant. c. matching grant. d. conditional block grant.

ANSWER: d 31. The federal government gives a state a _____ grant, promising to pay the state $0.25 for every $1 the state spends on health care for senior citizens, which _____ the price of health care to the state by 20%. a. block; increases b. block; decreases c. matching; increases d. matching; decreases ANSWER: d 32. A state is currently spending $40 million on highway improvements. If the federal government promises to pay the state $1 for every $1 spent by the state on highway improvements, it is offering a _____ grant that _____ increase total state spending on highway improvements. a. conditional; will b. conditional; will not c. matching; will Copyright Macmillan Learning. Powered by Cognero.

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Chapter 10 d. matching; will not ANSWER: c 33. A state is spending $40 million on highway improvements. If the federal government promises to pay the state $0.25 for every $1 spent by the state on highway improvements and if highway improvements are a normal good, the income effect induces the state to spend _____ on highway improvements; the substitution effect induces the state to spend _____ on highway improvements. a. less; less b. less; more c. no more or less (there is no income effect); more d. more; more ANSWER: d 34. A state is spending $30 million on disability programs in schools. If the federal government promises to give that state $25 million to spend on disability programs in its schools, the federal government is offering a _____ grant that _____ state spending on disability programs in schools. a. block; will increase b. block; may or may not increase c. conditional block; will increase d. conditional block; may or may not increase ANSWER: d 35. A city that is currently spending $1 million on policing receives a one-for-one matching grant of up to $2.5 million to spend on policing. Assume policing is a normal good, as are other programs paid for by the city. The income effect _____; the substitution effect _____. a. increases spending on all programs; increases spending on policing b. increases spending on nonpolicing programs; decreases spending on policing c. increases spending on policing; does not affect spending on policing d. does not change spending on policing; increases spending on nonpolicing programs ANSWER: a 36. The federal government gives a state $300 million that it must spend on highway improvements. If the state was already spending $400 million, then from the state's perspective, this _____ grant is effectively _____. a. conditional block; unconditional b. unconditional block; conditional c. matching; unconditional d. matching; conditional ANSWER: a 37. Which of these always has an income effect? a. matching grants but not block grants b. block grants but not matching grants Copyright Macmillan Learning. Powered by Cognero.

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Chapter 10 c. conditional block grants but not block or matching grants d. block grants, matching grants, and conditional grants ANSWER: d 38. A city that is spending $1 million on policing receives a conditional grant of $500,000 to spend on policing.

Assume policing is a normal good. The income effect _____ spending on policing; the substitution effect _____ spending on policing. a. increases; increases b. increases; decreases c. increases; does not affect d. decreases; increases ANSWER: c 39. A city is spending $1 million on policing and receives a one-for-one matching grant of up to $2.5 million to spend on policing. Assume policing is a normal good. The income effect _____ spending on policing; the substitution effect _____ spending on policing. a. increases; increases b. increases; decreases c. increases; does not affect d. decreases; increases ANSWER: a 40. Matching grants have _____; block grants have _____. a. both income and substitution effects; both income and substitution effects b. only substitution effects; only income effects c. both income and substitution effects; only income effects d. only income effects; only substitution effects ANSWER: c 41. Which of these never has a substitution effect? a. matching grants b. block grants c. conditional block grants d. neither matching grants nor block grants ANSWER: b 42. To the extent that federal block grants do not replace state spending but increase overall spending, there is: a. no flypaper effect. b. an income effect. c. no substitution effect. d. crowding out.

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Chapter 10 ANSWER: b 43. Excluding school finance equalization laws, which of these is the primary reason educational spending can vary widely across towns? a. the difference in political influence of state legislators representing the towns b. the difference in the political influence of U.S. representatives c. the difference between the property values across towns d. the difference between local sales and gasoline taxes across towns ANSWER: c 44. If government believes that Tiebout sorting is optimal, which of these is TRUE? a. School spending should be equalized across districts. b. School spending should not be equalized across districts. c. Local property taxes should not be linked to local education spending. d. Property taxes should be the same in each community.

ANSWER: b 45. Which of these is TRUE? a. Tiebout sorting in California was more effective prior to the passing of Proposition 13. b. Tiebout sorting in California was less effective prior to the passing of Proposition 13. c. Equalizing school spending across districts within a state leads to more Tiebout sorting. d. Tiebout sorting creates equal educational opportunity.

ANSWER: a 46. The Sixteenth Amendment led to: a. an increase in the share of federal government spending as a portion of total government spending. b. a decrease in the share of federal government spending as a portion of total government spending. c. no change in the share of federal government spending as a portion of total government spending. d. an increase in the share of revenue the federal government collects through property taxes.

ANSWER: a 47. Brant values green spaces, and everyone else in his community does not. He is not satisfied with the current number of green spaces in his town. According to the Tiebout model, what is Brant’s response? a. He would use voter initiatives to add green spaces. b. He would vote out the local officials in the next general election. c. He would voluntarily pay more taxes to pay for more green spaces. d. He would move to a different community.

ANSWER: d 48. Sirius value green spaces, and everyone else in his community does not. He is not satisfied with the current number of green spaces in his town. According to the Tiebout model, Sirius would move to a community: a. that is far away from his current community.

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Chapter 10 b. where citizens share his same preference for green spaces. c. where fewer taxes are paid. d. that is exactly like his current community.

ANSWER: b 49. Which of these is TRUE of community zoning regulations? a. They require multifamily housing units in communities. b. They lower the cost of real estate for both low-income and wealthy households. c. They protect the tax base of wealthy towns by pricing lower-income people out of the housing market. d. They increase the likelihood of free riding.

ANSWER: c 50. All of these are common community zoning regulations EXCEPT: a. prohibition against using one's home to run a business in a residential neighborhood. b. restriction on the maximum number of occupants a lot or building may house. c. requirement for minimum lot sizes. d. requirement to build multifamily housing.

ANSWER: d 51. Regulations that are focused on more tightly targeted local issues: a. should be decided at the federal level. b. should be handled by local governments. c. should be decided by national elections. d. should be consistent across all states.

ANSWER: b 52. Regulations that have large economies of scale: a. should be decided at higher levels of government. b. should be handled by local governments. c. should be decided by local elections. d. should be tailored to specific locales.

ANSWER: a 53. Recent evidence indicates that states: a. have taken a much more aggressive role in limiting the ability of local governments to enact regulations. b. have taken a less aggressive approach to how local governments enact regulation. c. have taken away local governments' ability to enact regulation. d. have appointed individuals to city councils.

ANSWER: a Copyright Macmillan Learning. Powered by Cognero.

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Chapter 10 54. Gun control regulation should be: a. decided at higher levels of government. b. handled by local governments. c. decided by local elections. d. tailored to specific locales.

ANSWER: a 55. Which of these is less likely to have large spillovers in localities having looser regulations than the rest of the state? a. gun control b. minimum wage c. smoking bans d. transgender bathrooms ANSWER: d 56. Which of these following is a large element of federal spending? a. transportation b. education c. Social Security d. housing ANSWER: c 57. Which of these following is a large element of state and local spending? a. interest payments on government debt b. education c. Social Security d. national defense ANSWER: b 58. All of these following are examples of black grants EXCEPT: a. $4 million to be spent on education. b. up to $4 million to be spent on infrastructure. c. $4 million to the state government to be spent on any state program. d. a $1 increase in federal grant money for every $1 spent by the state.

ANSWER: d 59. The Tiebout model is LEAST likely to apply to: a. the county government. b. the state government. c. the national government.

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Chapter 10 d. the city government.

ANSWER: c 60. Which of these following would prevent the Tiebout result? a. rich people paying the same in taxes as poor people b. individuals in a city not having similar tastes c. many different communities for individuals to choose from d. variation in public services among communities ANSWER: b 61. Suppose two individuals have identical incomes. One of them has a house worth $100,000, and the other has a house worth $200,000. The local government levies a tax based on the value of the property on each of them, as it does on the homes of the rest of its residents. What kind of tax is this? a. a property tax b. a benefit tax c. an income tax d. a lump-sum tax ANSWER: a 62. Individuals who wish to receive the benefits of the free rider effect would: a. live in a community with individuals who are less wealthy than they are without paying higher property taxes. b. aim to use public transportation without paying the necessary costs. c. move to a location where other citizens pay the same amount of taxes and have similar tastes and preferences. d. live in a community with individuals who are more wealthy than they are without paying higher property taxes.

ANSWER: a 63. Which of these following is consistent with the assumptions in the Tiebout model? a. Local governments raise money using federal income taxes. b. Public parks in one town also benefit neighboring towns. c. Projects with large economies of scale should be undertaken at the federal level. d. Public goods and services are equivalent in every community.

ANSWER: c 64. The Tiebout model implies that _____ should be financed at the local level and that _____ should be financed at the state and federal levels. a. garbage collection; education programs b. street sweeping; national defense programs c. road repair; education programs d. national defense; snow plows Copyright Macmillan Learning. Powered by Cognero.

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Chapter 10 ANSWER: b 65. Discuss the views of supporters and opponents regarding legislation intended to address the Covid-19 crisis.

What is the fundamental issue in the debate? How do these debates reshape the original legislation?

ANSWER: At heart, the central issue in these debates over the rescue of state and local government is the optimal level of involvement and spending by the federal government in these matters. An important piece to consider in this matter is that state and local governments are subject to balanced budget requirements. Thus, they cannot rely on running deficits in tougher times and paying them off in better times (a strategy that can be used by the federal government). The Covid-19 crisis caused a higher need to aid hospitals, first responders, and social programs to assist those in need while simultaneously reducing the tax revenue to which these programs are funded. Thus, states are faced with the choice of raising taxes and/or cutting spending in order to meet budget requirements, and each of these options would hurt citizens instead of helping. Thus, one side wanted to give as much aid as possible. New Jersey Governor Phil Murphy said that these additional funds would allow the states to "keep firefighters, teachers, police and emergency medical services on the payroll, serving communities in their hour of need" during a meeting with President Trump. While the CARES act was passed in March of 2020, the HEROES Act was also proposed in June 2020 to provide further aid. While this act was passed by the House of Representatives, it did not make it through the Senate. Republicans in Congress opposed this bill due to the high level of spending and amount of aid sent to varying states.

President Trump stated that he did not think some states should be bailed out at the expense of others under the guise of the Covid-19 crisis. A different (and smaller) stimulus package was passed in December of 2020, and the Biden Administration eventually sent an additional 350 billion to state and local governments in early 2021. These events are a more recent example of the discussion regarding optimal fiscal federalism, and how the debates shaped the legislation that followed the crisis.

66. Suppose that the U.S. Congress is debating whether to end the Temporary Assistance to Needy Families (TANF) program and instead let local governments replace this program with their own programs. Which approach would be more efficient? Explain.

ANSWER: To the extent that society wants to help the neediest people through government programs, such programs should be administered at central levels of government, such as the federal government.

The problem with administering them at the local level is that high-income people who don't benefit from these sorts of programs would vote with their feet and move to communities with lower property taxes that do not offer those programs. Consequently, Tiebout sorting is a limitation on the extent to which local governments can pursue programs that benefit only a minority of their residents.

67. Suppose that a city mayor proposes to pay for the acquisition and construction of public parks by implementing a seven-year local sales tax. Someone argues that the financing mechanism should instead be something that is spread out over more time, noting that a person who moves here eight years from now would get to enjoy the parks but under the current proposal wouldn't pay for them. Similarly, this individual argues that those who live in the community now pay for it, but if they move, they won't benefit at all from it after a few years. The mayor argues that those who move out of this area will in fact benefit from the parks beyond their personal use and that those who move to this area after the seven-year period will implicitly pay for the access to the parks. What does the mayor mean?

ANSWER: The mayor is referring to the fact that the benefit of the parks and the extent to which they have been paid for may well be capitalized into house prices. Consequently, if someone moves away from this community in eight years, after paying a higher sales tax for the previous seven years, their house Copyright Macmillan Learning. Powered by Cognero.

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Chapter 10 will be worth more both because there are nicer parks, which are valued by homeowners, and because those parks have already been paid for and thus will not be paid for in the future by increased property or sales taxes.

68. If the federal government gives one state a matching grant of $4 million and another state a conditional block grant of $4 million and requires that both be used only for policing costs, which state is likely to increase its spending on policing more, and why?

ANSWER: A federal matching grant ties the grant amount to the amount of spending by the state. For example, the government might offer a one-for-one matching grant to a state for policing, which means that for every $1 the state spends, the federal government will also contribute $1 to policing in that state.

In contrast, a block grant is simply a grant that is not tied to anything and is essentially an increase in revenue for the state. It does not reduce the price of state spending and therefore has no substitution effect. Rather, a block grant has only an income effect, meaning that after receiving such a grant, the state will spend more on all normal goods. In contrast, a matching grant does reduce the price of spending. In the policing example we gave, it reduces the price of $1 of spending on police to $0.50. Consequently, the substitution effect of a matching grant induces the state to spend more overall. In addition, the income effect of the grant induces the state to spend more on all normal goods.

69. What is the tax price of a school equalization scheme? Why might these tax prices affect overall per-pupil spending in a state?

ANSWER: The tax price of a school equalization scheme is the amount of revenue a local district would have to raise to gain $1 more of spending. For example, a local district might have to raise its local revenues by $0.80 to achieve a $0.20 increase in spending. Overall spending statewide would increase by $1, but the local taxpayers reap only a small benefit from increases that raise their taxes a lot. In this case, the tax price of $0.80 measures the cost to a district of raising its own spending.

70. Describe the arguments for redistributing funds from high-revenue, high-spending communities to lowrevenue, low-spending communities in each of the following situations: (a) The world operates in a perfect Tiebout fashion. (b) The world does not operate in a perfect Tiebout fashion.

ANSWER: (a) In a perfect Tiebout world, there should be no redistribution since individuals are in the community they are in because it offers them the efficient level of public goods for their tastes. Any redistribution should focus on individuals because redistributing across communities would impede this Tiebout efficiency. (b) In this case, there are two arguments. The first is, what if the Tiebout mechanism fails? That is, what if individuals cannot effectively vote with their feet and go to a community with the desired level of taxes and public goods? In this situation, it could be efficient to redistribute money to the low public goods communities to help those stuck in that situation.

The second argument for this redistribution in an imperfect Tiebout world is externalities across communities. For example, if low public goods communities have negative spillover effects on neighboring communities, redistributing from the high to low public goods communities can help compensate for this externality.

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Chapter 11 1. Which is TRUE about per pupil spending and educational attainment in the United States? a. State and local governments spend about 5% of their budgets on education. b. The United States spends much more per student and achieves outcomes that are notably better than those of other nations. c. U.S. eighth graders are less proficient in math and science than students in some much less wealthy countries. d. The federal government spends 30% of its budget on education.

ANSWER: c 2. The Common Core is a(n): a. widely accepted set of learning objectives that govern K–12 curriculum design. b. controversial set of national standards that outline what students ought to know. c. attempt to give local school districts more control over educational goals. d. set of learning objectives considered too elementary to be helpful in improving educational outcomes.

ANSWER: b 3. In the United States, approximately _____% of K–12 students attend public schools rather than privately funded institutions. a. 10 b. 25 c. 50 d. 90 ANSWER: d 4. Education is an example of a: a. pure public good. b. pure private good. c. good characterized by positive externalities. d. good characterized by negative externalities.

ANSWER: c 5. Which of these is a positive externality of education? a. Better-educated people tend to earn higher wages. b. Better-educated people make their coworkers more productive. c. Better-educated people live longer than less educated people. d. Better-educated people are less likely to vote and participate in a democracy.

ANSWER: b 6. Government is involved in education in part because society benefits from: a. a large workforce and lower wages. b. fewer public sector jobs.

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Chapter 11 c. high levels of spending on education. d. greater income mobility.

ANSWER: d 7. If a talented student from a low-income family cannot receive a loan to finance her education because she lacks collateral, this _____ could be addressed by _____. a. government failure; the privatization of education b. government failure; the abolition of the federal Department of Education c. credit market failure; the privatization of education d. credit market failure; government intervention ANSWER: d 8. Suppose a politician says that the government should intervene in the education market because uneducated parents don't fully understand the value of education for their children. The politician is invoking which rationale for public intervention in education? a. credit market failure b. the potential for productivity spillovers c. the promotion of a sense of citizenship d. the failure of family utility maximization ANSWER: d 9. Suppose a politician states that poorly educated people have a higher propensity to commit crimes than more educated people and that, consequently, the government should intervene in the education market. The politician is invoking which rationale for public intervention in education? a. credit market failure b. the potential for productivity spillovers c. the need for redistribution d. the promotion of a sense of citizenship ANSWER: d 10. Suppose a politician states that, since parents always have their children's best interests at heart, the government should not intervene in the education market. According to this individual, which of these is NOT a legitimate rationale for government intervention in the education market? a. credit market failure b. the potential for productivity spillovers c. the promotion of a sense of citizenship d. the failure of family utility maximization ANSWER: d 11. Suppose a politician states that educated workers are no better at teaching coworkers valuable job skills than are uneducated workers. According to this individual, which of these is NOT a legitimate rationale for government intervention in the education market?

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Chapter 11 a. credit market failure b. the potential for productivity spillovers c. the need for redistribution d. the promotion of a sense of citizenship ANSWER: b 12. If the government justifies intervention in the education market by asserting that it wants to enhance income mobility, which rationale for intervention is it invoking? a. credit market failure b. the potential for productivity spillovers c. the need for redistribution d. the promotion of a sense of citizenship ANSWER: c 13. Suppose a politician claims that the government should intervene in the education market to "even the playing field" among low-income and high-income families. The politician is invoking which rationale for government intervention in the education market? a. credit market failure b. the potential for productivity spillovers c. redistribution d. the promotion of a sense of citizenship ANSWER: c 14. If the government were to directly operate schools, it would be intervening in the education market through _____. If the government were to require that everyone attend school through age 16 without intervening in the education market in any other way, it would be intervening through _____. a. public provision; private provision b. the price mechanism; the quantity mechanism c. the quantity mechanism; the price mechanism d. public provision; the quantity mechanism ANSWER: d 15. If the government were give parents vouchers they could redeem at any school, it would be intervening through _____. If the government were to mandate a maximum tuition cost of $6,000/year without intervening in the education market in any other way, it would be intervening through _____. a. public provision; private provision b. the price mechanism; the price mechanism c. the quantity mechanism; the price mechanism d. the price mechanism; the quantity mechanism ANSWER: b 16. Which of these is an argument in support of educational vouchers?

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Chapter 11 a. They decrease competition in the education market. b. They make public schools less expensive. c. They increase competition in the education market. d. They enable families to send their children to unconventional, specialized schools.

ANSWER: c 17. If the government were to subsidize the purchase of education without intervening in the education market in any other way, it would be intervening through _____. If the government were to mandate that everyone attend school through age 16 without intervening in the education market in any other way, it would be intervening through _____. a. public provision; private provision b. the price mechanism; the quantity mechanism c. the quantity mechanism; the price mechanism d. the price mechanism; the price mechanism ANSWER: b 18. According to the economist Sam Peltzman, government provision of a fixed amount of public education: a. may lower educational attainment by inducing families to choose higher-quality private schools over lower-quality public schools. b. may lower educational attainment by inducing families to choose lower-quality public schools over higher-quality private schools. c. will not affect educational attainment because families will choose the highest-quality school they can afford. d. will improve educational attainment because families will choose the highest-quality school they can afford.

ANSWER: b 19. Suppose the education system goes from a private school-only system to a public school system in which families can choose between a fixed amount of free public education and a private education for which they would have to pay extra. The introduction of free public education would a. reduce educational quality. b. increase educational quality. c. not affect educational quality. d. have an indeterminate effect on educational quality.

ANSWER: d 20. Under a system of education vouchers: a. families are given the means to purchase education at a public or private school of their choice, forcing public and private schools to compete in a market setting. b. schools are given credits for especially strong improvements in educational attainment by students, qualifying the schools for public funding. c. public officials, on the basis of test scores, vouch for the educational attainments of students who Copyright Macmillan Learning. Powered by Cognero.

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Chapter 11 lack diplomas, helping these students in the job market. d. young adults are given the means to purchase education at two- or four-year colleges of their choice, enabling many more citizens to attain higher education.

ANSWER: a 21. Vouchers could bring about greater competition in the education sector by: a. making private schools more affordable. b. encouraging greater specialization among schools. c. enabling parents to use the Tiebout mechanism, that is, "vote with their feet" in choosing the optimal combination of tax rates and school quality for their children. d. incentivizing segregation.

ANSWER: a 22. Which of these is NOT a potential problem with school vouchers? a. allowing parents greater choice in educational options b. fostering excessive school specialization c. allowing greater segregation by race or income d. encouraging a "teaching to the test" approach to teaching ANSWER: a 23. Suppose a politician argues that vouchers will lead students of different races to sort into "White" and "Black" schools. He is arguing that vouchers will lead to: a. excessive school specialization. b. segregation. c. the provision of education as a natural monopoly. d. an inefficient use of public resources.

ANSWER: b 24. Suppose an advocate of vouchers argues that an advantage of vouchers would be to allow high school students to learn to weld and operate a mill instead of learning about Beowulf. This individual is expressing a lack of concern that vouchers may lead to: a. excessive school specialization. b. increased segregation. c. the provision of education as a natural monopoly. d. an inefficient use of public resources.

ANSWER: a 25. Suppose a critic of vouchers argues that vouchers would lead to the brightest students leaving the public school system. This criticism expresses a concern that vouchers may lead to: a. excessive school specialization. b. segregation. c. the provision of education as a natural monopoly.

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Chapter 11 d. an inefficient use of public resources.

ANSWER: b 26. A market in which economies of scale confer an efficiency advantage on having just one provider of a service is a: a. black market. b. free market. c. natural monopoly. d. natural monopsony.

ANSWER: c 27. The arguments of voucher supporters are based on a(n) _____ model of the education market. a. monopolistically competitive b. perfectly competitive c. natural monopoly d. oligopoly ANSWER: b 28. A critic of education vouchers argues that under a voucher system, schools will try to avoid taking students who require significant accommodations and are therefore expensive to teach. The critic is arguing that vouchers may lead to: a. segregation. b. the provision of education as a natural monopoly. c. excessive school specialization. d. an inefficient use of public resources.

ANSWER: c 29. In the United States, the average student with a disability costs about: a. $6,000 a year to educate, more than twice the cost of educating a student without a disability. b. $6,000 a year to educate, about half the cost of educating a student without a disability. c. $12,700 a year to educate, more than twice the cost of educating a student without a disability. d. $12,700 a year to educate, about half the cost of educating a student without a disability.

ANSWER: c 30. Suppose a state institutes a voucher program. Schools that have too many applicants use a lottery to randomly determine who can attend. The BEST approach to determining the effect of a voucher program on student achievement is to compare the outcomes for students _____ to those for _____. a. who win the lottery; students in public schools b. in private schools; students in public schools c. who win the lottery; students who lose the lottery d. in schools with increased enrollment; students in schools with decreased enrollment ANSWER: c Copyright Macmillan Learning. Powered by Cognero.

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Chapter 11 31. Small, independent public schools not subject to many of the regulations imposed on traditional public schools, including restrictions on teacher qualifications, are called: a. magnet schools. b. charter schools. c. parochial schools. d. private schools.

ANSWER: b 32. Which is an unintended consequence of school accountability programs? a. Some teachers "teach to the test" and do not focus enough on learning. b. Teachers increase their focus on subjects, not on the test, to add balance. c. Schools are careful to ensure that all students take standardized exams. d. Teacher promotions are not based on student performance.

ANSWER: a 33. The positive correlation between education and earnings is consistent with education as a(n): a. escape for those who don't want to work. b. screening device that may not affect skills. c. waste of taxpayer money. d. way of preventing income inequality.

ANSWER: b 34. With respect to empirical evidence related to education, which is NOT true? a. Higher levels of education are associated with a reduced likelihood of participation in the political process. b. Higher levels of education are associated with a lower likelihood of criminal activity. c. Higher levels of education are associated with improved health. d. Higher levels of education among workers are associated with higher rates of productivity of their coworkers.

ANSWER: a 35. If education serves to separate high-ability workers from low-ability workers, it _____ a valuable social role, and the educational institutions that do this best should be _____. a. does not play; taxed b. does not play; subsidized c. plays; taxed d. plays; subsidized ANSWER: d 36. Loans made to students by the U.S. Department of Education are referred to as: a. direct student loans.

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Chapter 11 b. deferred student loans. c. subsidized student loans. d. guaranteed student loans.

ANSWER: a 37. Which of these is NOT true about Pell Grants? a. Pell Grants are provided to low-income families to pay for higher education. b. Pell Grant eligibility is entirely merit-based. c. The amount of a Pell Grant depends on the applicant's characteristics. d. The Pell Grant program is intended to provide more opportunities to low-income families.

ANSWER: b 38. Recent work by Marx and Turner (2015) suggests that Pell Grants: a. largely crowd out borrowing for college, creating very little net change in funding for college. b. largely crowd out borrowing for college, creating a significant net change in funding for college. c. have no significant crowding-out effect on borrowing for college, so the net change in college funding is negligible. d. have no significant crowding-out effect on borrowing for college, so the net change in college funding is substantial.

ANSWER: a 39. Large cuts in public education financing over the past decade have led to: a. a shrinking debt burden on students. b. a growing debt burden on students. c. no change in the debt burden on students. d. a large reduction in the amount borrowed by students to pay for college.

ANSWER: b 40. Monica attended college for four years but did not graduate. She currently makes $28,000 annually. Her twin sister, Louisa, attended the same college for four years and obtained her bachelor's degree. Using estimates from the Jaeger and Page (1996) study, which of these is the BEST estimate of Louisa's earnings, everything else held constant? a. $21,000 b. $28,000 c. $35,000 d. $56,000 ANSWER: c 41. June and Simone both work for ABC Computing. June completed 14 years of schooling and earns $37,000 annually. Simone completed 15 years of schooling. Using the typical estimate of the impact of each year of education on earnings, which of these is the BEST estimate of Simone's earnings, holding everything else constant?

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Chapter 11 a. $27,750 b. $37,000 c. $39,590 d. $64,750 ANSWER: c 42. Which of these is a plausible reason why U.S. higher education is seen as an enormous success relative to primary/secondary education in the United States? a. the degree of regulation of and government support for higher education b. differences in educational standards between the two systems c. greater financial aid given to higher education students d. the degree of private provision and competition in higher education ANSWER: d 43. Suppose a metro area has about 82,000 students in primary and secondary schools. Assuming the student population of this area is representative of national averages, approximately how many students attend private schools? a. 800 b. 8,200 c. 10,000 d. 73,800 ANSWER: b 44. The Brookings Institution estimates that 39% of students attend private universities. If there are about 20 million college students in the United States, how many attend private universities? a. 780,000 b. 3.9 million c. 7.8 million d. 12.2 million ANSWER: c 45. Which is NOT true about the 2008 introduction of the Common Core standards? a. It was initially fairly uncontroversial among governors and school chief officers. b. It had more rigorous standards than those already in place in a number of states. c. It outlined academic standards for graduates of four-year collegiate institutions. d. It was introduced to improve the achievement levels of students across the country.

ANSWER: c 46. Why is education not a pure public good? a. It meets the condition of rivalry but not of excludability. b. It meets the condition of excludability but not of rivalry.

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Chapter 11 c. The demand for education rises with income. d. It does not meet the condition of rivalry or of excludability.

ANSWER: d 47. Assume education is a normal good in a private market. Which of these statements is TRUE? a. Low-income families will demand more education for their children than high-income families. b. High-income families will demand more education for their children than low-income families. c. There is no relationship between families' income levels and the demand for education. d. Low- and high-income families will demand the same amount of education to maximize total family utility.

ANSWER: b 48. When public education provision crowds out private education provision: a. families increase their education spending in response to public education provision. b. an increase in government spending leads to a fall in private investment. c. families reduce their education spending in response to public education provision. d. an increase in government borrowing for education boosts the economy.

ANSWER: c 49. According to the literature, which two characteristics are common among successful charter schools? a. provision of intensive tutoring and rigorous standards b. teaching qualifications and school proximity c. rigorous math and language curriculums d. funding and parent involvement ANSWER: a 50. Banks are generally unwilling to loan money to finance higher education because: a. there is no clear evidence that higher education leads to higher earnings. b. there is no collateral for banks to repossess if a loan is not repaid. c. students who finance their higher education through loans are more likely to take low-paying public interest jobs, leaving them unable to repay the loans. d. higher education does not actually improve skills but only serves as a screening device.

ANSWER: b 51. President Barack Obama appointed Arne Duncan to be the secretary of education in 2009. Discuss Secretary Duncan's methods to address education woes during his tenure as chief executive officer of the Chicago public school system as well as his efforts during his term as secretary of education. Summarize the views of his supporters and opponents.

ANSWER: Duncan addressed "nonperforming" public schools and demonstrated a willingness to close failing schools. He also promoted controversial ideas, such as school choice and "pay for performance." He opened more than 100 new schools, closed underperforming schools, raised standards for teachers, and built public–private partnerships. He developed a plan to substantially broaden the federal role Copyright Macmillan Learning. Powered by Cognero.

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Chapter 11 in local primary and secondary education through tougher requirements on students and teachers, intensified efforts to assist failing schools, and developed a growing focus on alternatives to the traditional public school model, such as charter schools, which provide an alternative to traditional public schools. The economic stimulus bill of 2009 sent billions of dollars to states over a two-year period to prevent layoffs, create jobs, modernize school buildings, and promote the education of disadvantaged students. To supporters, these changes and Duncan's larger plan represent a needed first step toward fundamental educational reform. To critics, some aspects of the stimulus bill represented overreach by the federal government into an area traditionally regulated by state and local governments. Particularly criticized were the aspects of the bill that favored charter schools.

52. Several states mandate that school district boundaries follow county lines, while other states allow several school districts to locate in the same county. Assume that county size is approximately the same in both of these groups of states. Suppose both groups are considering implementing school vouchers, with proponents in both groups arguing that increased competition will lead to greater efficiency. Which group of states is more likely to achieve greater efficiency gains? Hint: Think about Tiebout sorting.

ANSWER: Tiebout sorting is likely to be more of a factor in states with many school districts for a given area, since people there are more likely to be able to "vote with their feet" against inefficient school systems if another school district is nearby. Consequently, introducing vouchers into a state in which school districts are defined by county boundaries is likely to cause a greater increase in competitive pressure on the school districts than if they are introduced into states where the Tiebout mechanism already puts a significant amount of pressure on the school districts.

53. One unintended consequence of incentivizing public schools to prepare their students to perform well on standardized tests is that it may lead to "teaching to the test" at the expense of broad educational goals. If the standardized exams given by the state test reading comprehension and mathematics, would these teaching distortions to be the same at the elementary and high school level? Explain.

ANSWER: Since more subjects are taught to high school students than to elementary students, one might expect that accountability programs will lead to more distortions at the high school level than at the elementary level. For example, if elementary education focuses primarily on reading comprehension and mathematics even without the test, then teaching to the test will not prevent students from learning other material. In contrast, to the extent that the focus of high school education is broader, teaching to the test could narrow the scope of teaching to a greater degree.

54. Studies of the effects of voucher programs on student achievement typically compare the achievements of students who used vouchers to switch to different schools to the achievements of otherwise similar students who wanted to but could not use vouchers to switch to different schools. Will such studies capture the effects of increased competition on inefficient schools in voucher-eligible areas? Explain.

ANSWER: Not necessarily. In particular, they will not capture the effects of increased competition if all schools are thereby made more efficient. Consider two schools: School A, which is inefficient prior to the introduction of school vouchers, and school B, which is efficient prior to the introduction of school vouchers. After vouchers are introduced, some students from school A want to transfer to school B, but only some (say, the lottery winners) can. If school A becomes more efficient as a result of the voucher system, then a comparison of the achievement levels of lottery winners to those of lottery losers might reveal no effect, even though the voucher system as a whole led to higher student achievement.

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Chapter 11 55. Jaeger and Page (1996) show that if two individuals both have four years of college, but one doesn't graduate, while the other does, the one with a bachelor's degree will earn 25% more, suggesting that the degree signals higher productivity among graduates than nongraduates. (a) Assume that students who attend college for four years acquire identical amounts of human capital, regardless of whether they graduate. Why might people who graduate in four years be more productive workers than those who attend college for four years but do not graduate? (b) Suggest reasons why the student with a degree might have acquired different human capital in college than the student who attended college for four years but did not graduate.

ANSWER: (a) Several characteristics may account for a positive correlation between productivity and graduation from a four-year college. Such individuals might be competent planners and be persistent in seeking to achieve their goals. Consequently, the degree may signal positive employee characteristics. Students who do not graduate, even though they attended college for four years, may lack the planning abilities and persistence that an employer might seek, even if in college they acquired skills identical to those of the other student. (b) One possible reason is that, rather than learning a set of skills useful in a certain job (e.g., engineering), the student may have switched majors and learned a variety of skills. Consequently, the student who didn't graduate may have failed to learn the same set of job-relevant skills in college that the graduate did. If that is true, then the effect that Jaeger and Page found could indeed be a consequence of different levels of human capital.

56. Employers often list a four-year college degree as a requirement for those applying for certain jobs. Is this practice consistent with the screening explanation for education, the human capital story, both, or neither?

Explain.

ANSWER: The requirement that prospective employees have a college degree is consistent with both the screening model and the human capital model. Obviously, if a college education does increase human capital and thereby productivity, an employer would want to find employees who have gained job-relevant skills as a result of their education. However, even if education adds nothing of value to an employee's skill set and serves only to signal employers that an individual is of high quality, the employer would still want to identify prospective employees who signal they are of high quality by obtaining four-year college degrees.

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Chapter 12 1. By 2019, about _____ ¢ of each dollar of federal spending was used for national defense, and about _____ ¢ of each dollar was used for Social Security. a. 5; 20 b. 14; 25 c. 15; 18 d. 10; 50 ANSWER: c 2. Which is NOT true about changes in government spending over the past 50 years? a. The share of defense spending has decreased significantly. b. Spending on social insurance has increased dramatically. c. After adjusting for inflation, government spending has remained constant. d. Government spending on health care increased more than spending on Social Security.

ANSWER: c 3. Which provides insurance against job loss? a. disability insurance b. workers' compensation c. Medicare d. unemployment insurance ANSWER: d 4. Which provides insurance against career-ending injuries? a. disability insurance b. workers' compensation c. Medicare d. unemployment insurance ANSWER: a 5. Which provides insurance against on-the-job accidents? a. disability insurance b. workers' compensation c. Medicare d. unemployment insurance ANSWER: b 6. Which program provides insurance to cover medical expenditures for individuals over the age of 65? a. disability insurance b. Social Security c. workers' compensation d. Medicare Copyright Macmillan Learning. Powered by Cognero.

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Chapter 12 ANSWER: d 7. Which provides insurance against earnings loss due to retirement? a. disability insurance b. Social Security c. workers' compensation d. Medicare ANSWER: b 8. A federal insurance program for which one may not qualify if one's income is too high is subject to: a. adverse selection. b. means testing. c. moral hazard. d. experience rating.

ANSWER: b 9. In the United States, private insurance exists in each of these product areas EXCEPT: a. auto insurance. b. life insurance. c. casualty and property. d. Medicare.

ANSWER: d 10. Consumers engage in _____ because of _____. a. self-insurance; diminishing marginal utility b. consumption smoothing; diminishing marginal utility c. self-insurance; means-tested program benefits d. consumption smoothing; means-tested program benefits ANSWER: b 11. Suppose Gilbert foresees two possibilities for his health: He will either have a brain tumor or nothing more serious than a bout of the flu. In expected utility analysis, these two possibilities outcomes are referred to as: a. moral hazards. b. self-insurance. c. consumption. d. states of the world.

ANSWER: d 12. Insurance allows individuals to: a. consume more in every period in the future. b. have steadier consumption in every period in the future.

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Chapter 12 c. shift consumption from bad possible outcomes to good possible outcomes. d. avoid negative outcomes, such as automobile accidents.

ANSWER: b 13. People buying insurance aim to shift consumption from periods when consumption is _____ and marginal utility is _____ to periods when consumption is _____ and marginal utility is _____. a. high; low; high; low b. high; low; low; high c. low; high; low; high d. low; high; high; low ANSWER: b 14. Which BEST describes risk aversion? a. insurance premiums set equal to the insurer's expected payout b. adverse actions taken by individuals or producers in response to insurance against adverse outcomes c. the fact that insured individuals know more about their risk level than the insurer knows d. the extent to which a negative change in income impacts individuals more than a positive change in income of the same magnitude ANSWER: d 15. Paula earns $40,000 per year and rides her bicycle to work. There is a 1% chance that she will break her leg in the next year and a 99% chance that she will not be hurt at all. Medical bills for a broken leg are estimated at $4,000. If Paula buys full health insurance at an actuarially fair premium, she will pay a premium for the next year of: a. $4. b. $40. c. $400. d. $4,000.

ANSWER: b 16. An actuarially fair premium is set equal to the insurer's: a. expected payout, assuming no administrative costs or profits. b. expected administrative costs, assuming maximum profits. c. desired amount of profits. d. total costs.

ANSWER: a 17. Which term refers to charging an insurance premium that is a function of realized outcomes? a. actuarial adjustment b. moral hazard rating c. experience rating d. risk adjustment Copyright Macmillan Learning. Powered by Cognero.

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Chapter 12 ANSWER: c 18. Asymmetric information between buyers and sellers can lead to: a. adverse selection. b. rent seeking. c. actuarial adjustment. d. X-inefficiency.

ANSWER: a 19. Suppose that, among a group of uninsured people, the only ones who want to buy health insurance are those who enjoy jumping out of airplanes. This is an example of: a. adverse selection. b. rent seeking. c. moral hazard. d. X-inefficiency.

ANSWER: a 20. Adrianne is buying a life insurance policy and the underwriter asks her to allow the company to access all her medical records. What is the underwriter concerned about? a. adverse selection b. rent seeking c. moral hazard d. X-inefficiency ANSWER: a 21. A market equilibrium in which all types of individuals buy full insurance, even though it is not fairly priced to all individuals, is called a _____ equilibrium and occurs when all consumers are _____. a. pooling; not averse to risk b. pooling; risk averse c. separating; not averse to risk d. separating; risk averse ANSWER: b 22. Suppose the government mandates that all drivers have auto insurance because injuries and damages that uninsured motorists cause can be costly to other drivers. On which justification for government intervention in the insurance market does such a mandate rely? a. redistribution b. paternalism c. externalities d. adverse selection ANSWER: c Copyright Macmillan Learning. Powered by Cognero.

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Chapter 12 23. Reasons for government involvement in social insurance do NOT include: a. a potential adverse selection problem stemming from asymmetric information. b. potential savings on the administrative costs of insurance. c. the paternalistic belief that some individuals will not engage in necessary planning. d. the revenue stream the government can tap by getting into the insurance market.

ANSWER: d 24. Suppose the government subsidizes the health insurance of individuals because it believes that people do not adequately understand the importance of health insurance. On which justification for government intervention in the insurance market does this action rely? a. high administrative costs b. redistribution c. paternalism d. adverse selection ANSWER: c 25. Which is NOT a reason for government intervention in insurance markets? a. adverse selection b. moral hazard c. redistribution d. paternalism ANSWER: b 26. If the government intervenes in the health insurance market to address the adverse-selection problem and improve efficiency: a. there will likely be some redistribution of income from high-risk individuals to low-risk individuals. b. there will likely be some redistribution of income from low-risk individuals to high-risk individuals. c. everyone will be better off as a result. d. everyone will be worse off as a result.

ANSWER: b 27. Suppose the government pays part of the health care costs of citizens who are genetically predisposed to have certain health problems. On which justification for government intervention in the insurance market does this action rely? a. high administrative costs b. redistribution c. paternalism d. externalities ANSWER: b 28. Administrative costs for private insurance average about _____% of claims paid, whereas the administrative costs of Medicare average about _____% of claims paid.

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Chapter 12 a. 10; 10 b. 2; 20 c. 12; 2 d. 1.35; 15 ANSWER: c 29. Members of the Martinez family agree to support one another in the event that one of member loses their job. This is an example of: a. disability insurance. b. workers' compensation. c. self-insurance. d. unemployment insurance.

ANSWER: c 30. If a person has imperfect or partial self-insurance against job loss, they are likely to: a. allow consumption to fall to zero in the event of a job loss. b. maintain constant consumption in the event of a job loss. c. smooth consumption fully. d. smooth consumption to some extent but not fully.

ANSWER: d 31. Idun just bought her first health insurance policy. She celebrates by jumping out of an airplane for the first time—attached to a parachute, of course. This behavior is BEST characterized as: a. adverse selection. b. means testing. c. moral hazard. d. X-inefficiency.

ANSWER: c 32. Cyril lowers the deductible on his car insurance and starts driving like Michael Schumacher, a retired Formula One race car driver. This is an example of: a. adverse selection. b. rent seeking. c. moral hazard. d. X-inefficiency.

ANSWER: c 33. Maria is a rational consumer with no health insurance. She will use medical care up to the point at which her: a. total benefit is equal to the cost of medical care. b. marginal benefit is zero.

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Chapter 12 c. marginal benefit is equal to the marginal cost of medical care. d. total benefit is equal to zero.

ANSWER: c 34. Lee is a rational consumer with complete health insurance (no copayments or deductibles). He will use medical care up to the point at which his: a. total benefit is equal to the cost of care paid by the insurance provider. b. marginal benefit is zero. c. marginal benefit is equal to the marginal cost of care paid by the insurance provider. d. total benefit is equal to zero.

ANSWER: b 35. Individuals value insurance because they would ideally like to: a. have more consumption when an adverse event like unemployment or illness befalls them. b. have less consumption when an adverse event like unemployment or illness befalls them. c. have the same consumption regardless of whether an adverse event like unemployment or illness befalls them. d. not have an adverse event like unemployment or illness befalls them.

ANSWER: c 36. Under realistic conditions, optimal social insurance systems should: a. not insure individuals against adverse events. b. partially, but not completely, insure individuals against adverse events. c. completely insure individuals against adverse events. d. prevent adverse events.

ANSWER: b 37. Which illustrates the samaritan's dilemma? a. People forego buying flood insurance, knowing the government will step in with financial support in the event of flooding. b. Once people have government-provided flood insurance, they act irresponsibly, building floodvulnerable structures. c. Flood insurance companies know that those who buy flood insurance are mostly those with the most flood-prone lands, forcing the companies to raise premiums above many people's willingness to pay. d. Government-provided flood insurance crowds out privately provided flood insurance, leading to inefficiency in the provision of flood insurance.

ANSWER: a 38. Which discouraged homeowners in flood-prone areas from purchasing flood insurance? a. The likelihood of hurricanes making landfall has decreased substantially in recent years. b. Many homeowners in flood-prone areas have moved to other states and no longer need such insurance.

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Chapter 12 c. The government will help homeowners in flood-prone areas rebuild if their property is damaged. d. Construction costs have fallen dramatically, so the cost of rebuilding is low.

ANSWER: c 39. Matt's utility function is U = ln(C), where C is consumption. He earns $45,000 per year and races stock cars in his spare time. There's a 10% chance that he will crash on the racetrack in the next 12 months and incur medical costs of $15,000. He will also have to miss work and will lose about $5,000 in earnings. What is his expected utility? a. 0.90 × ln(45,000) + 0.10 × ln(25,000) = 10.66 b. 45,000 − 15,000 − 5,000 = 25,000 c. ln(45,000) + ln(25,000) = 20.84 d. (0.90 × 45,000) + (0.10 × 25,000) = 43,000 ANSWER: a 40. Matt's utility function is U = ln(C), where C is consumption. He earns $45,000 per year and races stock cars in his spare time. There's a 10% chance that he will crash on the racetrack in the next 12 months and incur medical costs of $15,000. He will also have to miss work and will lose about $5,000 in earnings. Assume he buys insurance to cover medical expenses and forgone wages. What is an actuarially fair price for this insurance policy? a. $600 b. $1,000 c. $2,000 d. $4,500 ANSWER: c 41. Matt's utility function is given by U = ln(C), where C is consumption. He earns $45,000 per year and races stock cars in his spare time. There's a 10% chance that he will crash on the racetrack in the next 12 months and incur medical costs of $15,000. He will also have to miss work and will lose about $5,000 in earnings. Assume he buys insurance to cover medical expenses and forgone wages. What is Matt's expected utility if he buys the insurance policy at the actuarially fair price? a. 10.61 b. 9.60 c. 10.67 d. 20.84 ANSWER: c 42. Suppose an insurance company knows that there are two groups on the demand side of the market, the careful and the careless. It has good estimates of the probability a person in each group will have an accident, but it cannot identify who is in which group. The company charges a premium based on the average probability of an accident. What could prompt a careful person to buy the insurance? a. The average risk is very close to the risk faced by a careful person. b. The average risk is very close to the risk faced by a careless person.

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Chapter 12 c. The average risk is below the risk faced by a careful person. d. The average risk is below the risk faced by a careless person.

ANSWER: a 43. Suppose an insurance company knows that there are two groups on the demand side of the market, the careful and the careless. It has good estimates of the probability a person in each group will have an accident, but it cannot identify who is in which group. The company charges a premium based on the average probability of an accident. Since the average probability is _____ than a careless person's probability of experiencing an adverse event, the careless person will choose _____ buy the insurance. a. higher; not to b. lower; not to c. higher; to d. lower; to ANSWER: d 44. Suppose an insurance company knows that there are two groups on the demand side of the market, the careful and the careless. It has good estimates of the probability a person in each group has an accident, but it cannot identify who is in which group. The company charges a premium based on the average probability of an accident. Most likely, the share of buyers who are in the careless group will be disproportionately _____, and the company will _____. a. large; suffer a loss b. small; suffer a loss c. large; make a profit d. small; make a profit ANSWER: a 45. Suppose an insurance company knows that there are two groups on the demand side of the market, the careful and the careless. It has good estimates of the probability that a person in each group will have an accident, but it cannot identify who is in which group. The company charges a premium based on the average probability of an accident.

Careful people would be more likely to buy the policy if they are more _____, and the risk for careful people is _____ the average risk.

a. risk averse; close to b. risk seeking; far above c. risk seeking; close to d. risk averse; far below ANSWER: a Copyright Macmillan Learning. Powered by Cognero.

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Chapter 12 46. The problem of moral hazard is more severe when monitoring the behavior of insured individuals is _____, and qualifying for insurance is _____. a. difficult; relatively easy b. relatively easy; difficult c. difficult; difficult d. relatively easy; relatively easy ANSWER: a 47. The problem of moral hazard is less severe when monitoring the behavior of insured individuals is _____, and qualifying for insurance is _____. a. difficult; relatively easy b. relatively easy; difficult c. difficult; difficult d. relatively easy; relatively easy ANSWER: b 48. Which of these is NOT an illustration of moral hazard? a. Because Nuria is relatively healthy, she chooses not to buy health insurance. b. Because Nuria has workers' compensation insurance, she isn’t as careful at work. c. Because Nuria has medical insurance, she uses more medical care than she otherwise would. d. Because Nuria has medical insurance, physicians provide too much care to her.

ANSWER: a 49. Moral hazard leads to workers with workers' compensation to set the wage: a. above the marginal value of leisure. b. equal to the workers' compensation payment. c. above their marginal product. d. equal to the marginal value of leisure.

ANSWER: a 50. Typically, individuals do not have a private supplier of _____ insurance available to them. a. unemployment b. automobile c. health d. property ANSWER: a 51. When no private market for insurance exists, social insurance programs make _____ possible. a. consumption smoothing b. self-insurance Copyright Macmillan Learning. Powered by Cognero.

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Chapter 12 c. adverse selection d. moral hazard ANSWER: a 52. One potential problem with social insurance is that it may: a. crowd out private insurance. b. create moral hazard. c. occasion adverse selection. d. prevent consumption smoothing.

ANSWER: a 53. In which scenario would social insurance have the largest impact on a person's ability to smooth consumption? a. The person has no private insurance or private source of help. b. The person has no private insurance but can rely on some help from friends and family. c. The person has no friends of family with the ability to help but does have limited private insurance. d. The person is fully privately insured.

ANSWER: a 54. Is self-insurance more likely to be chosen by rich or poor people? Explain why.

ANSWER: In general, one would expect that wealthy families are better able to self-insure. Possible reasons for this include that wealthy families are more likely to have savings that they can use to smooth consumption. High-income families are also more likely to have attractive borrowing options because they may have more equity in their home, among other things, against which to borrow.

55. Suppose that there are two regions of a state, one where car theft is high and the other where car theft is very low. The state allows insurance companies to charge different premiums for insurance against vehicle theft based in part on where the driver lives. Suppose the government is considering a policy change that would make it illegal to charge higher premiums to people in the areas of higher car theft. (a) Assume that all drivers in the state are very risk averse with regard to insurance against theft and that the insurance firms offer one rate for all drivers in that state. What kind of equilibrium will result? Who, if anyone, will pay a risk premium? Who will be better off, and who will be worse off? (b) What might happen if the drivers in the areas of low car theft were not very risk averse?

ANSWER: (a) The result would be a pooling equilibrium in which everyone buys full insurance. However, those in low-car-theft areas must now pay a risk premium; they're charged premiums that are actuarially unfair. In contrast, drivers in the high-car-theft areas are better off. (b) If drivers in the low-car-theft areas are not very risk averse, then several of them may no longer choose to buy insurance against car theft. That is, they might not be willing to pay the risk premium that they face in the pooling equilibrium. This would raise premiums. Then, as a result of the higher premiums, still more people in the low-theft areas may no longer choose to buy the insurance. If many drivers in low-car-theft areas are not very risk averse, the spiraling premiums could lead to an outcome in which insurance is offered at a high price that is attractive only to residents of high-theft areas.

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Chapter 12 56. Feliciano sells life insurance. A 40-year-old male nonsmoker asks him for a price on a $1 million policy for the next 10 years. A coworker suggests that the rate should be based on the death rates of male nonsmokers in their 40s in the general population. Is how Feliciano should determine the rate?

ANSWER: The coworker is forgetting about the problem of adverse selection. Feliciano is not interested only in how likely it is that the average 40-year-old nonsmoking male will die in the next 10 years. Rather, he is interested in how likely it is that the average 40-year-old nonsmoking male who wants to buy life insurance will die in the next 10 years. That is, he needs to be worried that this man knows something about his own risk of dying that Feliciano might not know about.

57. How do the benefits of disability insurance compare with the benefits of unemployment insurance?

Compare and contrast each with respect to the factors that influence how much social insurance increases consumption smoothing.

ANSWER: The first factor is the predictability of the event. It's not clear that disability is more predictable than unemployment, or vice versa, although to the extent that disability is caused by an accident, it's likely to be less predictable than is a job loss.

The second factor is the duration of the event. It's likely that a disability will last considerably longer than unemployment. Consequently, savings or borrowing are likely to be insufficient to smooth consumption for disabled persons, whereas they are likely to more effectively smooth consumption during a relatively short term of unemployment. Social insurance will thus be more valuable in the case of disability than unemployment.

The third factor is the availability of other forms of consumption smoothing. It's not clear whether a recently unemployed person would have more or fewer forms of consumption smoothing than a recently disabled person.

58. Is moral hazard likely to be a bigger problem in the health insurance market or the life insurance market?

Explain.

ANSWER: Since the primary cost of death is death itself, it's unlikely that a purchaser of a life insurance policy would not take adequate precaution against dying. However, a significant cost of incurring a major injury is the cost of health care and rehabilitation. Since having health insurance prevents people from shouldering all those costs themselves, they may be less likely, if insured, to take precautions against getting injured or sick. In addition, if someone has health insurance, they may use more medical care than they would have if they were uninsured, since they wouldn't bear all the costs of this care. Consequently, moral hazard is likely to be a bigger problem in the health insurance market than the life insurance market.

59. Optimal social insurance systems should partially but not completely insure individuals against adverse events. Explain.

ANSWER: Higher social insurance improves social efficiency by fixing a market failure but reduces social efficiency by reducing production and raising taxes. As with most trade-offs in economics, the resolution of this full insurance–adverse behavior trade-off will generally be somewhere in the middle, optimally providing some, but not full, insurance against adverse events.

60. Seung’s utility function is given by U = ln(C), where C is consumption. She makes $30,000 per year and enjoy jumping out of airplanes. There's a 5% chance that in the next year, she will break both legs, incur medical costs of $15,000, and lose an additional $5,000 from missing work. (a) What is Seung’s expected utility without insurance?

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Chapter 12 (b) Suppose Seung can buy insurance that will cover the medical expenses but not the forgone part of her salary.

How much would an actuarially fair policy cost, and what is her expected utility if she buys it? (c) Suppose Seung can buy insurance that will cover her medical expenses and forgone salary. How much would such a policy cost if it's actuarially fair, and what is her expected utility if she buys it?

ANSWER: (a) Expected utility is 0.95 × ln(30,000) + 0.05 × ln(10,000) = 10.25. (b) Since there's a 5% chance of paying out $15,000, an actuarially fair policy would cost 0.05 × $15,000 = $750 per year. Her expected utility if she buys it is: 0.95 × ln(30,000 − 750) + 0.05 × ln(25,000 − 750) = 10.274. (c) Now there's a 5% chance of paying out $20,000, so an actuarially fair policy would cost 0.05 × $20,000 = $1,000. Her expected utility if she buys it is: 0.95 × ln(30,000 − 1,000) + 0.05 × ln(30,000 − 1,000) = 10.275.

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Chapter 13 1. The Social Security program faces a serious financing problem over the next 75 years because it has promised benefits: a. that exceed what it expects to collect in taxes by $17.8 trillion. b. equal to what it expects to collect in taxes. c. that fall short of what it expects to collect in taxes by $17.8 billion. d. that exceed what it is allowed to collect in taxes, since the tax rate cannot be changed.

ANSWER: a 2. Which of these is NOT correct about the Social Security program in the United States? a. It is the largest single source of income for the elderly population in the United States. b. It provides more than 90% of income for almost a quarter of the elderly. c. It is the single largest government expenditure today and is the nation's largest social insurance program. d. Politicians are eager to make changes to Social Security, and they have reformed the program several times in the past few decades.

ANSWER: d 3. President Joe Biden proposes financing higher Social Security benefits by: a. raising the payroll tax charged to employers from 6.2 to 8.4%. b. applying the payroll tax to earnings above $400,000. c. making Social Security an on-budget item financed by payroll, income, and sales taxes. d. borrowing, that is, issuing Treasury bonds.

ANSWER: b 4. The Federal Insurance Contributions Act tax on earnings is _____% for employees and _____% for employers. a. 4.3; 4.3 b. 4.3; 0 c. 6.2; 6.2 d. 6.2; 0 ANSWER: c 5. Which of these features do NOT characterize Social Security? a. The total Federal Insurance Contributions Act tax burden on self-employed people is 8.4%. b. Eligibility requirements include 40 quarters of work. c. Individuals must be at least 62 years of age to receive Social Security benefits. d. When eligible, the Social Security claimant receives an annuity payment.

ANSWER: a 6. If Sonam’s average preretirement earnings were $30,000 per year, his highest preretirement earnings were $90,000 per year, and he receives $20,000 per year in retirement benefits, what is his replacement rate? a. 16.67% Copyright Macmillan Learning. Powered by Cognero.

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Chapter 13 b. 22.22% c. 33.33% d. 66.67% ANSWER: d 7. Suppose that Hope, now retired, worked for 10 years in a retail shop, earning $18,000 per year, and for 27 years in an office, earning $25,000 per year. In today's dollars, Hope's retail job paid $25,000 per year, and her office job paid $45,000 per year. What is Hope's Average Indexed Monthly Earnings? a. $32,643 b. $37,829 c. $40,429 d. $44,316 ANSWER: c 8. Suppose that Bartholomew, now retired, held just one job in his working life—as a forklift operator for 29 years, earning $23,000 per year, or $44,000 per year in today's money. What is Bartholomew's Average Indexed Monthly Earnings? a. $36,457 b. $39,631 c. $40,560 d. $44,119 ANSWER: a 9. Social Security's Primary Insurance Amount: a. rises proportionally with past average monthly earnings. b. rises with past average monthly earnings but at a slower rate. c. rises with past average monthly earnings but at a faster rate. d. is a set amount that is unrelated to past average monthly earnings.

ANSWER: b 10. What is the Full Retirement Age for those born in 1960 or later? a. 50 b. 55 c. 67 d. 72 ANSWER: c 11. What is the Early Entitlement Age? a. 50 b. 55 c. 62 Copyright Macmillan Learning. Powered by Cognero.

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Chapter 13 d. 65 ANSWER: c 12. The earnings test in Social Security is essentially a: a. tax on earnings. b. subsidy on earnings. c. forced savings mechanism. d. redistribution mechanism.

ANSWER: c 13. In 2021, the annual Social Security earnings limit for those reaching full retirement in 2022 or later is $19,960. Suppose, at age 62, Joan wants to claim Social Security benefits while continuing to work part-time, earning $21,960 per year. Under the earnings test, how much will be taken from her Social Security benefits each year (to be repaid with interest after she reaches the full retirement age)? a. $750 b. $950 c. $1,000 d. $2,000 ANSWER: c 14. Suppose Sushil is thinking about retiring one year earlier than he had planned. Which rationale provides him with an incentive to do so? a. Since earnings generally rise with age, his 35-year benefits average will be lower. b. He won't pay an extra year of payroll taxes on his earnings. c. He'll get a lower Social Security benefit level than he would otherwise have. d. He will collect Social Security benefits for a smaller number of years.

ANSWER: b 15. The retirement hazard rate refers to the percentage of: a. working people who retire at a certain age. b. retirees who are injured at a certain age. c. retirees who die at a certain age. d. working people who die at a certain age.

ANSWER: a 16. Suppose a politician states that their plan for reforming Social Security will work because rich retirees don't need Social Security benefits. Which approach to Social Security reform is the politician probably advocating? a. raising taxes further b. raising the retirement age c. lowering benefits for all recipients d. lowering benefits for higher-income groups ANSWER: d Copyright Macmillan Learning. Powered by Cognero.

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Chapter 13 17. Which person has the highest Social Security Wealth on average? a. a woman born in 1920 b. a man born in 1920 c. a woman born in 1950 d. a man born in 1950 ANSWER: a 18. For the average person receiving Social Security benefits, benefits are roughly _____% of preretirement earnings and are _____ for low-income earners than for high-income earners. a. 40; higher b. 60; higher c. 80; higher d. 40; lower ANSWER: a 19. Suppose Robin participates in a plan by buying assets with the expectation that she can live on the accumulated assets when she retires. This is an example of: a. workers' compensation. b. a funded retirement plan. c. an unfunded retirement plan. d. Social Security Wealth.

ANSWER: b 20. Which is an example of a funded retirement plan? a. a couple's plan to save 10% of all future income b. a retirement portfolio with an investment bank c. Social Security d. a decision to make larger payments to pay off the mortgage sooner ANSWER: b 21. Which is an example of an unfunded retirement plan? a. a company-sponsored pension plan b. a retirement portfolio with an investment bank c. Social Security d. an individual retirement account ANSWER: c 22. Which of these refers to the debt incurred by the government because early generations of beneficiaries received much more in benefits than they paid in taxes? a. early debt b. legacy debt Copyright Macmillan Learning. Powered by Cognero.

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Chapter 13 c. program deficits d. the Social Security fiscal imbalance ANSWER: b 23. Which of these is a reason why Social Security redistributes income from those born later to those born earlier? a. Social Security benefits diminish with age, and those born earlier have lived longer. b. Those born earlier paid into the system for only part of their lives but received benefits throughout their retirement. c. The size of the payroll tax has remained constant over the years. d. Social Security benefits have increased over the years in order to keep pace with inflation.

ANSWER: b 24. In general, which is TRUE about Social Security? a. Females have higher Social Security Wealth than males. b. Singles have higher Social Security Wealth than married people. c. The poor lose and the rich win from Social Security. d. Every family pays the same percentage of earnings into Social Security.

ANSWER: a 25. Which of these is a moral hazard effect of Social Security? a. Retirees die sooner than they would without Social Security. b. Workers retire sooner than they would without Social Security. c. Retirees buy less health insurance than they would without Social Security. d. Workers work longer and become unhealthier than they would without Social Security.

ANSWER: b 26. Existing research suggests that each dollar of Social Security wealth crowds out approximately $_____ of private savings. a. 0 b. 0.35 c. 0.60 d. 0.85 ANSWER: b 27. How does adverse selection cause market failure in the private annuities market, providing a rationale for Social Security? a. The fact that people know more about their potential life expectancy than insurers do entails that a disproportionately large share of buyers will live relatively short lives after retirement. b. The fact that people know more about their potential life expectancy than insurers do entails that a disproportionately large share of buyers will live relatively long lives after retirement. c. Since insurers have more sophisticated techniques for assessing people's life expectancy than people Copyright Macmillan Learning. Powered by Cognero.

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Chapter 13 have, insurers have a disproportionate share of the market power in the private annuities market and so will overcharge. d. Since the government has more sophisticated techniques for assessing people's life expectancy than insurers have, the annuities market can reach an optimum only through government intervention.

ANSWER: b 28. Social Security solves the adverse selection problem in the annuities market by: a. incentivizing people to save more for retirement. b. paternalistically ensuring that the elderly do not fall into poverty. c. compelling people to think in the long run rather than the short run. d. mandating that everyone with an income below a certain level pay into the system.

ANSWER: d 29. Which of these, if true, would constitute evidence that Social Security smooths consumption? a. The elderly poverty rate is positively correlated with Social Security spending. b. Each dollar of Social Security wealth crowds out exactly $1 of private savings. c. Each dollar of Social Security wealth crowds out $0.30 of private savings. d. Social Security provides a larger boost to the income of the wealthy than the poor.

ANSWER: c 30. Which of these is NOT true about poverty among the elderly and Social Security expenditure since 1959? a. Poverty among the elderly has generally decreased in the past 50 years. b. Poverty rates among the elderly have increased over the last 10 years. c. In 1960, 35% of the elderly were living in poverty, compared with 9.3% in 2016. d. The steepest reductions in poverty occurred during the 1960s and 1970s.

ANSWER: b 31. The earnings test is an effort to mitigate which problem associated with Social Security? a. retirement hazard b. adverse selection c. the long-term fiscal imbalance d. the crowd-out of private savings ANSWER: a 32. Suppose Niv is thinking about the implications of delaying retirement by one year. Which of these provides him with an incentive to do so? a. Since earnings generally rise with age, his 35-year benefits average will be higher. b. He will pay an extra year of payroll taxes on his earnings. c. He will receive one less year of Social Security benefits. d. His potential benefits will be reduced if he waits to retire.

ANSWER: a Copyright Macmillan Learning. Powered by Cognero.

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Chapter 13 33. In 1950, there were approximately _____ persons over the age of 65 for every 100 persons of working age.

By 2060, there will be approximately _____ persons over the age of 65 for every 100 persons of working age. a. 2; 60 b. 13; 60 c. 12; 42 d. 40; 60 ANSWER: c 34. Which of these is equal to the present discounted value of Social Security's obligations minus the present discounted value of projected Social Security taxes over the next 75 years? a. $6.1 trillion b. $9.6 trillion c. $13.1 trillion d. $17.8 trillion ANSWER: d 35. Which of these is one reason for the fiscal imbalance in the Social Security system? a. Wage growth has slowed substantially. b. The birth rate has increased over time. c. Life expectancy has decreased. d. More workers, entitled to Social Security benefits, have immigrated to the United States.

ANSWER: a 36. Which of these was a recommendation of the Greenspan Commission in 1983? a. Social Security should become more of a pay-as-you-go system. b. Social Security should become more of an unfunded system. c. Scheduled payroll tax increases should be accelerated. d. Scheduled payroll tax increases should be slowed.

ANSWER: c 37. Suppose an economist proposes improving the finances of the Social Security system by easing restrictions on immigration. The economist, in other words, advocates: a. raising taxes further. b. extending the base of taxable wages. c. raising the retirement age. d. lowering the benefits of all recipients.

ANSWER: b 38. Suppose an economist proposes improving the finances of the Social Security system by mandating that workers currently excluded from Social Security must enroll. The economist, in other words, advocates: a. raising taxes further. b. extending the base of taxable wages.

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Chapter 13 c. raising the retirement age. d. lowering benefits for all recipients.

ANSWER: b 39. Suppose a politician proposes that the solvency of Social Security be improved by increasing the amount employers pay into the Social Security program. Which approach to the reform of Social Security is the politician advocating? a. raising taxes further b. extending the base of taxable wages c. raising the retirement age d. lowering benefits for all recipients ANSWER: a 40. Suppose someone argues that the problems faced by Social Security could be solved if we adjusted for the fact that people live longer than they used to, even given the changes to Social Security over that time. This individual advocates: a. raising taxes further. b. extending the base of taxable wages. c. raising the retirement age. d. lowering benefits for all recipients.

ANSWER: c 41. If a politician advocates that Social Security benefits be means-tested, which of these approaches is that politician suggesting? a. extending the base of taxable wages b. raising the retirement age c. lowering benefits for all recipients d. lowering benefits for higher-income groups ANSWER: d 42. To maintain a stable pay-as-you-go Social Security system as people live longer: a. average benefits could be increased, and the payroll tax rate could be reduced. b. average benefits could be reduced, and the payroll tax rate could be increased. c. the retirement age must be raised. d. the payroll tax rate must be raised.

ANSWER: b 43. If the ratio of people receiving Social Security benefits to the number of people paying Social Security taxes increases, then: a. average benefits divided by average earnings must fall. b. the payroll tax rate must rise. c. individuals' maximum taxable earnings could be increased to avoid either an increase in the payroll Copyright Macmillan Learning. Powered by Cognero.

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Chapter 13 tax rate or a decrease in benefits. d. there is no way to preserve benefits at their present levels.

ANSWER: c 44. In order to maintain a solvent pay-as-you-go Social Security system in the future: a. the retirement age will have to be gradually decreased as life expectancy increases. b. the government may have to raise the payroll tax or the maximum amount of taxable earnings. c. the government may have to increase benefits to keep up with inflation. d. only retirees with documented financial need will receive benefits after 2040.

ANSWER: b 45. Suppose that the primary insurance amount is changed so that it is indexed by the consumer price index minus 2 percentage points. Which approach to reforming Social Security would this represent? a. raising taxes further b. extending the base of taxable wages c. raising the retirement age d. lowering benefits for all recipients ANSWER: d 46. Which of these would be a benefit of privatizing Social Security? a. Savings would be managed by federally paid financial planners, thus insulating individuals from excessively high management fees. b. Individuals with varying degrees of risk aversion would have options regarding how they wanted to invest. c. Administrative costs would be lower than the federal program can achieve. d. The government would no longer play a role in Social Security.

ANSWER: b 47. Which of these BEST illustrates the liquidity constraints theory of excessive retirement at 62 years of age? a. Noah cannot retire at age 60 because he does not have enough savings. b. Jess works at a company with mandatory retirement at 62 years of age. c. Michael does not see the financial benefit of waiting to retire, so he retires when he turns 62. d. Denise was offered an early retirement package through her employer, so she retired at 62.

ANSWER: a 48. Which of these BEST illustrates the behavioral bias theory of excessive retirement at 62 years of age? a. Bess cannot retire at age 60 because she has too many expenses. b. Marg decides to retire early because she fell at work and suffered an injury. c. Michael does not see the financial benefit of waiting to retire, so he retires when he turns 62. d. Denise was offered an early retirement package through her employer, so she retired at 62.

ANSWER: c Copyright Macmillan Learning. Powered by Cognero.

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Chapter 13 49. Which of these is NOT a component of the 2016 Social Security reform proposal by Democratic lawmakers? a. an increase in minimum benefits to 25% above the poverty line b. an increase in benefits by 2% for all recipients c. a more generous cost-of-living adjustment d. lower payroll taxes ANSWER: d 50. Which of these is a component of the 2016 Social Security reform proposal by Republican lawmakers? a. a higher retirement age b. an increase in benefits by 2% for all recipients c. a more generous cost-of-living adjustment d. higher payroll taxes ANSWER: a 51. Which of these is a rationale for the Social Security program? a. concern that people won't save enough for retirement b. that it is relatively inexpensive to implement c. that very few people live long enough to receive Social Security benefits d. that most people have enough savings and only require a little assistance from Social Security ANSWER: a 52. Suppose that a 60-year-old family friend says that she wants to start receiving benefits at the Early Entitlement Age but doesn't want to quit working until she has reached the Full Retirement Age. She wants advice on whether she'd be penalized for working while receiving benefits at the early entitlement age. What advice should she be given? Be sure to discuss the significance of the earnings test.

ANSWER: The earnings test of Social Security reduces the benefits by $0.50 for each $1 of earnings above $8,960. However, this reduction is not a tax but is returned with interest in the form of an actuarial adjustment when a worker's earnings fall below this threshold. Consequently, the family friend should not be discouraged from working, since Social Security does not penalize her for doing so.

53. For each of these, determine which group would have higher Social Security Wealth (SSW), all other things equal. Explain. (a) male or female (b) born in 1925 or born in 1985 (c) single or married (d) low-wage earner or high-wage earner (e) single-earner couple or two-earner couple ANSWER: (a) Females have higher SSW than males because both pay the same taxes, but females live longer than males and so receive benefits for a longer time. (b) A person born in 1925 would have a higher SSW because of the tax-rate growth effect.

Furthermore, the wage growth effect and the population growth effect decreased in size starting in the 1970s. (c) A married person has the higher SSW because a spouse of a worker is entitled to 50% of the Copyright Macmillan Learning. Powered by Cognero.

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Chapter 13 worker's benefits, and a surviving widow receives 100% of a worker's benefits. So a married worker receives not just their own benefits but spousal benefits as well. (d) A low-wage worker has higher SSW because of the way Social Security redistributes income. (e) Single-earner couples have more SSW because, although only one person works, the couple receives 150% of the earner's benefits. A two-earner couple pays taxes on their full earnings, even though they may not receive more benefits than a one-earner couple.

54. Explain the two fundamental problems related to investing the Social Security trust fund in the stock market.

ANSWER: First, politicians tend to use this fund to finance other government projects. As long as the trust fund is used to finance other government projects, investing it in the stock market may not solve Social Security's long-term fiscal problem. Second, there is a legitimate concern that the government might abuse its position to manipulate capital markets for its own benefit. As then Federal Reserve Chairman Alan Greenspan testified in 1999, "Investing a portion of the Social Security trust fund assets in equities would arguably put at risk the efficiency of our capital markets and thus our economy."

55. What would be the redistributive implications of fully privatizing Social Security? How does this compare with the current system?

ANSWER: In a fully privatized funded system, each worker would invest their own money in a retirement account. Consequently, this system would not redistribute income at all. In contrast, the current system redistributes income from high-income to low-income individuals and from later-generation to earlier-generation individuals.

56. Suppose the federal government allowed taxpayers to invest a portion of their payroll taxes in a personal retirement account. Assume that the personal retirement accounts could earn a higher rate of return than they could have through Social Security. How would this higher rate of return affect the timing of a taxpayer’s retirement?

ANSWER: This is an income effect. A higher rate of return will yield taxpayers a higher income. This income will lead them to purchase more of all normal goods, one of which may be retirement.

Consequently, taxpayers may choose to retire earlier than they would have otherwise.

57. Under one plan for Social Security reform, younger workers can put up to $1,000 of their payroll taxes into an individual retirement account (IRA) in exchange for lower benefits when they retire. However, advocates of this plan typically offer a method of ensuring that funds in an IRA are turned into benefits that work in a Social Security–like fashion (e.g., monthly payments until one dies). (a) What restriction could policy makers implement to ensure that money in an IRA be paid similarly to Social Security? (b) Why wouldn't policy makers simply allow individuals to accept a lower level of Social Security benefits in exchange for a lower level of taxation without also mandating that individuals put the saved tax funds in an IRA? ANSWER: (a) Policy makers could mandate that all workers who opt into the IRA system use the funds to purchase an annuity in the private insurance market when they reach retirement age. In this way, the lump sum of cash from the IRA could be used to purchase a contract in which the retiree would receive fixed payments from the insurer until the retiree dies, similarly to how Social Security pays out benefits. (b) The most convincing answer is probably paternalism. Policy makers may be concerned that Copyright Macmillan Learning. Powered by Cognero.

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Chapter 13 individuals may not save enough for their own retirement if the choice is left to them. For example, the government may believe that people are not sufficiently forward-looking to save enough for their retirement or may mistakenly believe that a reduced Social Security benefit will provide sufficient income when they retire. Alternatively, policy makers may believe that if given the choice, individuals would choose not to use the tax savings to save for retirement because they expect that politicians will ensure that the benefit is sufficient.

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Chapter 14 1. The Coronavirus Aid, Relief, and Economic Security Act, passed in 2020, did NOT include: a. 13 additional weeks of federally financed unemployment insurance. b. unemployment insurance for self-employed, independent contractors, and gig economy workers for 39 weeks. c. a federal works program to employ U.S. citizens and permanent residents who had been laid off due to the pandemic. d. an additional $600 in benefits per week for all recipients of unemployment insurance.

ANSWER: c 2. The Federal Pandemic Unemployment Compensation program, which provided an additional $600 of federal unemployment insurance in additional to state unemployment insurance, was especially controversial because: a. a majority of recipients earned more on unemployment insurance than when they were working. b. states were required to match the federal funds. c. it was insufficient to prevent poverty from dramatically rising. d. the President implemented the program by executive order, bypassing congress.

ANSWER: a 3. Unless the federal government passes specific legislation to change it, unemployment benefits are: a. extended to workers only during times when the economy is officially in recession. b. extended to workers only in states with an unemployment rate above the national average. c. available for a maximum of 26 weeks. d. available for a maximum of 99 weeks.

ANSWER: c 4. The American Rescue Plan, passed in March, 2021, did NOT: a. provide stimulus checks of $1,400 to most individuals. b. increase the amount of benefits by $600 for all recipients of unemployment insurance. c. extend the duration of unemployment insurance for another six months. d. expand the Child Tax Credit from $2,000 to $3,600 per child and make it fully refundable.

ANSWER: b 5. Which is a criterion that workers must meet to be eligible for traditional unemployment benefits? a. They must have earned more than a minimum amount in the previous year. b. They must be hourly wage, not salaried, workers. c. They cannot have a four-year college degree. d. They must not have made a previous claim to receive unemployment benefits.

ANSWER: a 6. To be eligible for traditional unemployment benefits, a worker must meet each criterion EXCEPT: a. they must have earned more than a minimum amount in the previous year. b. they cannot have been fired for cause or quit their job.

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Chapter 14 c. they must be actively searching for work and willing to take a comparable job to the one lost. d. their previous employment must be from the private sector.

ANSWER: d 7. Which is TRUE regarding unemployment insurance? a. The federal government mandates that all 50 states administer the program. b. The federal government mandates the benefit levels of the program. c. It is used to compensate only workers whose jobs are moved overseas. d. Benefits are automatically provided to all eligible workers.

ANSWER: a 8. Which could be TRUE given the relationship between a firm's layoffs and its payroll tax for unemployment insurance relative to those of an average firm? a. Firms with twice as many layoffs pay twice as much in payroll taxes. b. Firms with twice as many layoffs pay 50% less in payroll taxes. c. Firms with twice as many layoffs pay less than twice as much in payroll taxes. d. Firms with twice as many layoffs pay more than twice as much in payroll taxes.

ANSWER: c 9. Currently, approximately _____% of unemployed workers receive unemployment insurance benefits. a. 8 b. 28 c. 55 d. 67 ANSWER: b 10. What is one reason why relatively low numbers of unemployed workers take advantage of unemployment benefits? a. There may be a perceived stigma of receiving unemployment benefits. b. Few unemployed workers are actually eligible for benefits. c. The opportunity cost of filing paperwork often exceeds the benefit. d. Many unemployed workers are concerned about privacy and are against providing sufficient information to receive the unemployment benefits.

ANSWER: a 11. In general, which is TRUE about unemployment benefits? a. Benefits received are based on the average earnings in the recipient's state. b. Benefits received are based on the previous earnings of each recipient. c. The replacement rate is lower for low-income workers than for high-income workers. d. Benefits are reduced for workers who file multiple claims.

ANSWER: b Copyright Macmillan Learning. Powered by Cognero.

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Chapter 14 12. How long do unemployment benefits last in the absence of a specific federal extension? a. The duration is determined using a formula based on the recipient's previous earnings. b. 12 weeks c. 26 weeks d. 52 weeks ANSWER: c 13. Which statement is TRUE about the unemployment benefit schedule? a. Benefit payments are fixed and do not depend on previous earnings. b. Benefit payments are an increasing function of previous earnings, and every worker receives some benefit regardless of previous earnings. c. Replacement rates are approximately the same for high- and low-income earners. d. Unlike most other social insurance programs, the benefits received from unemployment insurance are taxed.

ANSWER: d 14. Suppose that firm A has a low layoff rate while firm B has a high layoff rate. Assume both of the firms employ the same number of workers on average. Under the current unemployment insurance program: a. both firms pay the same amount of unemployment insurance. b. firm B subsidizes the layoffs of firm A. c. firm A subsidizes the layoffs of firm B. d. the average unemployment benefit to firm B workers is reduced.

ANSWER: c 15. Which statement is TRUE with respect to disability insurance? a. Disability insurance provides compensation to workers injured on the job until they can return to work. b. Workers can file for disability benefits even if they have no medical documentation. c. States set the level of disability benefits. d. Disability benefits are funded by a separate payroll tax.

ANSWER: d 16. Benefits under disability insurance are: a. taxed as regular income. b. equal to the amount the individual would have received at the full-benefits age under Social Security. c. equal to the amount the individual would have received at the early entitlement age under Social Security. d. equal to two-thirds of the earnings made in the year prior to becoming disabled.

ANSWER: b 17. With respect to disability insurance, the decision for qualification is made at the _____ level, and the level of benefits is decided at the _____ level.

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Chapter 14 a. state; federal b. federal; state c. state; state d. federal; federal ANSWER: a 18. A particular challenge of disability insurance is that: a. it is difficult to accurately and consistently determine a true disability. b. the decision for qualification is made at the federal level, but benefits are decided at the state level. c. disability insurance falls under both the social security and Old Age Security and Disability Income programs. d. the disability insurance program is chronically underfunded resulting in mandatory decreases in benefits over time.

ANSWER: a 19. Which type of insurance is NOT publicly provided? a. workers' compensation b. unemployment insurance c. disability insurance d. Medicare ANSWER: a 20. For which program are benefits levels set by the federal government? a. workers' compensation b. unemployment insurance c. disability insurance d. private insurance ANSWER: c 21. Which statement is NOT true with respect to disability insurance (DI)? a. Individuals cannot receive benefits until they have been disabled for 12 consecutive months. b. If granted, workers receive the same amount they would have received if they retired at the Full Benefit Age of 66 under the Social Security program. c. The DI program provides insurance against career-ending disabilities. d. The DI acceptance rate—the share of those applying who are initially accepted into the program—is only about one-third.

ANSWER: a 22. Workers' compensation covers: a. job search costs. b. medical costs associated with any injury incurred while employed.

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Chapter 14 c. medical costs associated with an injury incurred while at work. d. cash payments to replace exactly half of a worker's lost wages during recuperation.

ANSWER: c 23. Which benefit is taxed as regular income by the federal government? a. workers' compensation b. unemployment insurance c. disability insurance d. food stamps ANSWER: b 24. Which statement is TRUE with respect to workers' compensation? a. When there is a qualifying injury, benefits are paid out whether the injury was the worker's or the firm's fault. b. When there is a qualifying injury, benefits are paid out only if the injury was the firm's fault, as established in court. c. When there is a qualifying injury, benefits are paid out only if the injury was the firm's fault, as established by a committee paid by the federal government. d. When there is a qualifying injury, fewer benefits are paid out if the injury was the worker's fault than if it were the firm's fault.

ANSWER: a 25. Which state has an optional worker's compensation system? a. Massachusetts b. Texas c. Hawaii d. Oregon ANSWER: b 26. Which is NOT true with respect to the three-way comparison of unemployment insurance, disability insurance (DI), and workers' compensation (WC)? a. The replacement rate is the highest for WC because benefits are not taxable. b. Benefits are indefinite for DI and WC, subject to medical verification. c. Verification is the most difficult for WC. d. The qualifying events for DI and WC are essentially the same.

ANSWER: d 27. Which statement is TRUE? a. The moral hazard associated with giving disability benefits to blind people is greater than that associated with giving disability benefits for back sprains. b. Groups of people with easily verifiable disabilities have lower moral hazard costs than those with disabilities that are not easily verifiable.

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Chapter 14 c. The consumption-smoothing benefits of unemployment insurance are greater for those who regularly experience temporary unemployment than for those who do not. d. The consumption-smoothing benefits of unemployment insurance cannot be achieved privately because workers cannot anticipate periods of unemployment.

ANSWER: b 28. The moral hazard of social insurance _____ as duration increases; the benefits to consumption smoothing _____ as duration increases. a. increases; increase b. decreases; decrease c. increases; decrease d. decreases; increase ANSWER: a 29. The moral hazard problem associated with unemployment insurance (UI) results in a(n): a. reduction in the number of workers who are eligible for UI. b. increase in the average duration of unemployment. c. increase in the average amount of weekly benefits. d. reduction in the number of firms participating in the program.

ANSWER: b 30. Empirical evidence on the moral hazard of unemployment insurance (UI) indicates that the: a. post-unemployment wages are higher when UI benefits last longer. b. duration of unemployment falls when UI benefits fall. c. duration of unemployment rises when UI benefits fall. d. number of workers who apply for UI benefits falls when the weekly benefit is higher.

ANSWER: b 31. Which statement is consistent with a moral hazard effect stemming from disability insurance? a. After the disability insurance program begins, labor force participation declines. b. After the disability insurance program begins, labor force participation increases. c. Disability applications rise during economic expansions. d. A decrease in disability benefits causes the number of disability applications to increase.

ANSWER: a 32. Which is NOT evidence supporting moral hazard in disability insurance? a. the correspondence between the number of men receiving disability insurance and number dropping out of the labor force b. a connection between number of individuals on disability and the business cycle c. a correlation between the generosity of disability insurance and the number of individuals on disability insurance d. a lack of connection between the leniency of disability insurance screenings and number of Copyright Macmillan Learning. Powered by Cognero.

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Chapter 14 individuals on disability insurance ANSWER: d 33. An increase in incidences of _____ when workers' compensation is available is consistent with a moral hazard issue. a. missing limbs b. back strain c. deep cuts d. broken bones ANSWER: b 34. There is evidence of moral hazard if, after a worker's compensation program is introduced: a. the incidence of injuries falls. b. there is no change in the incidence of injuries. c. there are more injuries that are easy to prove. d. there are more injuries that are difficult to prove.

ANSWER: d 35. The fact that more workers claim work-related injuries on Monday than other days of the week is evidence of _____ in workers' compensation: a. moral hazard b. information asymmetry c. transaction costs d. hyperbolic discounting ANSWER: a 36. Replacing unemployment insurance with mandated worker self-insurance accounts is potentially beneficial because: a. unemployment occurs primarily when workers are older, thus at a time when their self-insurance accounts would be sufficiently large. b. moral hazard would be less than under a public unemployment insurance system. c. adverse selection would be less than under a public unemployment insurance system. d. both moral hazard and adverse selection would be unlikely to occur if workers self-insure.

ANSWER: b 37. Suppose that someone gets a large cut while hanging sheet metal on a paint line. The workers' compensation program would pay for the: a. medical expenses associated with treating the cut and lost wages from being unable to work. b. medical expenses only if the worker can prove that the accident was not her fault. c. cost of a new health insurance policy if the worker becomes unemployed. d. monetary value of the pain and suffering experienced by the worker.

ANSWER: a Copyright Macmillan Learning. Powered by Cognero.

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Chapter 14 38. At Pretty Flowers Nursery, the forklift driver runs into another employee, breaking her arm and leg. Under what circumstance will the injured worker receive workers' compensation? a. The injured worker will receive compensation if she is able to prove in court that the injury was a result of the forklift driver's negligence (perhaps caused by excessive staring at pretty flowers). b. The injured worker will receive compensation if she is able to prove in court that the injury was a result of the firm's negligence, for example, in hiring a forklift driver with a tendency to stare at pretty flowers. c. The injured worker will receive compensation if she is able to prove she was injured on the job. d. The injured worker will receive compensation if she is able to prove that she could not have avoided the accident.

ANSWER: c 39. Unemployment insurance is partially experience-rated, which means: a. a firm's payroll tax increases one-for-one with its number of layoffs. b. there is no connection between a firm's number of layoffs and its payroll tax. c. a firm's payroll tax increases faster than its number of layoffs. d. a firm's payroll tax increases with its number of layoffs, but at less than a one-for-one rate.

ANSWER: d 40. Which statement is TRUE? a. The unemployment insurance program is fully experience-rated. b. The unemployment insurance program is partially experience-rated. c. The unemployment insurance program is not experience-rated. d. Firms pay an additional tax each time they lay off a worker.

ANSWER: b 41. Which statement is TRUE? a. Unemployment lasts longer for laid-off workers at firms with partially experience-rated insurance than for laid-off workers at firms whose insurance is fully experience-rated. b. High-layoff firms tend to be more efficient than low-layoff firms. c. Injured workers return to work sooner at firms with partially experience-rated insurance than do workers at firms with fully experience-rated insurance. d. There is no empirical evidence that outcomes depend on whether unemployment or disability insurance programs are experience-rated.

ANSWER: a 42. The consumption-smoothing benefits of unemployment insurance are _____ those for disability insurance, and the negative behavioral responses to unemployment insurance are _____ those for disability insurance. a. larger than; larger than b. smaller than; smaller than c. smaller than; larger than Copyright Macmillan Learning. Powered by Cognero.

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Chapter 14 d. larger than; smaller than ANSWER: c 43. What is a potential advantage of a partial experience rating over a full experience rating of insurance? a. Moral hazard costs are lower with partial experience rating. b. Adverse selection is less likely with partial experience rating. c. It helps insure firms against downturns. d. Partial experience rating is fairer to efficient firms.

ANSWER: c 44. Which is equivalent to reforming the social insurance system to one of worker self-insurance? a. mandating that all insurance be fully experience-rated at the firm level b. mandating that workers contribute a portion of their income to a savings account that could be tapped if they have an adverse event c. eliminating the current insurance programs and mandating nothing to replace them d. mandating that all firms provide access to insurance for workers in the event of disability or unemployment ANSWER: b 45. What is the order of negative behavioral responses in response to social insurance programs, from greatest to least? a. workers' compensation, disability insurance, unemployment insurance b. disability insurance, workers' compensation, unemployment insurance c. unemployment insurance, workers compensation, disability insurance d. workers' compensation, unemployment insurance, disability insurance ANSWER: d 46. A flat benefit increment for unemployment insurance is not optimal, as it provides both high and low earners the same benefit regardless of economic conditions. Why then, did congress choose flat benefit increases to unemployment insurance (UI) during the COVID recession? a. UI systems in most states are too outdated to handle more complex systems. b. due to fairness, so that everyone was helped equally c. because it was less expensive for the federal government d. because the economic effects of the recession were concentrated on lower-income families, and a flat benefit helped lower-income households more ANSWER: a 47. In Texas, firms can opt out of the government-mandated workers' compensation program and can offer their own substitute workers' compensation coverage instead. Which is TRUE of these substitute programs? a. The benefit level is much higher than the government-mandated benefit level. b. It is less difficult to obtain the benefits. c. The benefit level is much lower than the government-mandated benefit level.

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Chapter 14 d. Very few firms opt out of the government-mandated program.

ANSWER: c 48. Which unemployed worker would have experienced greater consumption-smoothing benefits of unemployment insurance, according to research from Kolsrud et al. (2017)? a. Meg has been unemployed for three months. b. Kathleen has been unemployed for four days. c. Kurt has been unemployed for 47 days. d. Angelo has been unemployed for three weeks.

ANSWER: a 49. Existing research suggests that each dollar of unemployment insurance crowds out approximately $_____ of other forms of insurance. a. 0.70 b. 0.35 c. 0.30 d. 0.85 ANSWER: a 50. Which was NOT a conclusion of the Rothstein and Valletta (2017) study examining individuals experiencing long unemployment spells? a. Poverty rates were higher among this group. b. Self-reported disabilities fell after exhaustion of benefits. c. More consumption smoothing occurred. d. Self-reported disabilities increased after exhaustion of benefits.

ANSWER: b 51. Studies show that unemployment insurance crowds out other sources of income _____ disability insurance. a. more than b. less than c. at the same level as d. less than or equal to that of ANSWER: a 52. How is the unemployment insurance system in the United States different from most industrialized nations? a. It does not have an experience-rating system. b. It has a partial experience-rating system. c. It subsidizes only those with very short unemployment spells. d. It subsidizes only those with very long unemployment spells.

ANSWER: b 53. Bruce Meyer's classic 1989 study finds that a _______% increase in unemployment insurance benefits Copyright Macmillan Learning. Powered by Cognero.

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Chapter 14 increases the duration of unemployment by _________%. a. 12; 2 b. 8; 7 c. 5; 10 d. 10; 8 ANSWER: d 54. A reform leading to longer unemployment duration may be socially beneficial for which of these reasons? a. It would increase government spending, providing stimulus to the economy. b. It would lead to better chances of finding the best job, improving job match quality. c. As unemployment insurance benefits are taxed, it would lead to higher tax revenues for the government. d. It would increase the labor supply, as workers are more assured of a stronger safety net in case of job loss.

ANSWER: b 55. Discuss the efforts to alleviate the hardship due to high unemployment during the recent COVID recession.

What type of a role did the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 and the American Rescue Plan (ARP) of 2021 play? What were the fundamental differences between the Democrats and Republicans regarding these pieces of legislation?

ANSWER: There was tremendous controversy over how to address the high levels of unemployment and expiring unemployment insurance (UI) benefits during the most recent recession. In 2020, Congress passed the CARES Act, which increased the duration of unemployment benefits by up to 13 weeks, provided an additional $600 per week unemployment benefit, and extended unemployment insurance to those who were self-employed or independent contractors. It also provided stimulus checks of $1,200 to most individuals. The American Rescue plan, passed in 2021, renewed the expanded unemployment insurance, further extending its duration, giving stimulus checks of $1,400 to most individuals and providing an additional $300 per week of unemployment benefits.

Republicans argued against the economic principles of UI itself. GOP leaders disagreed with the Democrats' plan, especially the higher benefits and longer duration of the UI, which they argued would de-incentivize individuals from searching for jobs. Republicans argued that anecdotal reports of labor shortages in the months after the passage of ARP proved their position, although Democrats argued that other factors, such as the lack of child care options and continued fear of illness, were more significant reasons.

56. Consider the experiences of state A and state B. In period 1, state A and state B have equivalent workers' compensation (WC) programs. Between periods 1 and 2, state A reduces its WC benefit by 25%. Look at how this change affected the average duration of injury. In period 1, the average injury durations were 6 days and 8 days for state A and state B, respectively. In period 2, the average injury durations were 2 days and 6 days for state A and state B, respectively. (a) What is the difference-in-difference estimator of the effect of the policy change? (b) Suppose that between periods 1 and 2, new technology reduced the likelihood of injuries on the job. Would this bias the estimate in part (a)? Explain, including any conditions relevant to bias or no bias.

ANSWER: (a) The difference between the two states after state A was treated (in period 2) was −4 days.

However, the pretreatment (period 1) difference between the states was −2. Consequently, the Copyright Macmillan Learning. Powered by Cognero.

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Chapter 14 difference-in-difference estimator is −4 − (−2) = −2. That is, reducing the benefit by 25% caused the average injury duration to decrease by 2 days, or 25% (an elasticity of 1). (b) This would bias the estimate only if the technology had a different impact on duration of injury in state A than it did in state B. For example, if the technology primarily affected worker safety in auto parts manufacturing and state A had more auto parts manufacturing per capita than did state B, then the reduction in injury duration we reported in part might not be due to the policy change.

Rather, it could be that our estimate was merely the result of this change in technology. However, if the technology affected both states in the same way, then the estimate in part (a) would not be biased.

57. How does unemployment insurance in the United States compare with that provided by European countries?

Be sure to answer in terms of both benefits and funding.

ANSWER: In European countries, unemployment benefits are typically paid out for much longer than the United States' six months. Furthermore, after receiving benefits for the maximum time limit, unemployed workers in most European countries are moved to a welfare system that pays out a lower level of benefits for an indefinite period.

In addition, the United States is unusual in that it funds unemployment insurance through a partial experience rating, meaning that as a firm lays off more workers, it has to pay higher (but not onefor-one) premiums into the unemployment insurance system.

58. Explain how the benefits and costs of unemployment insurance are related to the duration of unemployment.

ANSWER: The benefit of unemployment insurance is the extent to which it allows increased consumption smoothing. For short durations, one would expect that workers would be able to self-insure and therefore that the consumption-smoothing benefits of unemployment insurance would be relatively small. However, for longer durations, unemployed workers may use all of their savings and be unable to smooth their consumption, implying that the benefits of unemployment insurance are greater. Similarly, unemployment insurance may crowd out private methods of consumption smoothing for short durations, although this is likely to be less so for longer durations of unemployment.

The costs of unemployment insurance are primarily the moral hazards associated with it. That is, the cost of unemployment insurance is the extent to which people remain unemployed longer than they would have if they had not received unemployment insurance. However, this longer duration may be socially efficient if it increases their job match quality when they do get a job.

59. A government official wants to determine the extent to which disability insurance (DI) prevents people's working who, in the absence of the program, would have worked. They do this by using the cross-sectional regression analysis technique described in Chapter 3 and comparing the work histories of those receiving DI with those who are not receiving DI benefits, controlling for observable characteristics. (a) Is this method likely to be sufficient? Explain. (b) Bound (1989) studied the moral hazard of disability insurance by examining the employment histories of workers who applied for benefits but were denied them and then comparing their employment with the employment records of individuals who received disability insurance benefits. (This is a quasi-experimental approach.) How does this approach compare with that described in part (a)?

ANSWER: (a) No, since there are also unobserved characteristics differences between individuals that cannot be captured with a cross-sectional regression. (b) The quasi-experimental approach is preferred to the cross-sectional approach in part (a) because Copyright Macmillan Learning. Powered by Cognero.

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Chapter 14 it allows for controls for individual-specific differences by comparing the changes over time for the same subjects. By comparing only individuals who applied for disability insurance, it is able to control for the fact that those who apply for disability insurance are likely to be different in unobserved ways from those who never applied for DI. However, the quasi-experimental approach cannot control for the fact that those who were denied DI benefits may still be different in unobservable ways from those who were not denied. It cannot identify the true causal effect, but it is a stronger method than a simple cross-sectional approach.

60. Suppose that the disability insurance (DI) program was changed so that individuals who want to receive DI must first go 10 months without working to demonstrate that they are truly disabled instead of the current five months. (a) How would this change affect the moral hazard costs of DI? (b) A critic of this change does some research and finds out that the acceptance rate (the share of those applying who are accepted into the program) of the DI program increased as a result of the change. He says that this is evidence that the change in the program has increased the moral hazard costs associated with workers' compensation. Is the critic correct? Explain.

ANSWER: (a) By increasing the number of months applicants must be unemployed, potential applicants face a much higher cost associated with applying since those able to work must now forgo that potential income for twice as long to apply. This should reduce the moral hazard costs of the disability insurance program. (b) By mandating that applicants go 10 months without working to show that they are truly disabled, the people who actually do apply are more likely to actually be disabled. Consequently, one would expect that the acceptance rate would increase as a result of the policy change. However, contrary to the critic's conclusion, the higher acceptance rate does not imply that moral hazard costs have increased.

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Chapter 15 1. In 2019, health care spending in the United States accounted for approximately _____% of GDP. a. 5 b. 17.7 c. 21.9 d. 33.5 ANSWER: b 2. Which of these is NOT true regarding health care in the United States? a. Health care spending is much higher in the United States than in the typical industrialized nation. b. Prescription drug spending accounts for almost half of health spending. c. In 2010, approximately 16% of the population was uninsured. d. The most important source of health insurance in the United States is private insurance.

ANSWER: b 3. According to a 2019 study by Shrank, Rogstad, and Parekh, the main areas of wasteful spending in health care include: a. medical malpractice insurance premiums and procedures designed to avoid malpractice claims. b. extended hospital stays and repeated services. c. inflated prices, excess administrative costs, and unnecessary services. d. unnecessary nursing services and excess medication.

ANSWER: c 4. Which of these is referred to as a fixed payment (e.g., $20) made by a privately insured patient in exchange for receiving a medical good or service? a. copayment b. premium c. coinsurance d. deductible ANSWER: a 5. Which of these is the percentage of each medical bill (e.g., 20%) that the patient pays rather than a flat dollar amount? a. copayment b. premium c. coinsurance d. deductible ANSWER: c 6. If an insured patient pays the full cost of the first $5,000 of medical expenses per year, what is that $5,000 amount called? a. copayment b. premium Copyright Macmillan Learning. Powered by Cognero.

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Chapter 15 c. coinsurance d. deductible ANSWER: d 7. Suppose that Nadim has private health insurance. Last year he was injured once, which represented the only time he had a medical expense. At the time, he paid $25 to see his doctor, who referred him to a specialist. The total bill for the specialist was $1,100. He paid the first $500, then 10% of the additional $600 (equal to $60).

Which of these is the coinsurance? a. the $25 paid for the doctor visit b. the $60 paid toward the cost of seeing the specialist c. the difference between the $25 paid to the doctor and what the doctor actually received (i.e., the amount the insurance company paid the doctor) d. the $1,100 that the specialist received ANSWER: b 8. Suppose that Clara has private health insurance. Last year she was injured once, which represented the only time she had a medical expense. At the time, she paid $25 to see her doctor, who referred her to a specialist. The total bill for the specialist was $1,100. She paid the first $500, then 10% of the additional $600 (equal to $60).

Which of these is the deductible? a. the $25 paid for the doctor visit b. the $60 paid toward the cost of seeing the specialist c. the difference between the $25 paid to the doctor and what the doctor actually received (i.e., the amount the insurance company paid the doctor) d. the $500 she paid toward the cost of the specialist ANSWER: d 9. Suppose that Clara has private health insurance. Last year she was injured once, which represented the only time she had a medical expense. At the time, she paid $25 to see her doctor, who referred her to a specialist. The total bill for the specialist was $1,100. She paid the first $500, then 10% of the additional $600 (equal to $60).

Which of these is the copayment? a. the $25 paid for the doctor visit b. the $60 paid toward the cost of seeing the specialist c. the $1,100 that the specialist received d. the $500 she paid toward the cost of the specialist ANSWER: a 10. Jermaine's health insurance policy has a deductible of $1,000, a $10 copayment on doctor visits, and coinsurance of 10% on all expenses other than those for which there are copayments. If Jermaine went to the doctor four times (doctor's fee is $40 per visit) and had a surgery that cost $2,000, how much of these expenses did Jermaine pay directly? a. $40 b. $1,000 c. $1,040 Copyright Macmillan Learning. Powered by Cognero.

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Chapter 15 d. $1,140 ANSWER: d 11. Elise's health insurance policy has a deductible of $500, a $20 copayment on doctor visits, and coinsurance of 10% on all expenses other than those for which there are copayments. She visited the doctor four times last year (doctor's fee is $40 per visit) and underwent a surgery that cost $3,000. If instead she had had a policy with a $1,000 deductible, a $10 copayment on doctor visits, and no coinsurance, which of these is TRUE regarding her expenses (excluding the cost of the insurance)? a. With the higher deductible, she would have saved between $70 and $249 relative to what she paid with her actual policy. b. With the higher deductible, she would have saved more than $250 relative to what she paid with her actual policy. c. With the higher deductible, she would have spent at least $300 more than she paid with her actual policy. d. With the higher deductible, she would have spent between $50 and $250 more than she paid with her actual policy.

ANSWER: d 12. Which of these increases the predictability of medical risk distributions for insurance risk pools? a. the individuals in the group having the average medical risk of their age and sex group b. the presence of adverse selection c. smaller, more manageable groups rather than large groups d. more diverse groups in each risk pool ANSWER: a 13. Which of these would make selling insurance to employees of a given firm problematic for the insurer in terms of risk pooling? a. The firm employs a large group of people. b. All workers are required to participate in the group insurance plan. c. Workers take into account their health status when choosing which firm to work for. d. Workers do not take into account their health status when choosing which firm to work for.

ANSWER: c 14. Which of these explains why nearly all firms with more than 50 employees offer health insurance, while only 53% of firms with fewer than 50 employees provide health insurance? a. The expected expenditure per worker is smaller for large firms than for small firms. b. Administrative costs per worker increase as the number of insured employees increases. c. The expected expenditure per worker is more predictable for large firms than it is for small firms. d. Health insurance companies target employers with fewer than 10 employees.

ANSWER: c 15. Suppose that there is a flat 20% income tax rate, but otherwise U.S. tax law is the same as that in place.

Haig makes $40,000 per year. If his employer pays for his $4,000 per year insurance policy and deducts the Copyright Macmillan Learning. Powered by Cognero.

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Chapter 15 expense from his salary, his after-tax, after-insurance take-home pay is $_____. If he pays for his $4,000 per year policy directly, his after-tax, after-insurance take-home pay is $_____. a. 36,000; 36,000 b. 36,000; 32,000 c. 28,800; 32,000 d. 28,800; 28,000 ANSWER: d 16. Suppose that there is a flat 25% income tax but that the U.S. tax policy with respect to health insurance remains the same. Kira makes $25,000 per year and wishes to buy a $2,000 health insurance policy. Is she better off, worse off, or neither better nor worse off if her employer buys the policy and deducts the $2,000 from her wages than if she buys the policy herself? By how much? a. better off; $500 b. worse off; $500 c. no better or worse off; $0 d. better off; $250 ANSWER: a 17. Which of these is TRUE? a. Current tax law provides a subsidy to employees for insurance purchased in the employment setting. b. Current tax law provides a subsidy to employers for providing health insurance to employees. c. Currently, tax law treats health insurance purchased in the employment setting the same as it treats health insurance purchased in the private market. d. Nearly all individuals not covered by employer or public insurance obtain health insurance in the private market.

ANSWER: a 18. One reason employers are the predominant source of health insurance is because: a. insuring at the firm level reduces the extent to which insurance has moral hazard effects. b. insuring at the firm level allows insurers to create large insurance pools with a predictable distribution of medical risk. c. government regulation requires that employee compensation include a non-cash component and health insurance premiums qualify. d. it is efficient from society's perspective to link employment and health insurance coverage.

ANSWER: b 19. Health insurance premiums are typically lower when a large group is insured because: a. larger groups have lower medical expenditures per person, on average. b. larger groups have more predictable medical expenditures per person, on average. c. administrative costs increase proportionally with the size of the group. d. the insurance company can pick and choose which group members to cover.

ANSWER: b Copyright Macmillan Learning. Powered by Cognero.

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Chapter 15 20. Medicare is financed by: a. revenues from federal excise taxes on cigarettes and alcohol. b. a payroll tax levied on both employees and employers. c. a payroll tax levied only on employers. d. a tax on Social Security benefits.

ANSWER: b 21. The unwillingness to move to a better job for fear of losing health insurance is referred to as _____ and results from being _____. a. moral hazard; insured through the private market b. job lock; insured through one's employer c. job lock; uninsured d. first-dollar coverage; insured through one's employer ANSWER: b 22. If Vera has a health insurance policy with a $500 deductible, a $30 copayment for visits to the doctor (doctor's fee is $60 per visit), and 5% coinsurance on covered expenses (excluding doctor's visits), how much of her health insurance expenses would the insurer pay if she went to the doctor twice and had a surgery that cost $1,500? a. $635 b. $985 c. $610 d. $1,010 ANSWER: d 23. Suppose that a healthy individual has worked for 10 years in Medicare-covered employment. At what age can this individual begin to receive Medicare? a. age 65 b. age 62 c. the age at which that individual starts to receive Social Security benefits d. depends on the average income that the individual had earned in those highest-paid 10 years of Medicare-covered employment ANSWER: a 24. Most recipients of Medicaid are _____; most of the costs of Medicaid are associated with benefits received by _____. a. low-income elderly; low-income mothers and children b. low-income mothers and children; disabled and low-income elderly c. military retirees; disabled veterans d. disabled veterans; military retirees ANSWER: b Copyright Macmillan Learning. Powered by Cognero.

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Chapter 15 25. Which of these is TRUE regarding uninsured individuals in the United States, on average? a. They have higher-than-average incomes. b. They have lower-than-average incomes. c. Approximately two-thirds of them are in the family of current or former military personnel. d. They tend to have jobs that require a college degree.

ANSWER: b 26. Which of these is a reason the high number of uninsured may be a problem? a. Because the uninsured may receive uncompensated care, the necessary cost shifting increases the prices for insured patients. b. Uninsured individuals fully comprehend the risks of being uninsured. c. Insured individuals have a better job match and are thus more productive workers. d. Those without insurance are not entitled to medical care in hospital emergency rooms.

ANSWER: a 27. Suppose that Lucia wants to estimate how health insurance affects the mobility rate of workers. Which of these is a problem with identifying this effect when she compares the mobility rate of those who have insurance with that of those who do not have insurance? a. Jobs that offer health insurance tend to be the same in other ways (e.g., pension plans or vacation). b. Jobs that offer health insurance may be better in other ways (e.g., pension plans or vacation). c. Those with health insurance may not want to switch jobs because they are fearful of losing their insurance. d. Health insurance does not affect worker mobility since workers are able to keep their insurance after changing jobs.

ANSWER: b 28. A person with health insurance, which pays 80% of the cost of all medical services, consumes: a. more than the socially optimal amount of medical services since the marginal cost is so high. b. more than the socially optimal amount of medical services since the marginal cost is so low. c. less than the socially optimal amount of medical services since the marginal cost is so high. d. less than the socially optimal amount of medical services since the marginal cost is so low.

ANSWER: b 29. Which of these health insurance policies is MOST likely to lead to the optimal consumption of health care services? a. Copayments are 50%, but there is no deductible. b. Copayments are 0%, and there is no deductible. c. Copayments are 25% until the insured individual pays $5,000, after which the copayment is 0%. d. There is a $5,000 deductible, after which the copayment is 0%.

ANSWER: d Copyright Macmillan Learning. Powered by Cognero.

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Chapter 15 30. Omari broke his arm and incurred his first medical expense ($2,000) of the year. Which of these is consistent with having an insurance plan that provides first-dollar coverage? a. Omari pays the entire $2,000 bill since it is below the insurance plan's coverage. b. The insurance company pays the entire bill. c. Omari pays 20% of the bill ($400). d. Omari pays a $50 copayment, and insurance covers the remaining expense.

ANSWER: b 31. For which of these events is the consumption-smoothing benefit from first-dollar coverage small? a. predictable events b. costly events that occur only very infrequently c. events such as serious injuries from car accidents d. injuries that are caused by the negligence of other people ANSWER: a 32. According to the notion that flat-of-the-curve medicine is practiced in the United States, which of these BEST describes the marginal health benefit from the next dollar of medical spending? a. It decreases as more is spent on health care. b. It increases as more is spent on health care. c. It first increases and then decreases as more is spent on health care. d. It first decreases and then increases as more is spent on health care.

ANSWER: a 33. As the case of McAllen, Texas, shows, there are significant differences in spending under Medicare across health referral regions (HRRs). Which factor primarily explains these differences? a. differences in sickness rates across HRRs b. higher-quality medical care in some areas than others c. variations in fee schedules across HRRs d. higher utilization of health services in some areas than others ANSWER: d 34. Which elasticity of demand with respect to health care would have the highest deadweight loss of insurance coverage, all other things equal? a. −0.5 b. −1 c. −2 d. −3 ANSWER: d 35. Retrospective reimbursement provides financial incentives for _____ medical care; prospective reimbursement provides financial incentives for _____ medical care. a. efficient; inefficient Copyright Macmillan Learning. Powered by Cognero.

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Chapter 15 b. excessive; efficient c. insufficient; efficient d. excessive; insufficient ANSWER: d 36. Retrospective reimbursement generally: a. creates incentives for providers to skimp on the quality of health care. b. causes providers to choose the efficient level of health care services. c. has no effect on the choice between low-quality and high-quality health care. d. provides little incentive to economize on health care services.

ANSWER: d 37. The main difference between retrospective reimbursement and prospective reimbursement is that retrospective reimbursement creates incentives for _____ care and prospective reimbursement creates incentives for _____ care. a. preventive; efficient b. efficient; preventive c. too much; too little d. too little; too much ANSWER: c 38. The results of the growing body of research on health care spending in the United States have: a. been incorporated in the system to reduce costs of medical procedures. b. been incorporated in the system, and the number of medical procedures has fallen. c. not been incorporated, but the quantity of medical procedures has fallen nonetheless. d. not been incorporated in the system, and health care costs as well as the number of unnecessary or ineffective procedures have risen.

ANSWER: d 39. What has been the impact of the results from the spinal fusion clinical trials in the United States? a. The cost of spinal fusion surgeries has fallen dramatically since 2000 because these studies found that the costs were exorbitant. b. The number of back surgeries performed in the United States has fallen dramatically due to these studies' results. c. There has been no impact on the number of back surgeries performed in the United States, as the rate of back surgeries remains high. d. The quality of spinal fusion surgeries has increased substantially, and the benefits are now higher than nonsurgical treatments.

ANSWER: c 40. Charlotte has insurance through her employer. She is given a list of doctors who are "in network." The treatment provided by doctors whom she visits outside the network costs about 20% more than treatment Copyright Macmillan Learning. Powered by Cognero.

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Chapter 15 provided by doctors on this list. Which type of insurance policy does she likely have through her employer? a. PPO policy b. HMO policy c. PPO and HMO policy d. neither a PPO nor an HMO policy ANSWER: a 41. Jorge has insurance through his employer. He is given a list of doctors who are "in network." His insurance covers only treatment provided by these doctors. He will have to pay the entire cost of treatment provided by doctors not on this list. Which type of insurance policy does he likely have through his employer? a. PPO policy b. HMO policy c. PPO and HMO policy d. neither a PPO nor an HMO policy ANSWER: b 42. Sara has an HMO insurance policy through her employer. She undergoes a $1,000 necessary medical procedure, and her insurance does not cover any of it. Which of these is likely TRUE? a. She did not notify her employer she would be absent the day of the procedure. b. Her employer did not pay the premium for that month. c. The procedure was performed by a doctor outside the network. d. The procedure was not an emergency procedure.

ANSWER: c 43. Wanda has a PPO insurance policy through her employer. She undergoes a $1,000 necessary medical procedure, and her insurance covers most of it. She would have had to pay more out-of-pocket if she would have had the procedure performed by her sister's favorite doctor. Which of these is likely TRUE? a. Her sister's doctor is in the same network as the doctor who performed the procedure. b. She would have paid more out-of-pocket if she had had a HMO insurance policy. c. The procedure was performed by a doctor in the network. d. The procedure was not performed by a doctor in the network.

ANSWER: c 44. What is the single largest category of health care spending in the United States? a. hospital care b. physician/clinical care c. prescription drugs d. nursing home care ANSWER: a 45. In the United States, patients do not have a strong incentive to price shop, as most of them have medical costs covered by insurance. The result is that: Copyright Macmillan Learning. Powered by Cognero.

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Chapter 15 a. certain hospitals end up with higher demand. b. resources are used efficiently. c. prices of comparable services vary enormously. d. costs of services matter to patients.

ANSWER: c 46. Medicaid is available to all these groups of people EXCEPT: a. low-income single parents and their children. b. low-income children and most low-income pregnant people. c. non-Medicare health care costs of the elderly and disabled. d. those who are currently or formerly in the military and their dependents.

ANSWER: d 47. Steven tripped and broke his ankle while walking down the sidewalk. Steven is homeless and moves from shelter to shelter. The hospital he was taken to did an MRI and determined he needed a plaster to help heal his ankle. However, Steven did not have health insurance that could cover the cost of the treatment given at the hospital. The hospital was not reimbursed for the care they provided. Over time incidents such as these led to higher prices of services at the hospital, Steven was taken to. This is an example of: a. job lock. b. cost-shifting. c. prospective reimbursement. d. retrospective reimbursement.

ANSWER: b 48. Which of these is NOT a reason explaining why insurance in the United States has traditionally been more generous? a. Doctors want to provide the best care to their patients and don't want to skimp on any tests or scans that might be helpful. b. Expenditures are tax subsidized, as payments to employees in the form of wages are taxed, whereas payments in the form of health insurance are not. c. Insurance makes unaffordable procedures affordable as the insurance cost is only a fraction of the procedure's cost. d. Buying insurance is a means for saving up for health emergencies, and individuals prefer to buy insurance with good benefits.

ANSWER: a 49. Jenna sets up recurring payments for her son's orthodontic payments through her tax-exempt spending account. This is an example of: a. managed care through a Preferred Provider Organization. b. a Health Saving Account. c. retrospective reimbursement to physicians and dentists. d. the kind of participants in the RAND Health Insurance Experiment.

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Chapter 15 ANSWER: b 50. Sophie's demand curve for visiting a physiotherapist for her backache per year is Q = 50 − ½P, where P is the price of one session with the physio. If the marginal cost for visiting a physiotherapist is $70, how many times will she visit the physio per year? a. 5 b. 10 c. 15 d. 20 ANSWER: c 51. Elena applies for private insurance and resents the number of questions asked on the application. She states that since the primary contribution of insurance companies is to pool the risk of many individuals, they should care less about the characteristics of any one applicant and more about increasing the number of the patients that they insure. Furthermore, she states, when she had insurance through her employer, she hardly had to answer any questions. Use economic reasoning to explain to Elena the insurance company's behavior.

ANSWER: The explanation is simple: the insurance company is concerned about adverse selection. When insurance companies are making a decision whether to cover a given individual, they want to know if the expected payout for medical expenses for that individual exceeds the premium charged to that individual. In contrast, when insurance companies offer insurance to people at a firm, they are interested in how the expected total payout to the group compares to the total premiums paid by the group. Since workers generally do not take their health status into account when choosing which firm to work for, adverse selection is less of a concern when insuring at the level of the firm than at the level of the individual.

52. What are the five fundamental reasons that government may care about the number of uninsured? Discuss.

ANSWER: First, there are physical externalities associated with communicable diseases; uninsured people are less likely to receive vaccinations and care for communicable diseases. Second, there is a significant financial externality imposed by the uninsured on the insured through uncompensated care. When the uninsured get served by medical providers and don't pay their bills, those costs are passed on to other users of the medical system through high medical prices, a practice called cost shifting. The third reason is that care is not delivered appropriately to the uninsured, thus jeopardizing their health and further raising the costs of uncompensated care that are paid by those who are insured. Fourth, there are paternalism and equity motivations for caring about the uninsured. In particular, individuals may irrationally underinsure themselves because they do not appreciate the risks they face, and governments may view such irrational underinsurance as justifying intervention in insurance markets. The final reason for caring about the uninsured is that becoming uninsured is a concern for millions of individuals who currently have insurance. Many individuals are afraid to search for or move to jobs where they may be more productive because they are afraid of losing their health insurance coverage.

53. If there are moral hazards associated with health insurance, then why not eliminate health insurance entirely and have individuals pay the full cost of their health care?

ANSWER: Although the moral hazards of health insurance are indeed a cost, these must be compared to the consumption-smoothing benefits of health insurance. The benefit may be particularly great when Copyright Macmillan Learning. Powered by Cognero.

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Chapter 15 individuals cannot self-insure against adverse events, implying that the benefits of health insurance are large when the adverse events are very costly and hard to predict. Indeed, many medical events satisfy both these characteristics. Consequently, some insurance may be socially optimal despite the fact that it creates moral hazards.

54. Assume that the marginal cost (supply) of influenza vaccinations is constant at $40. Assume that everyone in society has health insurance that pays 80% of all medical services, including flu shots. Assume that there are no external benefits associated with these vaccinations. Draw the market demand for flu shots and show graphically what the socially optimal number of flu shots is. Show how many flu shots will be provided in this market given the insurance. Show the deadweight loss caused by the health insurance.

ANSWER: The graph shows the market for flu shots.

Without insurance, the market equilibrium quantity would be where private marginal benefit equals private marginal cost, resulting in Q1 flu shots being made and purchased. With insurance, however, people will get flu shots as long as the marginal benefit from doing so exceeds the after-insurance cost. Given that insurance pays 80% of the cost of the flu shot, individuals with insurance pay only Copyright Macmillan Learning. Powered by Cognero.

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Chapter 15 $8 for a flu shot, resulting in Q2 flu shots being made and purchased. However, for every unit after Q1, the social marginal benefit is less than the social cost of $40, implying that the production of those units creates a deadweight loss. Specifically, the deadweight loss is equal to the area of triangle ABC.

55. What is a health savings account (HSA)? What is the goal of the creation of such accounts?

ANSWER: An HSA is a type of insurance arrangement whereby patients face large deductibles (at least $1,000 for individuals and $2,000 for families per year), and they put money aside on a tax-free basis to prepay these deductibles. HSAs provide a large tax subsidy to those whose health insurance plans have a high deductible. In this way, HSAs address the issue of overinsurance by encouraging the use of high-deductible plans that are closer to optimal and that will thus reduce the moral hazard associated with health insurance.

56. Imagine two scenarios. In scenario 1, Pablo has a $1 million health insurance policy. In scenario 2, he does not have health insurance. Pablo earns an income of $40,000 and has $60,000 in savings. In both scenarios, Pablo falls ill with exactly the same serious illness. In scenario 1, he undergoes treatment that costs $850,000. In scenario 2, he undergoes treatment that costs $50,000. Can the moral hazard costs of health insurance be identified in this case? If so, what are they? If not, why not? Explain.

ANSWER: The moral hazard costs cannot be identified in this case. Although there may be moral hazard associated with having health insurance since the resources that can be spent on medical care are not the same in both scenarios, it is impossible to distinguish the income effect of the health insurance from the moral hazard. For example, it is entirely possible that if Pablo had $1 million in savings in scenario 2, he would choose to undergo the $850,000 treatment. In that case, the additional spending ($850,000 − $50,000 = $800,000) would be due to the income effect and not the moral hazard of having health insurance. Consequently, with the current information, one cannot identify the moral hazard costs of insurance.

57. Suppose that 75% of medical expenses were incurred by 10% of individuals. What would the implication of such a fact be for the success of health savings accounts in reducing the moral hazards associated with insurance? Explain.

ANSWER: To the extent that a large proportion of total medical expenses nationally were incurred after the individual met even a relatively high annual deductible, one would expect that even optimal insurance plans would not reduce moral hazard. For example, imagine a world with two individuals, Mr. Sick and Ms. Healthy, both of whom have insurance plans with no coinsurance. In scenario 1, each individual has a $100 annual deductible. In scenario 2, each individual has a $5,000 deductible.

Under each scenario, major illness befalls Mr. Sick, while Ms. Healthy has only minor health problems. In scenario 1, Mr. Sick incurs $200,000 of medical treatment, and Ms. Healthy incurs $500 of medical treatment. In scenario 2, Mr. Sick incurs $199,000 of medical treatment, and Ms. Healthy incurs $200 of medical treatment. In this scenario, medical expenses are reduced by only $1,300, or 0.65%. Although this is an extreme example, it shows that when most of the total overall medical expenses are incurred by a few individuals, even optimal insurance plans may not affect the amount of total medical spending very much.

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Chapter 15

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Chapter 16 1. The Patient Protection and Affordable Care Act: a. requires each state to expand Medicaid coverage to anyone who is uninsured. b. bans insurers from denying coverage for pre-existing conditions. c. forces health care providers to reduce fees in order to control rising costs. d. protects doctors and hospitals from malpractice lawsuits.

ANSWER: b 2. Medicare provides health insurance primarily to: a. poor families. b. people over age 65. c. poor individuals over the age of 65. d. those who lost their health insurance coverage prior to retirement.

ANSWER: b 3. Medicaid provides health insurance to: a. some low-income individuals. b. all people over age 65. c. people with disabilities under age 65. d. people with disabilities over age 65.

ANSWER: a 4. Medicaid is administered by the _____ and is financed by _____. a. states; general state and federal revenues b. states; a payroll tax levied on employees and employers c. federal government; general state and federal revenues d. federal government; a payroll tax levied on employers ANSWER: a 5. Suppose that to estimate the effect of Medicaid on health status, a researcher compares those who choose to enroll in the program to those who are not enrolled. Which would cause the resulting estimate to be biased? a. Eligibility for Medicaid is established by factors that might also affect health. b. Eligibility for Medicaid is established by factors that do not affect health. c. Those who enroll in Medicaid are likely to receive more access to medical care than those who do not enroll. d. Access to health care is likely to have a significant impact on an individual's overall health.

ANSWER: a 6. Which statement is TRUE? a. Medicaid rules do not require states to cover services such as prescription drugs or dental care. b. Medicaid recipients receive dental benefits in fewer than half of the states. c. There are significant copayments associated with the prescription drug benefits under Medicaid.

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Chapter 16 d. Medicaid only covers services provided in a hospital emergency room.

ANSWER: a 7. The Children's Health Insurance Program introduced in 1997: a. expanded Medicaid's medical coverage of children to include prescription drugs. b. expanded eligibility of children for public health insurance. c. mandated that the states ensure that every child is covered by health insurance. d. replaced Medicaid with private insurance for all eligible individuals.

ANSWER: b 8. Which statement is TRUE with respect to the expansions of Medicaid in the 1980s and 1990s? a. More than half of those made eligible by those expansions enrolled in the program. b. More than half of those made eligible by those expansions already had private health insurance coverage. c. The percentage of individuals under age 18 who were eligible for Medicaid increased slightly by the Medicaid expansions. d. None of those made eligible by those expansions had private health insurance coverage.

ANSWER: b 9. Which statement reflects the findings of empirical studies of Medicaid? a. Infant mortality was not affected by the expansion of Medicaid coverage to pregnant women. b. The crowd-out effect of Medicaid on private insurance exceeds 50%. c. The crowd-out effect of Medicaid on private insurance is below 50%. d. Low-income families have the same health outcomes whether or not they apply for and receive Medicaid.

ANSWER: c 10. Which is TRUE regarding the cost-effectiveness of the Medicaid expansions? a. It costs Medicaid more to save an infant life than the estimates of the value of a life found by compensating differential studies. b. It costs Medicaid less to save an infant life than it does to save a life through alternative interventions, such as seat-belt safety. c. It is not possible to save an infant life simply by spending more on Medicaid. d. The cost of saving an infant life far exceeds the benefit of saving this life.

ANSWER: b 11. Medicare is administered by _____ and is financed by _____. a. states; general revenues b. states; a payroll tax c. the federal government; general revenues d. the federal government; a payroll tax ANSWER: d Copyright Macmillan Learning. Powered by Cognero.

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Chapter 16 12. Which statement is TRUE with respect to Medicare? a. The part of Medicare that covers inpatient hospital costs and some costs of long-term care is financed largely through a payroll tax. b. The part of Medicare that covers physician expenditures and outpatient hospital expenditures is financed largely through a payroll tax. c. Medicare recipients must pay a premium to receive coverage of inpatient hospital costs. d. Medicare recipients are not able to purchase additional coverage beyond the basic plan provided by the program.

ANSWER: a 13. Which provides coverage for prescription drug expenditure for older adults? a. Medicare Part A b. Medicare Part B c. Medicare Part D d. Medicaid ANSWER: c 14. Which is TRUE of the Prospective Payment System? a. It was established in 1996. b. Hospitals that treated fewer poor patients received higher reimbursements for the same services relative to other hospitals. c. All diagnoses for hospital admissions were grouped into 1 of over 400 groups on which reimbursement was based. d. Reimbursements were based on services provided rather than the patient's diagnosis.

ANSWER: c 15. As a result of the move to a Prospective Payment System (PPS): a. the treatment intensity of older adults was significantly increased. b. the rate of growth of hospital costs fell significantly and quickly. c. mortality rates increased. d. there were no major changes in coverage or costs.

ANSWER: b 16. Which is an advantage of a premium support system for Medicare enrollees? a. It would impose government's preferences on individuals. b. It would promote efficiency by introducing competition. c. It would lower overall costs by reducing adverse selection. d. It would lower moral hazard by allowing only the healthiest individuals to enroll for Medicare.

ANSWER: b 17. What is the effect of adverse selection in a premium support system for Medicare?

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Chapter 16 a. It raises the costs to the sickest individuals. b. It raises the costs to the healthiest individuals. c. More individuals choose the higher level of insurance coverage. d. Premiums are reduced for everyone.

ANSWER: a 18. According to the literature on Medicare Part D reviewed in Abaluck and Gruber (2016), which is TRUE of seniors facing the large number of choices of prescription drug plans? a. They are usually able to make a rational, informed decision that improves their well-being. b. Seniors are not eligible for a prescription drug plan under Medicare Part D. c. They are not doing a good job choosing their plans and are not learning to do better over time. d. Seniors typically choose the most expensive plan with the best benefits.

ANSWER: c 19. Which is NOT true regarding coverage gaps in Medicare? a. Low-income older individuals can fill coverage gaps by obtaining more generous coverage under the Medicaid program. b. Some retirees can fill coverage gaps through medical benefits from their former employer. c. Some individuals buy Medi-gap policies from insurance companies. d. Seniors are not able to fill coverage gaps in Medicare, as they are not eligible for other programs.

ANSWER: d 20. Approximately what percentage of total health care spending was spent on long-term care in 2019? a. 2% b. 8% c. 17% d. 31% ANSWER: b 21. Institutional care is provided in _____ and accounts for _____% of long-term care costs. a. the patient's home; 25 b. the patient's home; 60 c. nursing homes; 25 d. nursing homes; 60 ANSWER: d 22. Suppose that an older person receives daily care through nurses and aides who visit the person at home. This is: a. institutional care. b. acute care. c. home health care.

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Chapter 16 d. the most expensive type of long-term care.

ANSWER: c 23. When an individual in a nursing home can no longer afford the care, what typically happens? a. The individual is removed from the nursing home. b. The individual pays for it using a recently purchased long-term care insurance policy. c. The individual's nursing home costs are covered under Medicaid. d. The individual's nursing home costs are covered under Medicare.

ANSWER: c 24. Which is an effect of the current system of financing long-term care? a. Assets are implicitly taxed. b. Individuals have an incentive to save more as they get older. c. Individuals give larger bequests when they die than they would otherwise. d. There is an incentive for individuals to seek more long-term care.

ANSWER: a 25. Suppose that individuals have private information about the likely risk of going into a nursing home. This will directly cause: a. moral hazard in the market for long-term care insurance. b. adverse selection in the market for long-term care insurance. c. a reduction in the average cost of long-term care insurance. d. increased demand for long-term care insurance by those who are least likely to go into a nursing home.

ANSWER: b 26. Since 1980, long-term care has shifted toward _____, which makes up _____% of overall long-term care costs. a. home health care; 40 b. home health care; 73 c. institutional care; 40 d. institutional care; 50 ANSWER: a 27. Individuals who enter nursing homes usually pay first using: a. personal savings. b. private long-term care insurance. c. Medicaid coverage. d. Medicare coverage.

ANSWER: a 28. Which is a likely consequence of the current system of financing long-term care?

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Chapter 16 a. Individuals are more likely to opt for long-term care. b. Individuals have an incentive to hide their wealth. c. Individuals have less incentive to donate to charity. d. The current system does not affect individual incentives.

ANSWER: b 29. A public national health insurance plan would: a. solve the problem of the uninsured. b. worsen the problem of the uninsured. c. have no effect on the problem of the uninsured. d. raise per-person administrative costs of health insurance.

ANSWER: a 30. Which is probably the primary cause of the rapid rise in health care costs? a. moral hazard b. corruption and mismanagement c. obesity d. technological change in the delivery of health care ANSWER: d 31. Practicing medicine on the flat of the curve implies that the _____ value of medical treatment is exceeded by the _____ cost of treatment. a. average; average b. median; median c. marginal; marginal d. average; marginal ANSWER: c 32. Which technique is NOT used to control cost? a. a cap on the tax exclusion to employer-provided insurance for the highest-cost health insurance plans b. introduction of competitive health insurance exchanges c. pilot programs of alternative structures for organizing and reimbursing health care providers d. exclusion of certain older individuals, especially those who are in the last six months of their life ANSWER: d 33. Which is NOT primarily intended to address the problem of insuring people who do not have health insurance? a. mandates employers offer insurance or individuals buy insurance b. subsidies to the poor c. increased pooling of small business employees across states d. reducing deductibles and copays for all insurance policies Copyright Macmillan Learning. Powered by Cognero.

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Chapter 16 ANSWER: d 34. A public national health insurance system likely will: a. not resolve the problem of job lock. b. not reduce the administrative costs associated with the health insurance system. c. require massive new government expenditures. d. put a stop to rising health care costs.

ANSWER: c 35. Which is NOT a provision of the Patient Protection and Affordable Care Act of 2010 (ACA)? a. The ACA eliminates price discrimination against the sick by banning denial of coverage because of preexisting conditions. b. The ACA mandates employers offer insurance or individuals buy insurance. c. The ACA subsidizes health insurance coverage for the poor. d. The ACA varies insurance prices by age and health history.

ANSWER: d 36. Between 2014 and 2016, the rate of uninsured in the United States: a. fell to zero. b. increased slightly. c. increased dramatically. d. declined substantially.

ANSWER: d 37. Which is NOT a finding from recent studies examining the impact of the ACA on insurance coverage? a. Emergency room visits have decrease. b. Preventive care has increased. c. Self-reported health has improved. d. The quality of dental care has increased.

ANSWER: d 38. Which policy did the Trump administration and Congress adopt to weaken the ACA significantly? a. denial of emergency room visit coverage b. repeal of the individual mandate c. increase in the penalty for those without coverage d. force states to expand their Medicaid programs ANSWER: b 39. Which is a result of the Trump administration's policies aimed at weakening the ACA? a. an increase in the coverage among low-income individuals b. an increase in the uninsurance rate Copyright Macmillan Learning. Powered by Cognero.

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Chapter 16 c. an increase in Medicaid coverage across most states d. decrease in insurance premiums ANSWER: b 40. Why did so few of those made eligible by the expansions of Medicaid in the 1980s and 1990s actually enroll in the program? a. Their incomes were expected to increase substantially, thus making them ineligible for the program. b. Most of these individuals already had private insurance. c. They did not want to pay the high copayments associated with Medicaid. d. Many of these individuals had pre-existing conditions that were not covered through Medicaid.

ANSWER: b 41. Which statement is TRUE? a. The federal government mandates some minimal levels of eligibility and service coverage, and states are free to increase generosity beyond these mandates. b. The federal government mandates some maximum levels of eligibility and service coverage, and states are free to decrease generosity below these mandates. c. The states mandate some minimal levels of eligibility and service coverage, and the federal government is free to increase generosity beyond these mandates. d. The states mandate some maximum levels of eligibility and service coverage, and the federal government is free to increase generosity beyond these mandates.

ANSWER: a 42. Most states _____ the federally mandated eligibility for Medicaid. a. exceed b. match c. are exempt from d. resist ANSWER: a 43. Which statement is TRUE? a. In most states, Medicaid reimburses physicians at a much lower level than does the private sector. b. In most states, Medicaid reimburses physicians at a much higher level than does the private sector. c. In most states, Medicaid reimburses physicians at the same level than does the private sector. d. In most states, Medicaid reimburses physicians at a fixed percentage of private-sector reimbursement.

ANSWER: a 44. The primary goal of Medicaid is: a. consumption smoothing. b. improving physical health. c. improving mental health.

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Chapter 16 d. currying political favor.

ANSWER: a 45. When Oregon allocated public insurance benefits by lottery, the largest impact was: a. a large improvement in the mental health of the newly covered. b. a large improvement in the physical health of the newly covered. c. a large deterioration in the mental health of those not receiving coverage. d. a large deterioration in the physical health of those not receiving coverage.

ANSWER: a 46. The results of empirical studies suggest that spending on low-income health care: a. is a cost-effective way to improve health. b. is not a cost-effective way to improve health. c. has little effect on overall health. d. has a negative impact on overall health.

ANSWER: a 47. There were calls for changes to Medicare Part D after it became law because the coverage: a. structure was deeply flawed. b. did not extend to low-income families. c. did not include generic alternatives to higher-cost prescription drugs. d. had copayments that were too expensive for people on a fixed income.

ANSWER: a 48. The 2006 Medicare Part D cost structure contained a gap in coverage called: a. the donut hole. b. coinsurance. c. social insecurity. d. the illness tax.

ANSWER: a 49. Eliminating the gap in coverage for prescription drugs in Medicare Part D was one of the main goals of: a. the Affordable Care Act. b. Medicare Part E. c. quantitative easing. d. the Medical Recovery Act. ANSWER: a 50. Early evidence regarding the Affordable Care Act suggests: a. it significantly improved health and may have contributed to a slowdown in health care cost inflation. b. there was no significant improvement in health, but it may have contributed to a slowdown in health Copyright Macmillan Learning. Powered by Cognero.

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Chapter 16 care costs. c. it significantly improved health but may have contributed to a rise in health care costs. d. there was no significant improvement in health, and it may have contributed to a rise in health care costs.

ANSWER: a 51. How are the providers of health care services to Medicaid recipients paid? Has this affected the health care experiences of Medicaid recipients? Explain.

ANSWER: Medicaid reimburses physicians at rates determined by states. In most states, Medicaid reimburses physicians at a much lower level than does the private sector. Consequently, many physicians are unwilling to serve Medicaid patients. So even though Medicaid benefits are very generous, in a number of states individuals may have trouble finding physicians who will accept them as patients.

52. Compare and contrast the differences between Medicaid and Medicare with respect to eligibility, premiums, deductibles, copayments, and services excluded from each program.

ANSWER: Families on welfare, low-income children, pregnant women, and low-income older individuals or individuals with disabilities are eligible for Medicaid. Retirees and their spouses aged 65 and older and certain persons with disabilities under age 65 are eligible for Medicare. There are no premiums for Medicaid. Individuals in Medicare pay premiums for physician and prescription drug coverage.

Again, Medicaid carries no or very small deductibles or copayments; Medicare requires some deductibles and copayments for hospital, physician, and drug coverage. Medicaid excludes no services, whereas Medicare excludes some services, such as dental care and immunizations.

53. Most private health insurance plans have out-of-pocket limits, which limit the total amount an insured individual must pay in any given year. For example, a plan may have a 10% copayment on all medical services and a $5,000 out-of-pocket limit. If an individual insured under that plan incurs $60,000 of medical expenses in one year, the individual will pay 10% of the first $50,000 ($5,000), after which the insurer will pay 100% of expenses. Medicare does not have an out-of-pocket limit. Suppose the government is considering adding an outof-pocket limit. What are the advantages of doing so? What are the disadvantages of doing so?

ANSWER: The advantage of doing so is the consumption-smoothing benefit such a limit would provide. The disadvantage is that adding such a limit will increase public-sector spending, and to the extent that Medicare recipients purchase private policies to insure against spending over a certain limit, it would crowd out private insurance. Finally, as with any insurance, increasing insurance will also have moral hazard costs.

54. The textbook identifies three reasons why the prospective payment system (PPS) did not solve the long-run cost growth problems of Medicare. Describe two of those problems.

ANSWER: The first problem is the fact that hospitals have some control over the diagnosis given to patients when they are admitted. Consequently, hospitals can change the diagnosis of a patient to be reimbursed more highly. In this way, the prospective payment system is not quite prospective enough. Another problem with the PPS has been that it applies only to one part of the medical system for treating older adults, but there is enormous substitutability across different pieces of the medical system. For instance, there was an enormous shift of patients from acute care hospitals to some of the exempt rehabilitation institutions, undoing a large part of the savings from the PPS change.

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Chapter 16 55. Medi-gap insurance policies, available in the private market, are designed to cover many expenses that Medicare does not cover. Can such policies lead to an inefficient amount of health care? Explain.

ANSWER: Yes, such policies can lead to an inefficiently high amount of health care for those on Medicare. For example, if the cost of a medical service is $300, Medicare may require a copayment of $60 for that service. Suppose that the individual values the service at only $50 and so without Medi-gap insurance would not purchase the service. Suppose that the individual does have that insurance and so does not have to pay the $60. As a result, the Medicare recipient purchases the service despite the fact that the total social costs of $300 exceed the social benefit of $50.

56. Suppose that in response to learning that some sick individuals were denied health insurance, the government mandates that insurance companies offer insurance to everyone at unregulated rates. (a) Would this help reduce the number of uninsured? Explain. (b) An alternative strategy for reducing the number of uninsured might be to mandate that insurance companies charge individuals with health problems no more than individuals without health problems. Would this help reduce the number of uninsured? Explain.

ANSWER: (a) No, such a mandate would probably not help. In response, insurance companies would simply charge extremely high prices to unhealthy individuals and induce them to forgo insurance coverage. (b) No. In this case, insurers will charge high prices to both healthy and unhealthy individuals. Thus, insurance becomes more attractive to unhealthy individuals and less attractive to healthy individuals, leading to a reduction in health insurance coverage for healthy individuals. In fact, evidence suggests that this reduction exceeds the increase in coverage among unhealthy individuals after this type of policy is implemented.

57. Discuss the three-legged-stool approach of Massachusetts's experiment with incremental universalism. What were the consequences of the three-legged-stool implementation? How does this experience compare to the ACA? ANSWER: The first leg was insurance market regulations, which outlawed preexisting condition exclusions and differential insurance prices based on health status. As a result, individuals could wait until they were sick to buy insurance, so insurers had to set prices for all participants as if they were sick. As a result, the state became among the most expensive places in the nation to purchase nongroup insurance. The second leg of the stool was therefore an individual mandate, or a requirement that all residents purchase health insurance. By mandating purchase, Massachusetts could ensure broad participation in insurance pools, thereby allowing insurers to price fairly to all. In particular, residents for whom insurance is "affordable" have to buy coverage or face a tax penalty. The third leg of the stool was to offer subsidies to make insurance affordable. The state introduced a new program (called Commonwealth Care) to provide free insurance coverage for all residents below 150% of the poverty line and heavily subsidized coverage for those at up to 300% of the poverty line. The state now has covered about two-thirds of its uninsured residents with health insurance, with the uninsured rate falling to about 3%. The ACA is more ambitious than the Massachusetts reform, however, in two critical respects. The first is financing: The legislation includes a variety of mechanisms to finance the $1 trillion in projected new spending on public insurance and tax credits over the next decade. The second critical difference between the ACA and the Massachusetts plan is the effort to control costs.

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Chapter 17 1. In Sandtown-Winchester, a low-income neighborhood in Baltimore, the average life expectancy is _____ years; only three miles away in the wealthy Baltimore neighborhood of Roland Park, life expectancy averages _____ years. a. 48; 67 b. 67; 84 c. 75; 84 d. 83; 87 ANSWER: b 2. In 2015, the median household income in Sandtown-Winchester, a low-income neighborhood in Baltimore, was _____; only three miles away in the wealthy Baltimore neighborhood of Roland Park, median household income was _____. a. $12,000; $24,000 b. $18,000; $56,000 c. $24,000; $107,000 d. $36,000; $124,000 ANSWER: c 3. At its peak, cash transfer spending by the federal government amounted to: a. 1.7% of the federal budget. b. 10.7% of the federal budget. c. 24.5% of the federal budget. d. 33.3% of the federal budget.

ANSWER: a 4. How much the low-income individuals have relative to some measure of a reasonable minimally acceptable income level can be BEST described as: a. relative income inequality. b. the iron triangle of transfer programs. c. absolute deprivation. d. allocative inefficiency.

ANSWER: c 5. Which refers to the federal government's measure of minimally acceptable income? a. the poverty line b. relative income inequality c. the iron triangle d. income shares ANSWER: a 6. In the United States from the late 1960s through the late 1970s, the share of income accruing to the bottom income quintile _____, and the share accruing to the top income quintile _____.

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Chapter 17 a. fell; fell b. fell; grew c. grew; grew d. grew; fell ANSWER: d 7. In the United States from 1980 to the present, the share of income accruing to the bottom income quintile _____, and the share accruing to the top income quintile _____. a. fell; fell b. fell; grew c. grew; grew d. grew; fell ANSWER: b 8. In a society with no relative income inequality, the bottom quintile of the population would accrue _____% of aggregate income. a. 20 b. 10 c. 80 d. 100 ANSWER: a 9. Currently in the United States, the share of income earned by the top 1% is now similar to what it was in the: a. 1920s. b. 1930s. c. 1950s. d. 1960s.

ANSWER: a 10. The share of a nation's total income that accrues to the least wealthy individuals relative to the most wealthy is a measure of: a. the poverty line. b. relative income inequality. c. the iron triangle of transfer programs. d. absolute deprivation.

ANSWER: b 11. Which is NOT true about the evolution of poverty in the United States? a. In 2019, a family of four with an annual income below $26,200 was considered to be living in poverty. b. The poverty rates fell for all persons, for the elderly, and for the very young in the 1960s and early 1970s.

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Chapter 17 c. The share of income received by the lowest quintile in the United States is smaller than in any other OECD nation. d. For older adults, 65 and over, poverty rates have increased since the 1970s.

ANSWER: d 12. Suppose someone criticizes the federal measure of the poverty line by saying that the typical family spends less of its budget on food than families used to spend. This is an example of which of these criticisms of the federal poverty line? a. It is based on an oversimplified definition of family size. b. The bundle has changed. c. Differences in the cost of living across areas are ignored. d. It is inconsistent with international measures.

ANSWER: b 13. Suppose someone criticizes the federal measure of the poverty line by saying that it does not account for Medicaid receipts but that it should account for them. This is an example of which of these criticisms of the federal poverty line? a. The definition of income is incomplete. b. The bundle has changed. c. Differences in the cost of living across areas are ignored. d. It is inconsistent with international measures.

ANSWER: a 14. Suppose someone criticizes the federal measure of the poverty line by saying that it should but does not account for regional differences in housing prices. This is an example of which of these criticisms of the federal poverty line? a. It is based on an oversimplified definition of family size. b. The bundle has changed. c. Differences in cost of living across areas are ignored. d. It is inconsistent with international measures.

ANSWER: c 15. Which statement suggests that a relative measure of inequality is better than an absolute measure? a. Self-reported well-being may fall for people whose income remains stable as their neighbors' incomes rise. b. If those worse off achieve a sufficient level of consumption, it does not matter how rich the richest people are. c. Living in a 1,000-square-foot house is no more adequate when others live in 1,500-square-foot houses than when others live in 3,000-square-foot houses. d. A person's well-being is determined by their access to basic necessities, such as food, clothing, and shelter.

ANSWER: a Copyright Macmillan Learning. Powered by Cognero.

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Chapter 17 16. Which statement suggests that an absolute measure of poverty is better than a relative measure of inequality for measuring the well-being of less well-off individuals? a. Self-reported well-being may fall for people whose income remains stable as their neighbors' incomes rise. b. If those least fortunate achieve a sufficient level of consumption, it doesn't matter how rich the richest people are. c. Driving a $10,000 car is more adequate when others drive $10,000 cars than when others drive $30,000 cars. d. A person is living in poverty only if they have substantially less than others.

ANSWER: b 17. Which transfer term BEST describes transfer programs that provide recipients with a monthly check? a. in-kind transfer b. cash transfer c. means-tested transfer d. non-hedonic transfer ANSWER: b 18. Which transfer term BEST describes transfer programs that provide medical services to recipients? a. in-kind transfer b. categorical transfer c. means-tested transfer d. non-hedonic transfer ANSWER: a 19. Which transfer term describes transfer programs that restrict benefits by some demographic characteristic? a. in-kind transfer b. categorical transfer c. means-tested transfer d. non-hedonic transfer ANSWER: b 20. Suppose the government sends a monthly check to those earning less than $400 per week. This is an example of: a. in-kind transfer. b. categorical transfer. c. cash transfer. d. earned income.

ANSWER: c 21. Which transfer term describes transfer programs that are provided only to people qualifying on the basis of income and asset levels?

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Chapter 17 a. in-kind transfer b. categorical transfer c. means-tested transfer d. cash transfer ANSWER: c 22. Which transfer term describes transfer programs that deliver certain goods to recipients? a. in-kind transfer b. categorical transfer c. means-tested transfer d. cash transfer ANSWER: a 23. Suppose that a transfer is restricted to unmarried mothers who have at least one child. This type of transfer could be BEST characterized as: a. in-kind transfer. b. categorical transfer. c. means-tested transfer. d. cash transfer.

ANSWER: b 24. Suppose that a monthly check is given to people with HIV or AIDS who earn less than $400 per week. This is an example of: a. in-kind transfer. b. non-categorical transfer. c. categorical and means-tested transfer. d. in-kind and means-tested transfer.

ANSWER: c 25. The cash transfer benefit for individuals with no other income that may be reduced as income increases is referred to as the _____; the schedule that shows how transfer benefits will be reduced as other income increases is the _____. a. benefit guarantee; work requirement b. benefit reduction rate; benefit guarantee c. work requirement; benefit reduction rate d. benefit guarantee; benefit reduction rate ANSWER: d 26. The federal government restricts Temporary Assistance for Needy Families (TANF) to no longer than _____ years and mandates that recipients start working after receiving at most _____ months of TANF benefits, although there are some loopholes in these requirements. a. 3; 12 Copyright Macmillan Learning. Powered by Cognero.

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Chapter 17 b. 3; 24 c. 5; 12 d. 5; 24 ANSWER: d 27. Which is an in-kind program pair? a. food stamps and Supplemental Security Income b. Medicaid and Temporary Assistance for Needy Families (TANF) c. TANF and Supplemental Security Income d. public housing and Special Supplemental Nutrition Program for Women, Infants, and Children (WIC) ANSWER: d 28. Which is a moral hazard associated with transferring money from high-income to low-income groups? a. The taxation of higher-income individuals may cause them to work less hard. b. The taxation of higher-income individuals may cause them to save less. c. Individuals may reduce their labor supply to qualify for the means-tested transfers. d. The administrative costs of the transfer are high.

ANSWER: c 29. Which statement is TRUE if the benefit reduction rate of a transfer program is reduced? a. Total labor supply will go up. b. Everyone who was working will choose to work less. c. Total labor supply may go up or down. d. Work incentives are not affected by the benefit reduction rate.

ANSWER: c 30. The purpose of ordeal mechanisms is to: a. assist those who have been particularly unlucky in life. b. better target transfer benefits to those with particularly low incomes. c. redistribute income from high-income to low-income individuals without reducing the national savings rate. d. separate those who truly need assistance from those who can support themselves.

ANSWER: d 31. Which must be TRUE for an ordeal mechanism to be effective? a. The disincentive to work from taxing the high-income individuals must be minimized. b. The disincentive to work for transfer recipients must be less than the additional social transfer received from making them better off. c. The gains from the program to transfer recipients must exceed the cost imposed on transfer recipients.

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Chapter 17 d. The cost imposed on transfer recipients from the program must be equal to zero.

ANSWER: c 32. Suppose that the government could know for sure each individual's earnings capacity. This would allow government to: a. eliminate moral hazard to transfer recipients. b. prevent high-wage earners from working less in response to taxation. c. eliminate the administrative costs associated with transfer programs. d. reduce the administrative costs associated with transfer programs.

ANSWER: a 33. Which potential target group for welfare benefits would BEST satisfy the two characteristics of a good targeting mechanism? a. single parent with a graduate degree b. older adult with no job experience c. people earning less than $8 per hour d. single parent without health insurance ANSWER: b 34. In what way is instituting a work or training requirement in a transfer program an ordeal mechanism? a. It imposes a cost on high-ability individuals who want to receive transfer only to increase their leisure. b. It prevents those receiving transfer from doing so for longer than society deems optimal. c. It provides a long-term solution to the problems of those receiving transfer. d. It imposes the same burden on those who deserve assistance and those who don't.

ANSWER: a 35. Which statement describes the paradox of ordeal mechanisms? a. Transfer systems not only make the high-income individuals worse off but also reduce the well-being of low-income individuals in the long run. b. Making the receipt of transfer benefits less attractive and less generous may actually make the recipients better off. c. Low-income individuals are made worse off for having received transfer because of the corresponding reduction in self-worth. d. Transfer programs make the high-income individuals better off, even though they are the ones who are taxed to fund the transfer program.

ANSWER: b 36. Which statement identifies a problem with enforcement of child support obligations of absent fathers as a way of solving the mothers' transfer dependence? a. Empirical evidence shows that stronger enforcement of child support reduces the incidence of single motherhood by making it financially costly for fathers to abandon their families.

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Chapter 17 b. Since nearly 90% of court-ordered child support payments are made, the benefits from increased enforcement are quite small. c. Most of the fathers who are not making child support payments are low-income, so not much money can be collected from them. d. The mothers' transfer benefits are not dependent on whether an absent father is making child support payments.

ANSWER: c 37. The conclusion that transfer lock should be removed means that: a. the government should not incarcerate the fathers of children in single-mother transfer homes because it reduces child support payments. b. the government should unlink cash transfer from other in-kind benefits. c. the government should reduce the benefits reduction rate to increase the benefits of working. d. all transfer payments should be given based on unchangeable characteristics.

ANSWER: b 38. The Personal Responsibility and Work Opportunity Reconciliation Act of 1996: a. removed time limits on transfer recipients. b. removed work requirements on transfer recipients. c. gave more flexibility to the states in choosing the structure of cash transfer payments. d. replaced block grants from the federal government with matching grants.

ANSWER: c 39. Suppose that the government were to subsidize the market wages of those already on transfer directly for one month. Which is TRUE? a. This type of program creates disincentives to work for those receiving transfer. b. This type of program can result in increased rates of enrollment in the transfer program. c. This type of program is typically more costly than a general wage subsidy to the labor supply of the lowest-income workers. d. This type of program has no effect since transfer benefits must be reduced to compensate for wages earned.

ANSWER: b 40. Which statement is TRUE regarding the national reduction in transfer caseloads since the transfer reform legislation passed in 1996? a. About one-third of the decline in the transfer rolls can be ascribed to reform, with the rest due to the improving economy. b. Nearly all of the reduction in transfer caseloads was caused by the transfer reform. c. Nearly all of the reduction in transfer caseloads was caused by the economic expansion in the late 1990s. d. A nontrivial part of the reduction was due to the decreased fertility rates that were caused by the transfer reform.

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Chapter 17 ANSWER: a 41. Which is NOT a method of improving the outside option to transfer to reduce moral hazard problems? a. providing job skills training for transfer recipients b. directly subsidizing the market wages c. using ordeal mechanisms d. fully enforcing the child support obligations of the fathers of children whose mothers are transfer recipients ANSWER: c 42. Which would be a consequence of changing the poverty line to account for regional differences in cost of living? a. Government transfer payments to East Coast families would fall. b. Government transfer payments to Midwest families would fall. c. Government transfer payments to families living in the South would rise. d. Government transfer payments to West Coast families would fall.

ANSWER: b 43. In 2015, the median single-family home in the Boston-Cambridge-Newton area of Massachusetts cost $495,900. In that same year, the median single-family home in St. Louis, Missouri, cost only $185,700. This is information that supports which criticism of the federal poverty line? a. It is based on an oversimplified definition of family size. b. The bundle has changed. c. Differences in the cost of living across areas are ignored. d. It is inconsistent with international measures.

ANSWER: c 44. Recent research suggests that when states passed laws strengthening paternity identification, marriage rates: a. and fathers' involvement with their children were lower. b. were lower, but fathers' involvement with their children was higher. c. were higher, and fathers' involvement with their children was lower. d. and fathers' involvement with their children were higher.

ANSWER: a 45. Annual income growth for the bottom 50% of the population has been about: a. the same as the top 0.001% of the income distribution. b. 1%, which is much lower than the top 0.001% of the income distribution. c. 1.5%, which is much higher than the top 0.001% of the income distribution. d. 6%, which is much lower than the top 0.001% of the income distribution.

ANSWER: b 46. A Universal Basic Income plan would: Copyright Macmillan Learning. Powered by Cognero.

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Chapter 17 a. provide a flat income to citizens if they met certain work requirements. b. be available to single mothers only. c. provide a flat income and therefore distort labor supply less. d. not be very expensive if implemented in the United States.

ANSWER: c 47. Recent research examining the impact of the Alaska Permanent Fund Dividend on labor supply concludes that there: a. have been large reductions in long-run labor supply. b. have been small increases in long-run labor supply. c. have been large increases in short-run labor supply. d. has been no reduction in long-run labor supply.

ANSWER: d 48. Which BEST characterizes the Alaska Permanent Fund Dividend program? a. It is a state-run program that pays out property tax revenues to homeowners. b. It pays each citizen a portion of net income the state earns from oil exploration leases and royalties. c. It uses revenue from oil leases to fund Medicare and Medicaid programs in the state. d. It uses net income from oil leases to help local businesses finance capital investments.

ANSWER: b 49. Which is an alternative proposal to a Universal Basic Income program in the United States? a. a tax credit for married couples b. a universal child credit c. an in-kind transfer to each citizen d. an education grant ANSWER: b 50. Which is a major concern of the Universal Basic Income proposal? a. It may still distort labor supply, even though it is a flat grant. b. It will benefit the wealthy the most. c. Those who qualify for the program will not know how to apply. d. There will be a negative stigma that will discourage people from applying.

ANSWER: a 51. Which is a major concern of the Universal Basic Income proposal? a. It will not be enough to lift most individuals out of poverty. b. It will benefit the wealthy the most. c. Those who qualify for the program will not know how to apply. d. It will be a very expensive program.

ANSWER: d Copyright Macmillan Learning. Powered by Cognero.

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Chapter 17 52. Which was NOT a finding of researchers following participants of the New Leaf Project in Vancouver, Canada? a. Cash transfer increased spending on food and decreased spending on temptation goods. b. The one-time transfer program costs twice as much to the government than providing shelter to unhoused people. c. Financial stability was higher over the years for those who received the lump sum than those who did not. d. Those who received cash transfers moved into stable housing faster than those who did not.

ANSWER: b 53. In-kind benefits can serve to solve market failures. Which is an example of this benefit from in-kind benefits? a. In-kind transfers of a basket of food cause a supply effect in a market with a few sellers. b. In-kind transfers of a basket of food cause a supply effect in a perfectly competitive market. c. A lump-sum cash transfer increases supply, thus reducing deadweight loss in the market. d. Monthly cash transfers allow recipients to buy a basket of food leading to a change in prices.

ANSWER: a 54. Why do economists consider raising the minimum wage to be an outside option for those receiving transfers? a. Increasing the minimum wage leads to a reduction in spending on transfer programs. b. An increase in the minimum wage above the equilibrium wage increases unemployment. c. Those earning minimum wage experience a shift to the left in their budget constraints. d. Transfer beneficiaries would find minimum wage jobs more attractive after the wage increase.

ANSWER: d 55. What are the features that make a good targeting mechanism? a. The best mechanisms target individuals with high-earning capacity who cannot change their behavior. b. The best mechanisms target individuals with low-earning capacity who can change their behavior. c. The best mechanisms target individuals with low-earning capacity who cannot change their behavior. d. The best mechanisms target individuals with high-earning capacity who can change their behavior.

ANSWER: c 56. Which is TRUE according to the iron triangle of cash transfer programs? a. Encouragement to work, income redistribution, and lower costs are exclusive goals of cash transfer programs. b. A cash transfer program cannot encourage work, redistribute income, and lower costs at the same time. c. A cash transfer program can encourage work, redistribute income, and lower costs simultaneously. d. Cash transfer programs never create consensus among congressional committees, the bureaucracy, Copyright Macmillan Learning. Powered by Cognero.

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Chapter 17 and interest groups.

ANSWER: b 57. Does cash transfer have a constructive or destructive role in the lives of lower-income groups, according to Republicans and Democrats? Discuss the political views each party expressed during the debate on the Personal Responsibility and Work Opportunity Reconciliation Act of 1996.

ANSWER: To some conservatives, the negative effects of cash payments to low-income single mothers are responsible for many of the social ills in the United States. Newt Gingrich said in a televised address, "The transfer system's greatest cost is the human cost to the poor. In the name of 'compassion,' we have funded a system that is cruel and destroys families. Its failure is reflected by the violence, brutality, child abuse, and drug addiction in every local TV news broadcast." To some liberals, it is wrong to force low-income families off transfer and into the labor market. In a debate on work requirements for transfer recipients, Massachusetts Senator Edward Kennedy said, "We cannot throw workers into low-wage, dead-end jobs and expect them to support their families. We cannot force workers into jobs for which they have no skills and expect them to succeed."

58. Discuss reasons why many states have moved from mailing food stamps to recipients to sending electronic debit cards. Has this change increased or decreased the ordeal mechanism associated with food stamps?

ANSWER: The use of electronic debit cards decreases the ordeal mechanism associated with food stamps since there is less social stigma connected with swiping a card than with counting out and paying using food stamps. The intention was probably focused more on reducing the administrative costs of the program than on reducing the ordeal mechanism.

59. Suppose that the government is considering whether to implement a child care subsidy program for lowincome families. (a) Is this child care subsidy different from a wage subsidy to low-income families with children? Assume that all low-income families with children use formal child care in order to work. Explain. (b) Why might the government want to regulate the quality of the child care? What problems might such regulation cause? Explain.

ANSWER: (a) This is indeed equivalent to a wage subsidy. In determining her labor supply, a single mother does not care about her wage per se but rather the wage she could earn in the labor market net of the costs of the child care that she must buy for her children while at work. Consequently, subsidizing child care is equivalent to increasing the wage and thus the slope of the non-transfer budget constraint. (b) The government may want to regulate the child care it subsidizes to ensure that taxpayers are not paying for an inferior service that may be detrimental to the development of the children of single mothers. However, the trade-off associated with such regulation is that by increasing the costs of regulated child care, individuals may be pushed into unregulated forms of child care.

60. Suppose that the government were to allow the definition of poverty to change with the cost of living in different areas to fully offset a difference in cost of living. Discuss the potential moral hazards caused by this change.

ANSWER: The potential moral hazard from this change has to do with the incentives low-income families may now have to live in places with higher costs of living. Before the change, low-income families had an incentive to live in places with lower costs of living since the transfer benefits were not reduced proportionately when they lived in such places. After the change, however, there is no incentive to Copyright Macmillan Learning. Powered by Cognero.

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Chapter 17 live in a region with a low cost of living. If low-income families are mobile, this moral hazard effect could be quite significant. If, however, low-income families are not very mobile, those moral hazard effects from the policy change may be very small.

61. Empirical research shows that the transfer reform of 1996 has lowered transfer rolls without lowering the incomes of single mothers in the United States. Discuss the additional factors one must consider in order to determine whether this reform was successful in terms of raising the well-being of low-income families.

ANSWER: The text outlines four factors. First, although incomes did not fall for all women, they did fall for some. To the extent that society cares in particular about especially low-income families, these costs for a small share of women may exceed the gains from reduced government transfer spending.

Second, although income did not fall, leisure did, which under the standard utility maximization model implies that the mothers were worse off. Third, the reform was passed during an economic expansion; it is unclear how well off low-income families would have been after the reform if it had passed during a hard recession. Finally, the long-term implications of having children in child care instead of in their mother's care are unclear.

62. Suppose the way that a state links the receipt of transfer benefits to attending job-training sessions is being debated. A recent study has found that the job training has little to no effect on the earning prospects of transfer recipients. One politician argues that, for this reason, the job-training requirement should be eliminated. Others aren't so sure. Which group is correct? Explain.

ANSWER: The job-training requirement may serve as an ordeal mechanism. By imposing a cost on the recipients of the transfer, the requirement may prevent high-ability people who would like not to work and to receive transfer from going on transfer because of their higher opportunity costs of time. The requirement may thus be a way of having only those who cannot support themselves selfselect into transfer. In this way, the requirement may be beneficial even if the training itself does not appear to be effective. However, if the job-training program requirement prevents truly low-ability workers from participating, the ordeal mechanism would not be an effective mechanism for targeting low-ability individuals.

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Chapter 18 1. The American Taxpayer Relief Act of 2012: a. made all of the 2001 tax cuts permanent. b. increased the top tax rate from 35 to 39.6%. c. allowed all of the 2001 tax cuts to expire. d. reduced the top tax rate from 39.6 to 35%.

ANSWER: b 2. Which tax is paid by consumers to vendors at the point of sale? a. sales tax b. property tax c. wealth tax d. excise tax ANSWER: a 3. Which tax is paid on the value of assets (e.g., stocks) held by a person or family? a. sales tax b. capital gains tax c. wealth tax d. excise tax ANSWER: c 4. Which tax is an example of a tax on consumption? a. capital gains tax b. individual income tax c. property tax d. excise tax ANSWER: d 5. Which tax is paid by sellers (producers or merchants) on the sales of particular goods, such as cigarettes or gasoline? a. sales tax b. consumption tax c. individual income tax d. excise tax ANSWER: d 6. Which is a fundamental distinguishing feature of individual income taxes compared with payroll taxes? a. Individual income taxes are applied to a more narrowly defined set of income sources. b. Individual income taxes are applied in many cases to the entire income of a family. c. Individual income taxes are the primary means of financing social insurance programs. d. Individual income taxes are applied only on income earned up to a maximum value.

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Chapter 18 ANSWER: b 7. Which tax is paid on individual or household purchases of goods and, sometimes, services? a. wealth tax b. consumption tax c. individual income tax d. capital gains tax ANSWER: b 8. Which tax is based on the value of the estate left behind when a person dies? a. sales tax b. consumption tax c. estate tax d. capital gains tax ANSWER: c 9. Which tax is paid on earnings from selling assets, such as stocks, paintings, and houses? a. sales tax b. consumption tax c. individual income tax d. capital gains tax ANSWER: d 10. Which is considered to be a tax on wealth? a. capital gains tax b. individual income tax c. property tax d. excise tax ANSWER: c 11. Which tax is paid on individual income from sales of assets? a. excise tax b. estate tax c. sales tax d. capital gains tax ANSWER: d 12. Approximately what proportion of U.S. federal tax revenues comes from corporate taxes? a. 9% b. 20.2% c. 35% Copyright Macmillan Learning. Powered by Cognero.

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Chapter 18 d. 47.9% ANSWER: a 13. The type of tax that yields the highest amount of revenue to all U.S. governments—federal, state, and local combined—is the _____ tax. The tax that yields the second-highest amount is the _____ tax. The tax that yields the least amount of revenue is the _____ tax. a. payroll; individual income; wealth b. payroll; individual income; corporate c. individual income; payroll; corporate d. individual income; consumption; wealth ANSWER: c 14. Which statement about taxation in the United States is TRUE? a. Subnational governments rely more on sales and property taxes than does the federal government. b. Subnational governments rely more on individual income taxes than does the federal government. c. Subnational governments rely less on wealth taxes than does the federal government. d. Subnational governments rely less on property taxes than does the federal government.

ANSWER: a 15. Approximately what percentage of federal government revenue comes from individual income taxes? a. 4.2% b. 5.5% c. 38.8% d. 46.1% ANSWER: d 16. Which statement is TRUE? a. Less developed countries get a larger proportion of their tax revenues from wealth taxes than any other type of tax. b. Other OECD countries depend more heavily on consumption taxes than does the United States. c. Other OECD countries depend more heavily on wealth taxes than does the United States. d. Other OECD countries depend more heavily on income taxes than does the United States.

ANSWER: b 17. Which is a fixed amount that a taxpayer can deduct from taxable income? a. an itemized deduction b. a standard deduction c. a tax credit d. an exemption ANSWER: b 18. Suppose here is a 20% tax on the first $15,000 of income, a 30% tax on income above $15,000 until Copyright Macmillan Learning. Powered by Cognero.

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Chapter 18 $30,000, and a 40% tax on all income above $30,000. What is the average tax rate for someone making $35,000? a. 14.29% b. 20% c. 27.1% d. 31.7% ANSWER: c 19. A tax system in which average tax rates fall as income rises is a _____ tax system; the way in which the average tax rate changes as income rises is a measure of _____ equity. a. regressive; vertical b. regressive; horizontal c. progressive; vertical d. progressive; horizontal ANSWER: a 20. Which CANNOT be subtracted from gross income as a deduction? a. contributions to retirement savings accounts b. reimbursed employee expenses c. contributions to health savings accounts d. interest paid on student loans ANSWER: b 21. Which fixed amount can a taxpayer subtract from adjusted gross income for each dependent member of the household as well as for the taxpayer and their spouse? a. an itemized deduction b. a standard deduction c. a tax credit d. an exemption ANSWER: d 22. Which item enables taxpayers to reduce the taxes they owe to the government through spending, for example, on child care? a. itemized deduction b. standard deduction c. tax credit d. exemption ANSWER: c 23. In 2020, the lowest tax rate on taxable income was _____%, whereas the highest tax rate on taxable income was _____%. a. 0; 43 Copyright Macmillan Learning. Powered by Cognero.

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Chapter 18 b. 0; 35 c. 10; 37 d. 10; 43 ANSWER: c 24. Suppose that Dafydd owes $4,000 in income taxes but manages to reduce that amount by $2,000 because he paid college tuition that year. The subtraction of $2,000 is a(n): a. tax credit. b. standard deduction. c. exemption. d. withholding.

ANSWER: a 25. Suppose there is a 20% tax on the first $15,000 of taxable income, a 30% tax on taxable income above $15,000 until $30,000, and a 40% tax on all taxable income above $30,000. There is a $3,000 exemption per person. What is the marginal tax rate for a single mother making $35,000 who has one child? a. 20% b. 30% c. 31.7% d. 40% ANSWER: b 26. Which was a result of President Trump's tax overhaul bill that he signed into law in 2017? a. The income threshold for families having to pay the alternative minimum tax (AMT) rate increased. b. All of the 2001 tax cuts were made permanent. c. The top tax rate increased from 35 to 39.6%. d. The corporate tax rate increased from 21 to 35%.

ANSWER: a 27. Suppose there are two people in a society. The federal tax law states that the first $20,000 of income is taxed at 10% and income above that is taxed at 30%. The federal government allows taxes paid to local governments to be deducted. George earns a gross income of $40,000, and Jorge earns a gross income of $65,000. Out of his income, George pays $1,000 in local taxes; out of his income, Jorge pays $20,000 in local taxes. Which statement is TRUE? a. George's total tax bill, including both local and federal taxes, is greater than Jorge's total tax bill. b. The federal tax system is proportional. c. The federal tax system is progressive. d. The federal tax system is regressive.

ANSWER: d 28. The deduction of which item is hardest to justify on ability-to-pay grounds? a. high medical expenditures Copyright Macmillan Learning. Powered by Cognero.

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Chapter 18 b. property and casualty losses c. state and local tax payments d. child care expenses ANSWER: c 29. The Haig-Simons comprehensive income definition defines taxable resources as: a. income earned from participating in the labor market. b. the increase in an individual's wealth. c. an individual's actual consumption for the year. d. an individual's potential annual consumption.

ANSWER: d 30. There is a 50% income tax in a society with only two individuals. Both individuals have pre-tax incomes of $50,000. In period 1, there is no tax deduction, and Harry gives $5,000 to charity, whereas Sally gives $8,000 to charity. In period 2, the government makes charitable donations tax deductible, and Harry gives $6,000 and Sally gives $12,000. The marginal impact of the tax break was $_____; the inframarginal impact of the tax break was $_____. a. 2,500; 13,000 b. 2,500; 6,500 c. 5,000; 13,000 d. 5,000; 6,500 ANSWER: d 31. Which consideration BEST characterizes the justification for deducting some or all of the cost of business lunches as a deviation from the Haig-Simons comprehensive income definition? a. externality considerations b. ability-to-pay considerations c. cost-of-earning-income considerations d. imperfect-information considerations ANSWER: c 32. Which is equal to government revenue losses attributable to tax law provisions that allow special exclusions, exemptions, or deductions from gross income or that provide a special credit, preferential tax rate, or deferral of liability? a. tax deductions b. tax expenditures c. tax credits d. withholding ANSWER: b 33. The most cost-efficient tax breaks have large _____ impacts and small _____ impacts. a. inframarginal; supermarginal Copyright Macmillan Learning. Powered by Cognero.

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Chapter 18 b. inframarginal; marginal c. marginal; supermarginal d. marginal; inframarginal ANSWER: d 34. There is a 20% tax on the first $15,000 of income, a 30% tax on income above $15,000 until $30,000, and a 40% tax on all income above $30,000. What is the marginal tax rate for someone making $35,000? a. 14.29% b. 20% c. 30% d. 40% ANSWER: d 35. Suppose two people live in a society that has a 25% income tax. Both people have pre-tax income of $40,000. In period 1, there was no tax deduction, Lillian gave $6,000 to charity, and Susie gave $4,000 to charity. In period 2, the government makes charitable donations tax deductible, and Lillian gives $8,000. What amount must Susie give in period 2 so that the marginal impact of the tax break is equal to the inframarginal impact of the tax break? a. $2,000 b. $4,500 c. $6,500 d. $7,000 ANSWER: b 36. Suppose there are two people in a society that has a 50% income tax. Both people have pre-tax incomes of $40,000. In period 1, there was no tax deduction, Lillian gave $6,000 to charity, and Susie gave $4,000 to charity. In period 2, the government makes charitable donations tax deductible, and Lillian gives $8,000 to charity. What amount must Susie give in period 2 so that the marginal impact of the tax break is exactly twice the inframarginal impact of the tax break? a. $7,000 b. $8,000 c. $10,000 d. $12,000 ANSWER: d 37. Which statement about the subsidy for homeownership is TRUE? a. The subsidy mechanism is a tax credit for those who have purchased their home. b. The subsidy is consistent with the Haig-Simons definition of income. c. Empirical research shows that the subsidy causes more people to buy homes. d. The current U.S. tax system does not include the rental value of one's home in taxable income.

ANSWER: d Copyright Macmillan Learning. Powered by Cognero.

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Chapter 18 38. Which statement about the subsidy for homeownership is TRUE? a. The rationale behind the subsidy is that it would allow homeowners to donate more to charitable causes. b. Empirical research suggests that the tax subsidy does not change homeownership rates but rather induces homeowners to spend more on houses. c. The rationale behind the subsidy is that there is a positive externality associated with people buying larger, more expensive houses. d. Empirical research suggests that the home mortgage interest deduction is justified by large positive externalities associated with homeownership.

ANSWER: b 39. Which item was the largest tax expenditure of the federal government in 2020? a. exclusion of pension contributions and earnings, including 401(k) plans b. deductibility of state and local taxes c. exclusion of employer contributions for medical insurance from taxable income d. deductibility of home mortgage interest ANSWER: c 40. Three goals are all considered worthwhile for income tax design, but they cannot be achieved simultaneously. Which is NOT one of those goals? a. marriage neutrality b. the same tax rate for each family c. horizontal equity across families d. a progressive system ANSWER: b 41. A tax system is marriage neutral if: a. married couples pay the same tax amount in taxes as single individuals do. b. the marginal tax rate on income rises as income rises. c. the tax burden on two people is the same whether they are single or married to each other. d. couples are taxed as a family rather than as two individuals.

ANSWER: c 42. According to a 2012 report on tax-paying couples, _____% of couples pay a marriage penalty, _____% of couples receive a marriage subsidy, and _____% of couples have neither a penalty nor a subsidy. a. 48; 15; 38 b. 38; 15; 48 c. 48; 38; 15 d. 15; 38; 48 ANSWER: c 43. The existence of a marriage tax means that the: Copyright Macmillan Learning. Powered by Cognero.

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Chapter 18 a. marginal tax rate on a secondary earner is higher after marriage, which might reduce the labor supply of secondary earners. b. marginal tax rate on a secondary earner is lower after marriage, which might raise the labor supply of secondary earners. c. average tax rate paid by an individual earning of $100,000 is the same as that of a married couple with a combined income of $100,000. d. each individual faces the same penalty as a result of marriage, regardless of income.

ANSWER: a 44. Which was a result of President Trump's tax bill he signed into law in December 2017? a. It made all of the 2001 tax cuts permanent. b. It increased the top tax rate from 35 to 39.6%. c. It decreased the corporate tax rate from 35 to 21%. d. It reduced the estate tax exemption by half.

ANSWER: c 45. Which was a result of the 2016 bill signed into law by President Obama that impacted Olympians' prize bonuses? a. Prize bonuses are now taxable under federal tax code. b. Prize bonuses are now excludable from taxable income. c. The tax rate for prize bonuses increased so it was closer to capital gains tax rates. d. Approximately half of the prize bonus monies are no longer taxable.

ANSWER: b 46. Which is a result of the changes to the Child Tax Credit that was updated in 2017 as part of the tax reform bill? a. The bill reduced the tax credit per child by half. b. The refundability is capped at $1,400 or 15% of earnings above $2,500. c. The credit now has complete refundability. d. The child tax credit was eliminated from the tax code.

ANSWER: b 47. Which was NOT a conclusion of a comprehensive analysis of the 2017 tax reform bill? a. The richest 1% of Americans would get a break of $33,000. b. The poorest Americans would receive just $40. c. Within a decade, 83% of the benefits of the tax cut would go to the top 1% of Americans. d. Middle-income households receive nearly 90% of the benefits of the tax reform bill.

ANSWER: d 48. Which statement is TRUE? a. Consumption taxes provide a greater portion of national government revenue in all OECD countries than in the United States.

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Chapter 18 b. Income taxes provide a greater portion of national government revenue in all OECD countries than in the United States. c. Consumption taxes provide a smaller portion of national government revenue in all OECD countries than in the United States. d. Consumption taxes provide a nearly equal portion of national government revenue in all OECD countries and the United States.

ANSWER: a 49. On average, the share of tax revenues from consumption taxes in OECD countries is _____ as it is in the United States. a. twice as much b. half as much c. the same d. four times as much ANSWER: a 50. One result of the changes to the tax laws in 2018 was that: a. there was an increase in the share of people taking the standard deduction. b. there was a decrease in the share of people taking the standard deduction. c. itemized deductions were eliminated. d. state and local taxes were no longer deductible.

ANSWER: a 51. Which set of relative values is TRUE for most taxpayers? a. gross income > adjusted gross income > taxable income b. gross income < adjusted gross income < taxable income c. gross income > taxable income > adjusted gross income d. gross income > adjusted gross income = taxable income ANSWER: a 52. Which is an example of a tax credit? a. paying for the educational expenses of a family member b. gifts to charities c. state income taxes paid d. contributions to a retirement fund ANSWER: a 53. Which is an example of a deduction? a. gifts to charity b. expenses for caring for a dependent c. educational expenses for a dependent Copyright Macmillan Learning. Powered by Cognero.

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Chapter 18 d. hiring a veteran ANSWER: a 54. Which statement is TRUE? a. A pool tax is more regressive than property taxes. b. A pool tax is less regressive than property taxes. c. A poll tax is a charge for voting in an election. d. The amount of a poll tax is adjusted for a person's income.

ANSWER: a 55. _____ is the principle that groups with more resources should pay higher taxes than groups with fewer resources. a. Vertical equity b. Horizontal equity c. Tax fairness d. Gini equity ANSWER: a 56. _____ is the principle that similar individuals who make different economic choices should be treated similarly by the tax system. a. Vertical equity b. Horizontal equity c. Tax fairness d. Gini equity ANSWER: b 57. What is the rationale behind subsidizing homeownership? Does the empirical research support this rationale?

ANSWER: The rationale behind homeownership subsidies is the large positive externalities associated with homeownership. Indeed, Glaeser and Shapiro (2002) wrote, "To its supporters, the home mortgage interest deduction is the cornerstone of American society. Homeownership gives people a stake in society and induces them to care about their neighborhoods and towns. By subsidizing property ownership, the deduction induces people to invest and then to have a stake in our democracy.

Ownership makes people vote for long-run investments instead of short-run transfers."

They also reviewed existing studies that examine these positive externalities and concluded that relative to renting, homeownership is positively correlated with political activism and social connection, and homeowners take better care of their properties, leading to a higher property values.

The empirical studies, however, suffer from potential bias and do little to convince researchers that large positive externalities result from homeownership.

58. (a) What is the rationale behind allowing people to deduct charitable giving from their taxable income? (b) What are the two reasons given in the text that the government does not simply provide the charitable good itself? Explain.

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Chapter 18 ANSWER: (a) The rationale behind making charitable donations tax deductible is an externality/public goods rationale. Because of the free rider problem when costs are private but benefits are public, the private market is likely to underprovide charitable support for many public goods. To induce more private giving, the government may allow people to deduct those contributions, thus lowering the price of charitable giving relative to other consumption. (b) The first reason that tax subsidies may be superior to direct public provision is that direct public provision of the public good may crowd out private contributions. In contrast, when the tax code subsidizes charitable giving, it can increase private contributions through both the substitution effect and the income effect.

Second, when the government provides spending directly, it imposes its preferences on how the funds are spent. By offering tax subsidies to private people to donate as they wish, the government directly respects the preferences of its citizens.

59. Compare and contrast tax deductions and tax credits in terms of both efficiency and vertical equity.

ANSWER: The trade-off that the government faces is between a system that subsidizes all giving partially (the deduction) and one that subsidizes some giving fully and some not at all (the credit). The policy that is more efficient is dictated by two considerations. The first is the nature of the demand for the subsidized good. For some goods, individual demand may be very elastic in response to large reductions in the price but not very elastic in response to small reductions in price; in such cases, credits may cause a larger increase in one behavior than deductions since credits lead to larger reductions in price. Second, policy makers must decide how important it is to achieve some minimal level of the behavior. With some behaviors, however, the government may want to subsidize some minimal level of provision but not subsidize a particularly generous provision.

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Chapter 19 1. The MOST significant change in the tax code of the Tax Cuts and Jobs Act of 2017 was: a. a large reduction in the corporate tax rate. b. an increase in the child tax credit. c. a decrease in the average income tax rate. d. the elimination of the federal sales tax.

ANSWER: a 2. Evidence suggests that the corporate tax cut included in the Tax Cuts and Jobs Act of 2017 had _____ on workers' income. a. a large effect b. little to no effect c. a negative effect d. a moderate effect ANSWER: b 3. The International Monetary Fund calculated that _____% of higher corporate profits as a result of the Tax Cuts and Jobs Act of 2017 went to dividend payments and share buybacks. a. 20 b. 40 c. 60 d. 80 ANSWER: d 4. Statistics show that business investment was 4.5% higher a year after the corporate tax cuts included in the Tax Cuts and Jobs Act (TCJA) came into effect. What is the primary challenge of using this statistic? a. The economy was growing over the same time period, so it is difficult to attribute this increase to the TCJA. b. Most of the business investment was fueled by capital inflows and trade deficits. c. Much of the business investment may have been pre-planned and thus predated the change in the corporate tax rate. d. Much of the business investment was by foreign corporations who were not eligible for the lower tax rate.

ANSWER: a 5. Tax incidence focuses on who: a. has the most elastic demand. b. has the most inelastic supply. c. bears the economic burden of a tax. d. bears the statutory or legal burden of a tax.

ANSWER: c 6. Which statement regarding the source of federal government tax receipts from 1960 to 2016 is TRUE? Copyright Macmillan Learning. Powered by Cognero.

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Chapter 19 a. The share of revenues coming from the individual income tax has risen significantly. b. The share of revenues coming from payroll taxes has risen significantly. c. The share of revenues coming from the corporate income tax has risen significantly. d. The share of revenues coming from each type of tax has remained unchanged.

ANSWER: b 7. Suppose the pre-tax price of cigarettes is $3 per pack and the post-tax price is $4 per pack. The tax is $1.50 per pack and is paid by the retailers of cigarettes to the government. Prior to the tax, 600 packs were sold; after the tax, 500 packs were sold. What is the consumer tax burden per pack of cigarettes? a. $1 b. $1.50 c. $2.50 d. $3 ANSWER: a 8. Suppose the pre-tax price of cigarettes is $3.00 per pack and the post-tax price is $4.00 per pack. The tax is $1.50 per pack and is paid by the retailers of cigarettes to the government. Six hundred packs were sold prior to the tax increase; 500 packs were sold after the tax. What is the statutory incidence of the tax on consumers? a. $0 b. $1 c. $1.50 d. $150 ANSWER: a 9. Suppose the pre-tax price of gasoline is $1 per gallon. A tax of $0.50 is imposed and is paid by consumers to the government. What must the market price of gasoline be after the tax so that the consumer tax burden is equal to the producer tax burden? a. $0.50 b. $0.75 c. $1.00 d. $1.25 ANSWER: b 10. The difference between what consumers pay and what producers receive (net of tax) from a transaction is called the: a. statutory incidence. b. tax wedge. c. tax incidence. d. producer burden.

ANSWER: b 11. Suppose the pre-tax price of gasoline is $1 per gallon. A tax of $1.50 is imposed and is paid by producers to Copyright Macmillan Learning. Powered by Cognero.

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Chapter 19 the government. What must the post-tax price of gasoline be in order for the consumer tax burden to be equal to one-half of the tax wedge? a. $1 b. $1.25 c. $1.75 d. $2.25 ANSWER: c 12. Which statement is TRUE regarding a $1 per gallon tax on gasoline? a. The consumer tax burden is greater when the tax is imposed on consumers. b. The consumer tax burden is greater when the tax is imposed on the producers. c. The producer tax burden is the same no matter on whom the tax is imposed. d. The producer tax burden depends both on whom the tax is imposed and on the demand and supply elasticities.

ANSWER: c 13. Which statement is TRUE regarding a $1 per gallon tax on gasoline imposed on consumers? a. It shifts the supply of gasoline to the left. b. It shifts the supply of gasoline to the right. c. It shifts the demand for gasoline to the left. d. It shifts the demand for gasoline to the right.

ANSWER: c 14. Which statement is TRUE regarding a $1 per pack tax on cigarettes that is imposed on producers? a. It shifts the supply of cigarettes to the left. b. It shifts the supply of cigarettes to the right. c. It shifts the demand for cigarettes to the left. d. It shifts the demand for cigarettes to the right.

ANSWER: a 15. Suppose the pre-tax price of cigarettes is $3.00 per pack and the post-tax price is $4.00 per pack. The tax is $1.50 per pack and is paid to the government by cigarette retailers. Six hundred packs were sold prior to the tax increase; 500 were sold after the tax. What is the producer tax burden per pack of cigarettes? a. $0.50 b. 100 packs c. $150 d. $1.50 ANSWER: a 16. Suppose the government were to impose a $3 tax on high-speed Internet connections. The law states that $2 per connection is to be paid to the government by the producer and the remaining $1 to be paid by the consumer. Which statement regarding the tax is TRUE? Copyright Macmillan Learning. Powered by Cognero.

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Chapter 19 a. It shifts the supply curve of high-speed Internet connections to the left. b. It shifts the supply curve of high-speed Internet connections to the right. c. It shifts the demand curve for high-speed Internet connections to the right. d. It does not shift either the supply curve or the demand curve.

ANSWER: a 17. Suppose the pre-tax price of gasoline is $1 per gallon. An imposed tax of $0.50 per gallon is paid by producers to the government, increasing the price of gasoline to $1.30 per gallon. The gross price after the tax is $_____; the after-tax price is $_____. a. 1.30; 0.80 b. 1.30; 1.80 c. 1.80; 1.30 d. 1.80; 0.80 ANSWER: a 18. All things equal, producers bear more of a tax when supply is _____. All things equal, consumers bear more of a tax when demand is _____. a. unit elastic; unit elastic b. elastic; elastic c. inelastic; inelastic d. elastic; inelastic ANSWER: c 19. A tax levied on producers is fully shifted to consumers when: a. demand is perfectly elastic. b. demand is perfectly inelastic. c. supply is perfectly inelastic. d. supply and demand are both relatively elastic.

ANSWER: b 20. All other things equal, consumers bear more of a tax as demand becomes more _____ and supply becomes more _____. a. unit elastic; unit elastic b. elastic; elastic c. inelastic; inelastic d. inelastic; elastic ANSWER: d 21. A tax levied on producers is fully borne by producers when: a. demand is perfectly inelastic. b. supply is perfectly elastic.

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Chapter 19 c. supply is perfectly inelastic. d. supply and demand have the same elasticity coefficients.

ANSWER: c 22. Which statement related to elasticity and tax incidence is NOT true? a. For products with an inelastic demand, the burden of the tax is borne almost entirely by the consumer. b. For products with an inelastic supply, the burden of the tax is borne almost entirely by the producers. c. For products with an elastic demand, the burden of the tax is borne almost entirely by the producers. d. Parties with elastic demand or supply bear taxes; parties with inelastic demand or supply avoid them.

ANSWER: d 23. Which statement is TRUE? a. In labor markets, workers always bear the full burden of a tax. b. In labor markets, workers bear the full burden of a tax only when the tax is levied on workers. c. In labor markets, workers bear more of the burden of a payroll tax if labor supply is highly inelastic. d. Tax incidence is based on which party has the legal obligation to pay a tax.

ANSWER: c 24. In a labor market in which demand is perfectly elastic and supply is neither perfectly elastic nor perfectly inelastic, who bears the tax burden if the statutory incidence is placed on the firms? a. only the workers b. only the firms c. both the workers and the firms, although the workers bear more of the tax d. both the workers and the firms, although the firms bear more of the tax ANSWER: a 25. What information must be known to determine the tax burdens on firms and workers for a tax on labor? a. the relative elasticities of labor demand and labor supply b. the percentage of the statutory burden placed on employers c. the percentage of the statutory burden placed on workers d. how the statutory burden of the tax is divided between employers and workers ANSWER: a 26. Suppose the wage of unskilled workers is equal to the minimum wage. If a tax on labor is levied on _____, the presence of the minimum wage _____. a. workers; does not affect the tax burden of workers b. workers; reduces the tax burden of workers c. firms; reduces the tax burden of firms d. firms; does not affect the tax burden of firms ANSWER: a Copyright Macmillan Learning. Powered by Cognero.

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Chapter 19 27. Which rule related to the economic tax incidence is NOT true? a. The statutory burden generally does not describe who really bears the tax. b. If there are impediments to reducing wages, such as a minimum wage, firms are more likely to bear the burden of a tax on earnings. c. The incidence of taxation on producers and consumers is ultimately determined by the elasticities of supply and demand in most cases. d. When there are barriers to reaching the competitive market equilibrium, the side of the market on which the tax is levied does not matter.

ANSWER: d 28. Balanced budget incidence takes into account: a. the tax burden and the benefits of the spending financed out of the tax revenues. b. the extent to which the tax helps balance the federal budget. c. the benefits received by taxpayers when the federal government's budget is balanced. d. whether the business firms being taxed are perfectly competitive or monopolists.

ANSWER: a 29. The incidence on consumers of a tax on gambling, in which tax revenues are spent on public education, would be _____ under a balanced budget incidence analysis. a. higher b. lower c. the same d. equal to zero ANSWER: b 30. Economists support an increase in the gas tax for each of these reasons EXCEPT: a. balanced budget tax incidence shows that drivers benefit from the higher gas tax, as most of this money is spent on road infrastructure. b. an increase in the gas tax would likely lead to fewer cars on the road, reducing traffic. c. the incidence of a higher gas tax would primarily fall on producers, who have significant excess profits. d. an increase in the gas tax would likely lead toward substitution to low or zero emission vehicles, slowing climate change.

ANSWER: c 31. In a labor market in which demand is perfectly elastic and supply is perfectly inelastic, who bears a tax levied on the firms? a. only the workers b. only the firms c. both the workers and the firms, although the workers bear more of the tax d. both the workers and the firms, although the firms bear more of the tax ANSWER: a Copyright Macmillan Learning. Powered by Cognero.

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Chapter 19 32. If a tax on labor is levied on workers, the gross wage will _____, and the after-tax wage will _____, assuming that supply and demand are neither perfectly elastic nor perfectly inelastic. a. fall; fall b. fall; rise c. rise; rise d. rise; fall ANSWER: d 33. In a labor market in which demand is inelastic, but not perfectly inelastic, and supply is elastic, but not perfectly elastic, who bears a tax levied on the firms? a. only the workers b. only the firms c. both the workers and the firms, although the workers bear more of the tax d. both the workers and the firms, although the firms bear more of the tax ANSWER: d 34. Suppose the government were to tax all car wash businesses in town. Assume that the demand for car washes is perfectly elastic, the supply of car wash employees is perfectly elastic in the short run, and the supply and demand of capital (i.e., the car wash equipment) are elastic, but not perfectly so, in the short run and perfectly elastic in the long run. According to general equilibrium tax incidence analysis, _____ bear the tax in the short run, and _____ bear the tax in the long run. a. car wash employees; capital owners b. landowners and capital owners; landowners c. capital owners; landowners and capital owners d. landowners and capital owners; landowners and capital owners ANSWER: b 35. Suppose the government levies a tax on all computers sold in the United States. Assume that all goods are normal goods. Which of these results is a spillover complementary effect of the tax? a. People buy fewer computers because they are now more expensive. b. People buy fewer computers because people have less income. c. People buy more books because they spend less money on computers. d. People buy fewer computer printers because of the tax.

ANSWER: d 36. Suppose a tax is imposed on the producers of kitchen tables. Assume that demand for kitchen tables is perfectly elastic and that the supply is elastic but not perfectly elastic. The tables are produced in a factory using capital equipment (e.g., lathes) and labor. The supply of labor is perfectly elastic, and the supply of capital equipment is inelastic in the short run. In the short run, partial equilibrium tax incidence analysis suggests that _____ bear the tax; general equilibrium tax incidence analysis suggests that _____ bear the tax. a. consumers; table factories b. table factories; table factories Copyright Macmillan Learning. Powered by Cognero.

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Chapter 19 c. consumers; capital owners d. table factories; capital owners ANSWER: d 37. Which piece of information is necessary for general equilibrium tax incidence analysis but not for partial equilibrium tax incidence analysis? a. the elasticity of demand for the product b. the elasticity of supply of the inputs used to make the product c. the percentage of the tax that consumers are required to pay d. the percentage of the tax that producers are required to pay ANSWER: b 38. Suppose a city's government is considering levying a tax on all commercial car washes within the city limits. The state government is also considering levying a tax on all commercial car washes in the state. In the short run, consumers bear _____ of the tax burden under the local tax than under the state tax. In the long run, car wash employees bear _____ of the tax burden under the local tax than under the state tax. a. more; less b. more; more c. less; more d. less; less ANSWER: d 39. Suppose the government levies a tax on all ink pens sold in the country. Assume all goods are normal goods. Which is a spillover complementary effect of the tax? a. People buy fewer pencils because they have less income. b. People buy less paper as a result of the tax. c. People buy more pencils because pencils are now cheaper compared with pens. d. People buy more ink pens because sellers bear the tax.

ANSWER: b 40. In the long run, general equilibrium tax incidence analysis suggests which factor of production in general bears the greatest burden of a tax? a. land b. labor c. capital d. entrepreneurial ability ANSWER: a 41. Suppose the government levies a tax on all ink pens sold in the country. Assume all goods are normal goods. Which is a spillover income effect of the tax? a. People buy more pencils because they have less after-tax income. b. People buy fewer books because they have less after-tax income.

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Chapter 19 c. People buy more pencils because pencils are now cheaper compared with pens. d. People buy more ink pens because sellers bear the tax.

ANSWER: b 42. The average incidence of a tax can mask considerable differences in underlying price elasticity. For example, for a product that is taxed at the state level, such as cigarettes, Harding et al. (2012) found that the shifting of taxes to prices _____ the further one is from a state border. a. increases b. decreases c. remains the same d. first increases, then decreases ANSWER: a 43. A study by Hansen et al. (2017) found that in markets in which regulated firms compete against an underground market (e.g., marijuana), consumers are highly _____, meaning little of the incidence of the tax falls on consumers. a. price inelastic b. price elastic c. perfectly price inelastic d. unit price elastic ANSWER: b 44. A study by Bradley and Feldman (2020) found that the incidence on consumers of airline taxes _____ when companies were required to include the taxes in the prices of posted tickets. a. remained the same b. rose c. fell d. could not be determined ANSWER: c 45. What does the Congressional Budget Office assume with respect to the tax incidence of corporate taxes? a. Consumers of the corporations' products bear the entire tax burden. b. Consumers of the corporations' products bear half the tax burden, and the owners of capital bear half the tax burden. c. Employees at the corporation bear half the tax burden, and the owners of the capital bear half the tax burden. d. Employees at the corporation bear 20% of the tax burden, and the owners of the capital bear 80% of the tax burden.

ANSWER: d 46. Which statement is TRUE? a. Effective excise tax rates have risen for high-income groups over the last 20 years.

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Chapter 19 b. The bottom quintile pays much more in payroll taxes than in income taxes. c. Effective corporate tax rates are higher than effective income tax rates for all households. d. Effective income tax rates have not changed over the last 20 years.

ANSWER: b 47. Which is NOT an assumption of the Tax Policy Center? a. Income taxes are fully borne by the households that pay them. b. Payroll taxes are fully borne by employers. c. Excise taxes are borne by individuals in proportion to their consumption of the taxed item. d. Corporate taxes are borne 20% by workers and 80% by the owners of capital.

ANSWER: b 48. Which condition must be TRUE for the Congressional Budget Office's assumption about the tax incidence of payroll taxes to be correct? a. The payroll tax must be levied only on employers. b. The payroll tax must be levied evenly on employers and employees. c. Labor supply must be inelastic. d. Demand for labor must be inelastic.

ANSWER: c 49. What does the Congressional Budget Office assume with respect to the tax incidence of excise taxes? a. Producers bear the entire tax burden. b. Consumers bear the entire tax burden. c. Producers and consumers each bear part of the tax burden. d. The owners of the capital used to produce the taxed goods bear all of the tax burden.

ANSWER: b 50. According to analysis by the Urban Institute's Tax Policy Center, which statement related to the effective tax rates by income group for the last half century is NOT true? a. The total average tax rate on the bottom quintile fell sharply in the recession to only 1.1%. b. The average tax rate on the top quintile was 26% in 2017. c. Average corporate tax rates are small relative to income and payroll tax rates. d. Average excise tax has fallen for the bottom of the income distribution while rising for the top.

ANSWER: d 51. Which is NOT true regarding incidence of taxes in the United States in 2017? a. Households in the bottom quintile were net recipients, rather than payees, of income tax funds. b. Households in the bottom quintile had the highest effective payroll tax rate. c. Households in the top quintile had the highest effective corporate tax rate. d. Households in the top quintile had the highest effective excise tax rate.

ANSWER: d Copyright Macmillan Learning. Powered by Cognero.

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Chapter 19 52. What proportion of energy taxes are estimated to pass on to consumers through higher energy prices? a. 0% b. 30% c. 70% d. 100% ANSWER: c 53. Which is NOT a real-world complication to determining the incidence of taxation? a. variation in consumer preferences b. differential tax evasion c. imperfect competition d. variation in excise tax rates ANSWER: a 54. In some countries, such as the United States, sales tax is added at the point of sale, whereas in other countries, such as Germany, it is more common for the sales tax to be included in the posted price. All else equal, these different methods of presenting sales tax would lead to a _____ incidence of the tax on consumers in Germany relative to the United States. a. lower b. higher c. similar d. variable ANSWER: a 55. The major reason why research finds that prices rise less when taxes are levied on a retailer than a wholesaler of a product is that: a. wholesalers face less market competition and are able to remain competitive with price increases. b. retailers are more able to spread the cost of taxes across a variety of products. c. there is often only a single wholesaler in a product market, giving the firm monopoly power. d. retailers are more able to cheat and avoid tax payments.

ANSWER: d 56. Which is NOT a real-world complication to determining the incidence of taxation? a. variation in excise tax rates b. formal market competition with illegal markets c. imperfect competition d. perfectly inelastic demand or supply ANSWER: d 57. What proportion of marijuana taxes are estimated to pass on to consumers through higher marijuana prices? a. 0% Copyright Macmillan Learning. Powered by Cognero.

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Chapter 19 b. less than 50% c. about 65% d. 100% ANSWER: b 58. What is the rationale for taxing the consumption of college students, who are typically low-income? a. Low-income college students are projected to have high lifetime earnings, which makes the tax progressive. b. College students tend to spend more money on entertainment rather than necessity goods. c. College students have very inelastic demands for most goods, thus taxing them raises large amounts of revenue. d. Low-income college students are projected to have high lifetime earnings, which makes the tax regressive.

ANSWER: a 59. Why don't marijuana taxes completely pass through to consumers through higher marijuana prices? a. Tax rates vary dramatically across regional markets. b. Consumers' demand for marijuana is very price elastic. c. Marijuana laws are changing drastically across the country. d. Supply is perfectly inelastic in this market.

ANSWER: b 60. Suppose that a monopolist has a cost function given by C(q) = 20 + 4q + 2q2. The (inverse) demand for the product is given by P(q) = 40 − q. What is the market quantity and price? a. quantity = 6; price = $34 b. quantity = 7; price = $33 c. quantity = 30; price = $10 d. quantity = 9; price = $31 ANSWER: a 61. Suppose that a monopolist has a cost function given by C(q) = 20 + 4q + 2q2. The (inverse) demand for the product is given by P(q) = 40 − q. The government levies a tax of $6 per unit, to be paid to the government by the monopolist. What is the new market price and quantity? a. quantity = 6; price = $34 b. quantity = 7; price = $33 c. quantity = 10; price = $10 d. quantity = 5; price = $35 ANSWER: d 62. Suppose that a monopolist has a cost function given by C(q) = 20 + 4q + 2q2. The (inverse) demand for the product is given by P(q) = 40 − q. The government levies a tax of $6 per unit, to be paid to the government by the monopolist. How much of the tax do the consumers bear?

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Chapter 19 a. $0 b. $1 c. $5 d. $6 ANSWER: b 63. Suppose that a monopolist has a cost function given by C(q) = 20 + 4q + 2q2. The (inverse) demand for the product is given by P(q) = 40 − q. The government levies a tax of $6 per unit, to be paid to the government by the monopolist. How much of the tax does the monopolist bear? a. $0 b. $1 c. $5 d. $6 ANSWER: c 64. Discuss how the sources of federal government revenue evolved in the past half century. Can the change be regarded as an equitable shift in the burden of taxation?

ANSWER: In 1960, 23% of federal taxes was collected from corporations, and 61.5% was collected from individuals through income and payroll taxes. Today, 6% is collected from corporations, and 83% is collected from individuals. Income taxes remain virtually the same, and payroll taxes increased from 17% to more than 37%, whereas corporate taxes shrank from approximately 23 to 6%. The question related to equitable change in the burden is hard to answer. When we study tax incidence, we are always comparing taxes collected from one set of people to taxes collected from another set. This comparison makes the issue of figuring out who bears the burden of a tax less clear than if we view it simply as a matter of pitting rich corporations against poor individuals.

65. Recall that Social Security is funded through payroll taxes levied on both employers and employees.

Suppose a politician were to state that since large corporations can better afford paying such taxes, the payroll tax levied on employees should be shifted to employers. Would this change cause the economic burden of the tax to be shifted from employees to employers? Explain.

ANSWER: The second rule of tax incidence is that the side of the market on which a tax is imposed is irrelevant to the distribution of the tax burden. The politician has not taken into account the fact that markets react to taxation. For that reason, the economic incidence of a tax, as measured by the change in the resources available to any economic agent as a result of the taxation, does not depend on whether the tax is levied on consumers or producers (employers or employees in this case). Changing the statutory burden of the tax does not change the economic burden of the tax.

66. Is it possible for the government to impose a tax that causes the market price of the good to fall? Explain why it is or is not possible.

ANSWER: Yes, it is possible, if the government levies the tax on consumers. In that case, the demand curve for the product shifts to the left, causing the market price, or gross price, of the product to fall.

However, in addition to paying the price to the sellers, the consumer must also make a payment to the government. Consequently, although the market price falls, the after-tax price faced by consumers rises to the extent that there is a consumer tax burden. In general, the after-tax price will be higher than the pre-tax market price when consumer demand is not perfectly elastic.

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Chapter 19 67. Suppose that the demand for apples is perfectly elastic and the government levies a tax on apple producers.

Assume that the supply of apples is neither perfectly elastic nor perfectly inelastic. (a) How will the price paid by consumers change? Is this change bigger or smaller than the price change that would result if the demand for apples were not perfectly elastic? (b) How will the quantity of apples consumed change because of the tax? Is this change in quantity larger or smaller than the change that would result if the demand for apples were not perfectly elastic? (c) Explain the significance of the answers in both part (a) and part (b) in terms of how the tax affects the welfare of consumers in the apple market.

ANSWER: (a) The price paid by consumers will not change at all. If the demand for apples is perfectly elastic, it means that consumers have perfect substitutes for apples and will buy another product (and be no worse off) if the price goes up at all. Consequently, apple producers bear the entire burden of the tax. In contrast, if the demand for apples were not perfectly elastic, the price paid by consumers would rise, and, consequently, the consumers would bear some of the tax burden. (b) The quantity of apples will fall sharply. If the demand for apples were neither perfectly elastic nor perfectly inelastic—and if supply were neither perfectly elastic nor perfectly inelastic—then the quantity would fall but by less than it falls when the demand for apples is perfectly elastic. (c) Only price changes caused by the tax affect the welfare of the consumers in the market. Since in this case the price paid by consumers does not change, consumers are made no better or worse off because of the tax, even though they consume fewer apples. The reason for this is that the perfectly elastic demand curve for apples implies that consumers are indifferent between consuming apples at that price and consuming other goods at that price. Consequently, although people shift consumption to another good, they are no better or worse off for it.

68. Suppose that Jean is an unskilled worker who is making the market wage of $5 per hour and that the market for unskilled labor is competitive. Suppose further that the government is proposing to increase a payroll tax to fund changes to Social Security and is debating whether to levy the tax on employers or workers. (a) Assume there is no minimum wage. If Jean could lobby the government, what position should she take regarding whether the tax should be levied on employers or employees? Explain. (b) Would a $5.15-per-hour minimum wage change Jean's position? Why or why not?

ANSWER: (a) Jean should be indifferent. The second rule of tax incidence states that the side of the market on which the tax is levied does not affect tax incidence. (b) Jean should indeed change her position. If the tax is levied on workers, the pre-tax wage will rise —the exact amount depends on the elasticities of supply and demand—and the after-tax wage will fall. However, if the tax is levied on the firms who hire the workers, the minimum wage means that they will be unable to lower the wage. Consequently, firms will bear all of the tax. Since Jean would prefer to have her employer bear the tax, she should lobby the government to levy the tax on employers.

69. Suppose that a monopolist has a cost function given by C(q) = 10 + 2q + 0.5q2. The (inverse) demand for the product is given by P(q) = 47 − q. (a) What is the original market quantity and price? (b) The government levies a tax of $9 per unit, to be paid to the government by the monopolist. What is the new market price and quantity? (c) How much of the tax do the consumers bear? How much does the monopolist bear?

ANSWER: (a) Marginal cost is given by MC(q) = 2 + q. Total revenue is given by TR(q) = q(47 − q) = 47q − q2. Marginal revenue is thus given by MR(q) = 47 − 2q. Setting marginal revenue equal to marginal Copyright Macmillan Learning. Powered by Cognero.

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Chapter 19 cost, q = 15, and the price is $32. (b) The firm's cost function is now given by C(q) = (10 + 2q + 0.5q2) + 9q = 10 + 11q + 0.5q2 since it must pay an additional $9 in tax for each unit it produces. Setting marginal cost equal to marginal revenue, one finds that q = 12 and p = $35. (c) Consumers pay $3 more than they did prior to the tax, and so they bear $3 of the $9 tax. The monopolist used to receive a price of $32. Now it receives a price of $35 but pays the government $9 of that, so the monopolist bears $6 of the $9 tax.

70. Why is general equilibrium analysis called a game of follow the tax burden?

ANSWER: General equilibrium analysis does not stop with the effects on the market in which a particular tax is imposed but instead continues to all of the other markets that are related. The goal is to discover who ultimately bears the tax burden.

71. In the United States, there is a lot of variation in how cigarettes are taxed across different states. The excise tax on cigarettes varies from a low of 17¢ per pack in Missouri to a high of $4.35 per pack in New York.

Explain how this variation in taxation allows for quasi-experimental estimation of the impact of excise taxes on product prices.

ANSWER: Analysts can compare the change in the price of cigarettes in states raising their excise tax—the treatment group—relative to states not changing their excise tax—the control group—to measure the effect of each 1¢ rise in excise taxes on prices. Higher prices resulting from an increase in the tax are unlikely to be correlated with higher prices resulting from other factors. Recent studies reported that about 85% of the tax increases were passed to consumers in the form of higher prices, which is consistent with other studies that have estimated a highly inelastic demand for cigarettes.

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Chapter 20 1. Assuming there are no market failures, what is the effect on the market when participants are taxed? a. The market moves closer to the competitive equilibrium, thereby reducing social efficiency. b. The market moves closer to the competitive equilibrium, thereby enhancing social efficiency. c. The market moves away from the competitive equilibrium, thereby reducing social efficiency. d. The market moves away from the competitive equilibrium, thereby enhancing social efficiency.

ANSWER: c 2. What does it mean to say markets do not take taxes lying down? a. While taxes improve economic efficiency, they negatively affect equity. b. Market participants neutralize the impact of taxation by altering their consumption and production patterns. c. If there is some action that market participants can undertake to minimize the burden of a tax, they will do so. d. Taxes enable governments to raise revenues without adverse effects on the economy.

ANSWER: c 3. Deadweight loss is determined by changes in _____ when a tax is imposed. a. prices b. quantities c. government revenues d. vertical equity ANSWER: b 4. Assume a market is initially in equilibrium. If the good or service traded in that market is then taxed, the: a. deadweight loss is greater when the tax is levied on consumers than when it is levied on producers. b. deadweight loss is greater when the tax is levied on producers than when it is levied on consumers. c. social marginal benefit of consumption exceeds the social marginal cost of production. d. social marginal cost of production exceeds the social marginal benefit of consumption.

ANSWER: c 5. The _____ surplus in a market _____ as price falls and more units are sold. a. consumer; does not change b. consumer; increases c. producer; does not change d. producer; increases ANSWER: b 6. The deadweight loss of a tax is larger when: a. the taxed product is produced by a monopolist. b. there is a negative consumption externality. c. there is a negative production externality.

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Chapter 20 d. the demand for the product is perfectly inelastic.

ANSWER: a 7. Suppose that supply in the market for cigarettes is given by QS = 30 + 5P and that demand is given by QD = 48 − P. In the free market equilibrium, the price per pack is $_____, and the quantity bought and sold is _____. a. 3; 30 b. 3; 45 c. 13; 30 d. 13; 45 ANSWER: b 8. Suppose that supply in the market for cigarettes is given by QS = 30 + 5P and that demand is given by QD = 48 − P. If the government imposes a $6 tax on each pack of cigarettes, the quantity bought and sold changes from _____ to _____ packs. a. 30; 25 b. 30; 40 c. 45; 30 d. 45; 40 ANSWER: d 9. Suppose the supply of cigarettes is given by QS = 30 + 5P and that the demand is given by QD = 48 − P. If the government imposes a $6 tax on each pack of cigarettes, the price paid by consumers increases from $_____ to $_____. a. 3; 8 b. 3; 9 c. 13; 21 d. 13; 22 ANSWER: a 10. Suppose that the supply of cigarettes is given by QS = 30 + 5P and that the demand is given by QD = 48 − P. If the government imposes a $6 tax on each pack of cigarettes, the deadweight loss caused by the tax is equal to: a. $10. b. $15. c. $20. d. $30.

ANSWER: b 11. Which statement is TRUE when a good is taxed? a. There is a deadweight loss. b. The new equilibrium quantity is higher than the optimal amount. c. Firms produce more than the optimal amount of the good.

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Chapter 20 d. The price is reduced by the amount of the tax.

ANSWER: a 12. The deadweight loss of a tax is: a. the degree to which the burden of the tax falls on consumers. b. the amount of consumer and producer surplus that society loses by imposing the tax. c. the decline in consumer surplus arising from the tax. d. the amount of tax revenue taken from consumers and producers.

ANSWER: b 13. All else equal, the deadweight loss of a tax on producers is higher when supply is _____. All else equal, the deadweight loss of a tax on producers is higher when demand is _____. a. elastic; elastic b. unit elastic; elastic c. inelastic; inelastic d. elastic; inelastic ANSWER: a 14. Suppose that the elasticities of demand for apples, bananas, and peaches are −0.9, −1.6, and −0.8, respectively. Assume that an identical tax is levied on each good. Rank the products from highest to lowest in terms of the deadweight loss caused by the tax. a. apples, bananas, peaches b. apples, peaches, bananas c. bananas, apples, peaches d. bananas, peaches, apples ANSWER: c 15. When a tax causes deadweight loss: a. some efficient trades are not made. b. only inefficient trades are made. c. the quantity bought and sold is not affected. d. consumers are better off, but producers are worse off.

ANSWER: a 16. The marginal deadweight loss of a tax: a. increases as the tax rate increases. b. decreases as the tax rate increases. c. decreases, then increases, as the tax rate increases. d. increases, then decreases, as the tax rate increases.

ANSWER: a 17. Which statement concerning deadweight loss and the efficiency of a tax system is FALSE? Copyright Macmillan Learning. Powered by Cognero.

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Chapter 20 a. There are large efficiency costs in moving from a progressive to a proportional tax system. b. The more heavily the government taxes one source, the faster deadweight loss rises with a tax increase. c. The more a tax causes output in a market to decrease, the larger is the deadweight loss. d. The efficiency cost of imposing a tax on imperfectly competitive firms is greater than the cost of imposing the same size tax on firms in a perfectly competitive market.

ANSWER: a 18. Suppose a city council is debating how to fund a new junior league sports complex. Assuming a zero interest rate, which would be the MOST efficient way to fund the new complex to minimize deadweight loss? a. a 4% sales tax imposed over five years b. a 1% sales tax imposed over 20 years c. a 5% sales tax imposed over four years d. a 20% sales tax collected in the current year ANSWER: b 19. What is the rule for optimal commodity taxation? a. setting taxes across commodities so that the ratio of marginal deadweight loss to marginal revenue raised is equal across commodities b. balancing the value of having another dollar in the government's hands with the value of leaving a dollar in the hands of the private sector c. setting lower taxes on products with relatively inelastic demand and higher taxes on products with relatively elastic demand d. taxing a wide variety of goods at a moderate rate rather than very few goods at a high rate ANSWER: a 20. The Ramsey Rule says that efficient commodity taxation requires that: a. the deadweight loss per dollar of tax revenue generated from commodity taxes is equal to the deadweight loss per dollar of tax revenue generated from income taxes. b. the ratio of the price elasticity of demand to the tax rate on a commodity is equal across commodities. c. the per unit tax is equal across commodities. d. the deadweight loss per dollar of tax revenue associated with an additional dollar of taxes on a commodity is equal across commodities.

ANSWER: d 21. If a country wants to subsidize some goods in an optimal way, which statement is TRUE? a. The country should subsidize commodities with high elasticities of demand more than commodities with low elasticities of demand. b. The country should subsidize commodities with low elasticities of demand more than commodities with high elasticities of demand. c. Subsidies for commodities with low elasticities of demand result in larger deadweight losses than do subsidies for commodities with high elasticities of demand.

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Chapter 20 d. All goods should receive the same subsidy.

ANSWER: b 22. Which type of good would the Ramsey Rule suggest be taxed to minimize deadweight loss? a. wheat b. yachts c. appliances such as refrigerators d. photographic equipment ANSWER: a 23. Suppose that the ratio of the marginal deadweight loss of a tax on bananas to the marginal revenue of that tax is MDWLB/MRB = $0.80/$0.20 and that the ratio of the marginal deadweight loss of a tax on apples to the marginal revenue of that tax is MDWLA/MRA = $0.75/$0.25. What would move the tax rates on these commodities toward optimal commodity taxation? a. increasing the tax on bananas and lowering the tax on apples b. increasing the tax on apples and lowering the tax on bananas c. keeping tax rates as they are, as the tax system is currently optimal d. increasing the tax on both apples and bananas. .

ANSWER: b 24. The inverse elasticity version of the Ramsey Rule suggests that the government should tax: a. only those goods with the lowest elasticities of demand. b. all goods at the same rate. c. a wide variety of goods but most heavily tax goods with high elasticities of demand. d. a wide variety of goods but most heavily tax goods with low elasticities of demand.

ANSWER: d 25. Suppose a society consumes three goods: corn, beans, and quinoa. Additionally, suppose that the elasticity of demand for corn is low, while those for beans and quinoa are high. Finally, suppose that corn is heavily subsidized, beans are lightly subsidized, and quinoa is heavily taxed. Based on the Ramsey Rule, what might be a revenue-neutral way of increasing the efficiency of the society's tax and subsidy system? a. increasing the subsidy on beans, and decreasing the tax on quinoa b. decreasing the subsidy on corn, and decreasing the tax on quinoa c. increasing the subsidy on beans, and decreasing the subsidy on corn d. decreasing the subsidy on corn, and increasing the tax on quinoa ANSWER: a 26. The goals of optimal income taxation include all of these EXCEPT: a. maximizing tax revenue. b. minimizing the distortions due to taxation. c. maximizing the nation's social welfare function.

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Chapter 20 d. achieving vertical equity.

ANSWER: a 27. The Laffer curve illustrates that: a. it is possible for a reduction in tax rates to increase tax revenues. b. it is not possible for an increase in tax rates to increase tax revenues. c. increasing tax rates is the surest way to increase tax revenue. d. the goal of tax policy should be to set a tax rate so that tax revenue is maximized.

ANSWER: a 28. Which statement about the Laffer curve is TRUE? a. As the tax rate rises from 0 to 100%, tax revenues rise at a constant rate. b. As the tax rate rises from 0 to 100%, tax revenues rise and then fall. c. As the tax rate rises from 0 to 100%, tax revenues fall at a constant rate. d. As the tax rate rises from 0 to 100%, tax revenues rise but at a diminishing rate.

ANSWER: b 29. Assume that all people have identical utility functions that exhibit diminishing marginal utility.

Additionally, assume that people work less when they are taxed more. Which statement about the optimal income tax system is TRUE? a. The marginal utility of the last dollar of income for each person is equal. b. Each person is taxed so that the utility levels of everyone are equal. c. The marginal revenue raised from taxing each person is equal for each person. d. The ratio of marginal utility to marginal revenue is equal for each person.

ANSWER: d 30. Assume that all people have identical utility functions that exhibit diminishing marginal utility and that they work less as taxes rise. If the tax rate is currently 0%, which statement is TRUE? a. The marginal utility of high-income people is equal to the marginal utility of low-income people. b. The marginal revenue achieved by a 1% tax increase on high-income people is higher than the marginal revenue achieved by a 1% tax increase on low-income people. c. The marginal revenue achieved by a 1% tax increase on high-income people is lower than the marginal revenue achieved by a 1% tax increase on low-income people. d. The ratio of marginal utility to marginal revenue is equal for high- and low-income people.

ANSWER: b 31. Suppose there are only two people in an economy. Under the current income tax system, the marginal revenue of a 1% tax increase on Tyrone is $100, while the marginal revenue of a 1% tax increase on Vanessa is $30. The marginal utility of Tyrone is 150 utils, while the marginal utility of Vanessa is 45 utils. Which action would make the tax system optimal without affecting total government revenues? a. taxing Tyrone more and Vanessa less b. taxing Vanessa more and Tyrone less Copyright Macmillan Learning. Powered by Cognero.

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Chapter 20 c. keeping tax rates as they are, as the tax system is currently optimal d. It is not possible to determine how to make the tax system optimal.

ANSWER: c 32. Suppose there are only two people in an economy. Under the income tax system, the marginal revenue of a 1% tax increase on Harry is $50, and the marginal revenue of a 1% tax increase on Sally is $30. The marginal utility of Harry is 30 utils, and the marginal utility of Sally is 20 utils. Which option will make the tax system optimal without affecting total government revenues? a. Harry should be taxed more, and Sally should be taxed less. b. Sally should be taxed more, and Harry should be taxed less. c. The tax system is already optimal. d. More economic information is necessary to answer the question.

ANSWER: a 33. Suppose the government levies a payroll tax on both employees and employers to fund a workers' compensation program. Which of these would NOT affect the labor market? a. The new tax shifts the supply curve to the left. b. The workers' compensation program shifts the supply curve to the right. c. The new tax shifts the demand curve to the right. d. The equilibrium levels of employment and the wage change.

ANSWER: c 34. Suppose the government levies a payroll tax on employers to fund a workers' compensation program. The payroll tax shifts the labor demand curve to the _____; the workers' compensation program shifts the labor supply curve to the _____. a. right; right b. left; left c. right; left d. left; right ANSWER: d 35. Suppose the government levies a payroll tax on employers to fund a workers' compensation program. If workers value the benefit of the workers' compensation less than the cost to the employers, then: a. the wage will rise. b. there is a deadweight loss. c. the wage will be unaffected. d. there is no deadweight loss.

ANSWER: b 36. Under what assumption might the imposition of a payroll tax to finance a workers' compensation program cause an increase in employment? a. Workers are risk neutral.

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Chapter 20 b. Workers value the benefit of workers' compensation more than the cost to employers. c. Employers are risk adverse. d. Workers value the benefit of workers' compensation less than the cost to employers.

ANSWER: b 37. Numerous studies have investigated the impact of social insurance contributions on wages and employment.

The existing literature suggests that the cost of social insurance financing is borne by: a. employers in the form of higher wages and lower output. b. employers in the form of lower wages and higher output. c. workers in the form of lower employment but not lower wages. d. workers in the form of lower wages but not lower employment.

ANSWER: d 38. A study by Feldman et al. (2016) examined what happened to labor income when households lost eligibility for their child tax credit when their children turned 17. Which of these summarizes the major conclusion of this study? a. The likelihood of tax evasion for these households increased significantly. b. Households stopped filing income taxes. c. Households significantly reduced their reported labor income. d. Household labor income increased slightly.

ANSWER: c 39. A study by Abeler and Jager (2015) examined the relationship between tax schedule complexity and labor supply. Which of these summarizes the major conclusion of this study? a. Individuals facing the more complicated tax schedule were more responsive to tax incentives than those facing a less complex schedule. b. Individuals facing the more complicated tax schedule were less responsive to tax incentives than those facing a less complex schedule. c. Most individuals in the study ignored taxes entirely when the schedule got too complicated. d. Individuals found ways to avoid taxes when the schedule got too complicated.

ANSWER: b 40. Recent research indicates that the efficiency gains for tax collectors from tax rate misperceptions are: a. higher in the Midwest than anywhere else in the country. b. between 0.9 and 4.4% of total tax collections. c. about zero across all regions. d. not possible under a progressive tax system.

ANSWER: b 41. From 1747 to 1757, there was a window tax in the United Kingdom with the following structure: zero tax for houses with fewer than 10 windows, a tax of 6 pence per window for houses with 10 to 14 windows, a tax of 9 pence per window for houses with 15 to 19 windows, and a tax of 12 pence per window for houses with 20 Copyright Macmillan Learning. Powered by Cognero.

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Chapter 20 windows or more. Which of these was a distortionary effect of this tax? a. Many families started living under the same roof to avoid paying the tax altogether. b. There was a disproportionate number of households with 10 windows after the tax was implemented. c. Households boarded up all their windows to avoid the tax entirely. d. There were a disproportionate number of households with 9, 14, or 19 windows after the tax was implemented.

ANSWER: d 42. Artists and musicians in Ireland do not have to pay income tax on sales of their work. This tax policy was modified in 2006 to include only those making less than 250,000 euros per year. Which of these was an effect of this tax policy? a. The Irish band U2 moved most of their business operations to the Netherlands. b. Most of the creative community in Ireland relocated to Italy. c. Many of the artists and musicians in Ireland started working in other career fields with lower income tax rates. d. This tax had no effect on artists and musicians in Ireland.

ANSWER: a 43. Suppose that a state legislator observes that many of the wealthiest people in their area own 30- to 35-feet boats. The politician argues for a $500 annual tax on all boats registered in the state that are more than 30-feet long. The politician does a bit of research and finds that there are 1,000 such boats registered in the state; they figure that the tax, if implemented, will yield the state an additional $500,000 in revenues. Are they correct?

ANSWER: The politician is forgetting that taxes have inefficiencies, as producers and consumers will change their behavior to avoid a tax. In this case, the boat owners may respond by either registering large boats in another state or purchasing boats that are just under 30 feet. Boat producers may also build fewer boats that are 30 feet or longer—say, 29.5-feet boats—to avoid the tax. Consequently, the actual revenues from such a tax would likely be substantially less than $500,000.

44. How does the extent of competition in a market affect the size of the deadweight loss caused by a tax imposed on producers? Explain by comparing the deadweight loss from taxation in competitive and monopolistic markets.

ANSWER: The reason the extent of competition in a market affects the deadweight loss of a tax concerns the fact that producer and consumer surpluses are smallest for units produced close to the competitive equilibrium. In a competitive market, a tax that reduced the quantity sold by one unit would have almost no effect on consumer surplus because consumers value the good at approximately its price.

Similarly, the same tax in the same market would not affect producer surplus much, if at all, because the marginal cost of producing that unit is roughly equal to its price. However, if the market is a monopoly, then there is already underproduction. Consequently, the consumer and producer surpluses associated with producing the last good could be quite large and would be lost to the extent that a tax causes fewer goods to be sold.

45. Discuss the equity implications of the Ramsey Rule for optimal commodity taxation. How can these equity issues be addressed, if at all?

ANSWER: The Ramsey Rule implies that commodities with low elasticities of demand should be taxed at higher rates than commodities with high elasticities of demand. However, low-income people might Copyright Macmillan Learning. Powered by Cognero.

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Chapter 20 spend a higher proportion of their incomes on commodities with low elasticities of demand (food, clothing, and so on) than might high-income people. Consequently, following the Ramsey Rule may result in a regressive tax code that society may view as inequitable.

The equity issue could be addressed by reducing commodity taxes on goods consumed disproportionately by low-income groups below that implied by the inverse elasticity rule. However, while doing so would increase equity, it would reduce efficiency. Consequently, the extent to which society would want to reweigh the optimal commodity taxes depends on how much society wants to trade efficiency for equity.

46. Assume the demand for milk is given by the equation QD = 1,200 − 200P and that the supply of milk is perfectly elastic at P = $2. Also assume that the demand for champagne is given by the equation QD = 1,100 − 12P and that the supply of champagne is perfectly elastic at P = $50. (a) Calculate the price elasticity of demand coefficients for milk and champagne, and determine whether the demand for each is relatively elastic or relatively inelastic. (b) Assume champagne is taxed at a rate of 5% and that the tax rate on milk is set according to the inverse elasticity version of the Ramsey Rule. Calculate the tax rate on champagne and the deadweight loss in each market. (c) Does adherence to the Ramsey Rule minimize deadweight loss? Explain.

ANSWER: (a) In the market for milk, P = $2, and equilibrium Q = 800; the elasticity coefficient is (dQ/dP)(P/Q) = [(−200)(2/800)] = −0.5, so the demand for milk is relatively inelastic. In the market for champagne, P = $50, and equilibrium Q = 500; the elasticity coefficient is (dQ/dP)(P/Q) = [(−12)(50/500)] = −1.2, so the demand for champagne is relatively elastic. (b) According to the inverse elasticity rule, the tax on milk divided by the tax on champagne should be equal to the elasticity of demand for champagne divided by the elasticity of demand for milk; this indicates that t/5 = 1.2/0.5. Solving for t, we have t = 5[1.2/0.5] = 12. A 12% tax on milk causes the price to increase to $2.24 and quantity to fall to 752, while a 5% tax on champagne raises the price to $52.50 and reduces quantity to 470. Deadweight loss for each market equals: DWmilk = (0.5)(0.5)(2)(800)(0.12)2 = ½(48)(0.24) = 5.76 DWcham = (0.5)(1.2)(50)(500)(0.05)2 = ½(30)(2.50) = 37.5 (c) Adherence to the Ramsey Rule results in the smallest deadweight loss possible, given the amount of tax revenue being generated. Deadweight loss can be reduced to zero if tax rates are reduced to zero, but then the government would have no tax revenue to spend on items like education, defense, and infrastructure. Since some tax revenue is needed to finance government programs, the goal represented by the Ramsey Rule is to generate needed revenue with the smallest possible deadweight loss.

47. Suppose that there are two types of manufacturing markets in the country of Atlantis. The market for widgets has shown stable growth over the past several years, and employment has been stable. In contrast, the market for vollups has been much more volatile, as has employment in that industry. The government does not interfere in the economy in any way. (a) Assuming that jobs in these industries are similar, how will wages in the two industries compare? Explain. (b) The government of Atlantis is considering implementing a payroll tax on employees to fund an unemployment insurance program. In which of the two industries would there be a stronger tax-benefit linkage?

Explain and describe what would happen in these industries as a result of the government intervention.

ANSWER: (a) Employees in the vollups industry should be paid more because they have a higher risk of becoming unemployed. (b) One would expect a larger tax-benefit linkage in the labor market for vollups. This is because an Copyright Macmillan Learning. Powered by Cognero.

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Chapter 20 unemployment insurance program makes the jobs in the vollups industry less risky. Consequently, while the payroll tax on employers shifts the labor demand curve to the left (creating a deadweight loss), in the market for vollups, the reduction in risk for workers should shift the labor supply curve to the right.

48. Discuss the empirical evidence on tax-benefit linkages. Who pays for the social insurance, and do these taxes affect employment?

ANSWER: Many studies compare wages and employment across states or groups of workers in which social insurance contribution rates change. For example, Gruber and Krueger (1991) estimated the impact on wages and employment of changes in the costs of workers' compensation across states over time, and Anderson and Meyer (2000) studied the impact of changes in unemployment insurance payroll taxes across firms over time. Both studies concluded that, on average, the costs of financing these programs are largely paid through (shifted to) lower wages, with relatively little effect on employment.

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Chapter 21 1. Economic theory regarding the relationship between taxation and work suggests that: a. high taxes may discourage work effort, causing output and income to fall. b. tax breaks have very little effect on the decision to work, as with the tax holiday experienced in Iceland. c. when tax rates increase, people react by working longer hours, so that they will not experience a reduction in after-tax income. d. workers pay very little attention to tax changes, so a tax on earnings is optimal.

ANSWER: a 2. Historical evidence regarding tax cuts, such as those of President Bush in 2001 and 2003 and of President Trump in 2017: a. clarifies that, overall, tax cuts positively affect labor supply. b. clarifies that, overall, tax cuts negatively affect labor supply. c. is ambiguous about the overall effects of tax cuts on labor supply. d. is contradictory about the overall effects of tax cuts on labor supply.

ANSWER: c 3. In the standard labor supply model, the vertical axis shows _____, and the horizontal axis shows _____. a. hours worked; consumption/income b. consumption/income; hours of leisure c. hours of leisure; hours of work d. consumption/income; wage ANSWER: b 4. If a person responds to a tax on wages by working more, then the: a. substitution effect exceeds the income effect. b. substitution effect induces the individual to work more. c. income effect exceeds the substitution effect. d. income effect exactly offsets the substitution effect.

ANSWER: c 5. If a person responds to a tax on wages by working the same number of hours, then the: a. substitution effect exceeds the income effect. b. substitution effect induces the individual to work more. c. income effect exceeds the substitution effect. d. income effect exactly offsets the substitution effect.

ANSWER: d 6. Which statement is TRUE in the standard model of labor supply? a. If the income effect dominates the substitution effect, higher wages lead to a reduction in the quantity of labor supplied. b. If the substitution effect dominates the income effect, higher wages lead to an increase in the quantity Copyright Macmillan Learning. Powered by Cognero.

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Chapter 21 of labor supplied. c. Higher wages lead to a reduction in the quantity of labor supplied, regardless of whether the income or substitution effect dominates. d. Higher wages lead to an increase in the quantity of labor supplied, regardless of whether the income or substitution effect dominates.

ANSWER: a 7. If the tax rate on income is given by τ, and the wage is given by w, what is the after-tax wage? a. w − τ b. w − τ + 1 c. w(τ − 1) d. w(1 − τ) ANSWER: d 8. If the tax rate on income is given by τ, and the wage is given by w, what is the slope of the budget constraint? a. −w + τ b. w − τ + 1 c. w(τ − 1) d. w(1 − τ) ANSWER: c 9. The slope of the budget constraint is equal to: a. the before-tax wage. b. the after-tax wage. c. the tax rate. d. 1 minus the tax rate.

ANSWER: b 10. If the tax rate on income is 20%, and the wage is $18 per hour, what is the after-tax wage? a. $18.00 b. $21.00 c. $3.60 d. $14.40 ANSWER: d 11. Suppose that a tax is levied on wages, and a worker responds by working more. Which statement is TRUE? a. The income effect of the tax increase outweighs the substitution effect. b. The substitution effect of the tax increase outweighs the income effect. c. The substitution effect of the tax increase induces the worker to work more. d. The income effect of the tax increase partially offsets the substitution effect.

ANSWER: a Copyright Macmillan Learning. Powered by Cognero.

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Chapter 21 12. Suppose that a tax is levied on wages, and a worker does not change how many hours she works. Which statement is TRUE? a. The substitution effect of the decline in after-tax income outweighs the income effect. b. The income effect of the decline in after-tax income outweighs the substitution effect. c. The income effect and substitution effect of the decline in after-tax income outweighs are equal in magnitude. d. There is no income effect in this case.

ANSWER: c 13. Suppose that a tax is levied on wages, and a worker responds by working less. Which statement is TRUE? a. The income effect causes her to buy fewer of all goods except leisure. b. The income effect exceeds the substitution effect. c. The substitution effect exceeds the income effect. d. There is no income effect.

ANSWER: c 14. The supply curve in the labor market is upward-sloping if: a. the substitution effect of a tax change dominates the income effect. b. the income effect of a tax change dominates the substitution effect. c. the income and substitution effects of a tax change exactly offset each other. d. a tax change has only a substitution effect and no income effect.

ANSWER: a 15. If the tax rate on income is 25%, and the hourly wage is $20, what is the slope of the budget constraint? a. −$5 b. −$10 c. −$15 d. −$20 ANSWER: c 16. If the slope of the budget constraint is −$16, and the hourly wage is $20, what is the tax rate on income? a. 12% b. 15% c. 20% d. 25% ANSWER: c 17. The need to have many workers on site during specified work hours, or production complementarities: a. enables individuals to adjust their work hours freely as government tax policies change. b. enables individuals to vary their hours of work to find the tangency between their indifference curve and budget constraint.

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Chapter 21 c. limits the responsiveness of labor supply to changes in taxation. d. puts an upper, but not a lower, bound on the number of hours workers can work..

ANSWER: c 18. Which may help explain a high responsiveness of labor supply to tax changes? a. production complementarities b. overtime pay c. a lack of awareness among workers of tax changes d. the growth of freelance gig work ANSWER: d 19. Empirical evidence suggests that if the payroll tax were lowered: a. secondary earners would work more hours. b. primary earners would work fewer hours. c. labor force participation among secondary workers would fall. d. worker hours would not change.

ANSWER: a 20. Which group of workers is likely to exhibit the greatest responsiveness of labor supply to tax changes? a. primary workers who are not currently working b. primary workers who are currently working c. secondary workers who are not currently working d. secondary workers who are currently working ANSWER: c 21. The study cited in the text that uses the negative income tax system instituted in the United States between 1968 and 1976 to assess the effects of wages on labor supply illustrates what type of empirical analysis? a. a randomized experiment b. a cross-sectional regression c. a time series study d. a quasi-experimental study ANSWER: a 22. Empirical evidence suggests that if the payroll tax were increased: a. secondary earners would work more. b. primary earners would work more. c. secondary earners would change their hours worked more than primary earners would. d. primary earners would change their hours worked more than secondary earners would.

ANSWER: c 23. Non-labor income has _____ on labor supply; after-tax wages have _____ on labor supply.

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Chapter 21 a. substitution and income effects; substitution and income effects b. substitution effects; income effects c. income effects; substitution and income effects d. income effects; substitution effects ANSWER: c 24. Cross-sectional regression analyses of the effects of taxes on labor supply may be biased because: a. people who earn high wages may have a higher preference for work than people who earn low wages. b. people who earn low wages may have a higher preference for work than people who earn high wages. c. all people used in such studies work the same number of hours. d. everyone receives the same amount of utility from leisure time.

ANSWER: a 25. Nada Eissa's studies of the impact of the Tax Reform Act of 1986 on labor supply illustrate which type of approach to estimating the elasticity of labor supply? a. a randomized experiment b. a cross-sectional regression c. a time series study d. a quasi-experimental study ANSWER: d 26. The Earned Income Tax Credit subsidizes the wages of: a. all families with children. b. hourly workers only. c. low-income earners. d. high-income earners.

ANSWER: c 27. Unlike traditional social welfare programs, the Earned Income Tax Credit has been shown to increase: a. both equity and efficiency. b. equity but not efficiency. c. efficiency but not equity. d. neither equity nor efficiency.

ANSWER: a 28. Which statement about the Earned Income Tax Credit (EITC) is NOT true? a. Most of the benefits of the EITC go to families making less than $35,000. b. The EITC is refundable. c. The EITC has grown significantly since it was first introduced.

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Chapter 21 d. The EITC reduces tax liabilities only for families that pay high taxes.

ANSWER: d 29. Which potential reform of the Earned Income Tax Credit (EITC) is MOST likely to lead to an increase in labor supply? a. an increase in (the absolute value of) the phase-out rate b. an increase in the maximum credit c. an increase in the subsidy rate d. a decrease in the amount of money spent on the program ANSWER: c 30. Which statement BEST describes the current Earned Income Tax Credit (EITC) program? a. As earnings increase from zero, the EITC increases at a decreasing rate until it reaches the maximum and then decreases until it is zero. b. As earnings increase from zero, the EITC increases at a constant rate until it reaches the maximum and then remains at that level. c. As earnings increase from zero, the EITC increases at a constant rate to a maximum and then decreases to zero. d. As earnings increase from zero, the EITC decreases at a constant rate to zero.

ANSWER: c 31. Suppose a researcher identifies the effect of the Earned Income Tax Credit (EITC) on the labor supply of single mothers by comparing the labor supply of those mothers to the labor supply of single women without children before and after the EITC expansion. This is an example of which type of empirical study? a. a cross-sectional regression b. a randomized experiment c. a quasi-experimental study d. a structural estimation ANSWER: c 32. Empirical evidence suggests that the Earned Income Tax Credit: a. does not affect men's labor supply. b. reduces the labor supply of married women. c. has significantly increased hours worked by those in the labor force. d. has not caused workers to enter the labor force.

ANSWER: b 33. Which statement about the Earned Income Tax Credit (EITC) is TRUE? a. The credit is the same size for all recipients, regardless of family size. b. The credit is refundable. c. The credit is only refundable for high-income individuals. d. The EITC has had no significant effect on labor force participation or work effort.

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Chapter 21 ANSWER: b 34. Which statement is NOT true about the structure of the Earned Income Tax Credit (EITC)? a. Up to a threshold, the EITC pays a fixed percentage of wages earned. b. The EITC pays a fixed amount over a range of income. c. Over a range of income, the government reduces EITC payments at a fixed percentage rate per dollar earned. d. EITC payments decrease as earnings increase, but everyone qualifies for some amount.

ANSWER: d 35. For an individual who is not working, which statement would be TRUE if the individual were suddenly eligible for the Earned Income Tax Credit (EITC)? a. The income effect of the EITC may induce the person to work. b. The substitution effect of the EITC may induce the person to work. c. There is no substitution effect. d. The individual will work if the income effect outweighs the substitution effect.

ANSWER: b 36. Which is NOT a flaw of the Earned Income Tax Credit (EITC) in its current form? a. The EITC for single earners is too small to significantly affect single earners' labor supply decisions. b. Because the credit is based on the incomes of tax-filing units rather than individuals, it penalizes single parents who marry. c. Though it reduces poverty, it also disincentivizes work, lowering economic efficiency. d. The EITC is so complex that many people who are eligible for it do not apply.

ANSWER: c 37. If someone receives a wage subsidy: a. the effect of the program on her labor supply is ambiguous. b. the substitution effect induces her to work less. c. the income effect induces her to work more. d. income and substitution effects do not occur.

ANSWER: a 38. For persons who earn an income at which the Earned Income Tax Credit (EITC) benefit decreases with additional income, which statement is TRUE? a. The effect of the EITC on labor supply is ambiguous. b. The substitution effect induces these individuals to work less. c. The income effect induces these individuals to work more. d. There are no income or substitution effects.

ANSWER: b 39. For persons who earn an income at which the Earned Income Tax Credit (EITC) benefit neither increases Copyright Macmillan Learning. Powered by Cognero.

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Chapter 21 nor decreases with additional income, which statement is TRUE? a. The effect of the EITC on labor supply is ambiguous. b. The effect of the EITC is to increase labor supply. c. The EITC does not have a substitution effect. d. The EITC does not have an income effect.

ANSWER: c 40. Which statement about the estimated effects of the Earned Income Tax Credit (EITC) on labor supply is TRUE? a. The 1986 expansion of the EITC did not increase the labor market participation of single mothers. b. The 1986 expansion of the EITC did not affect the number of hours worked by those already in the labor force. c. The 1986 expansion of the EITC reduced the number of hours worked by those in the labor force. d. Researchers were unable to study the effects of the 1986 expansion of the EITC. ANSWER: b 41. Suppose a researcher identifies the effect of the Earned Income Tax Credit (EITC) on the labor supply of single mothers by comparing the labor supply of those mothers after the EITC expansion with the labor supply of single women without children before and after the EITC expansion. Which factor would cause the estimates from such a study to be biased? a. Single women without children tend to work more hours than do single women with children. b. Preferences regarding work among single women with children change over time. c. Single women with children have higher income requirements for their larger families than do single women without children. d. Preferences regarding work among single women with children remain the same over time.

ANSWER: b 42. Suppose the spouse of the primary earner in the household is considering joining the labor force. The spouse currently cares for two children and, if employed, would earn $20 per hour for 40 hours per week. The cost of child care would be $10 per hour for 50 (not 40) hours per week. Assume that the marginal tax rate on work is 50%. Also assume that child care is tax deductible and that child care at home is NOT imputed and taxed. What is the after-tax, after-child care addition to family income of the spouse working each week? a. $100 b. $0 c. $150 d. $300 ANSWER: c 43. Suppose that the spouse of the primary earner in the household is considering joining the labor force. The spouse currently cares for two children and, if employed, would earn $20 per hour for 40 hours per week. The cost of child care would be $15 per hour for 40 hours per week. Assume that child care is tax deductible and that child care at home is NOT imputed and taxed. Also assume that the spouse is indifferent between working and staying home except for the financial impact. What would be the marginal tax rate such that the spouse is Copyright Macmillan Learning. Powered by Cognero.

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Chapter 21 indifferent between entering the labor force and providing child care at home? a. 0% b. 25% c. 50% d. 100% ANSWER: d 44. The substitution effect of child care expenditures induces parents to _____; the income effect of child care expenditures induces parents to _____. a. work more; work more b. work more; work less c. work less; work less d. work less; work more ANSWER: d 45. Suppose that the spouse of the primary earner in the household is considering joining the labor force. The spouse cares for two children and, if employed, would earn $20 per hour for 40 hours per week. The total cost of child care would be $10 per hour for 50 (not 40) hours per week. Assume that the marginal tax rate on work is 50%. Also assume that child care is NOT tax deductible and that child care at home is NOT imputed and taxed. What is the after-tax, after-child care value of working per week? a. −$100 b. $0 c. $150 d. $300 ANSWER: a 46. Suppose that the spouse of the primary earner in the household is considering joining the labor force. The spouse cares for two children and, if employed, would earn $20 per hour for 40 hours per week. The total cost of child care would be $10 per hour for 50 (not 40) hours per week. Assume that the marginal tax rate on work is 50%. Also assume that child care is NOT tax deductible but that the value of child care at home is imputed as income and taxed. How much more would the government collect in tax revenues if the spouse chose to join the labor force rather than stay at home? a. −$100 b. $0 c. $150 d. $300 ANSWER: c 47. Suppose that the spouse of the primary earner in the household is considering joining the labor force. The spouse cares for two children and, if employed, would earn $20 per hour for 40 hours per week. The total cost of child care would be $15 per hour for 40 hours per week. Assume that child care is NOT tax deductible and that the value of child care at home is NOT imputed as income and taxed. Also assume that the spouse is indifferent between working and staying at home except for the financial impact. What would be the marginal Copyright Macmillan Learning. Powered by Cognero.

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Chapter 21 tax rate such that the spouse is indifferent between entering the labor force and providing child care at home? a. 0% b. 25% c. 50% d. 100% ANSWER: b 48. Government spending on the Earned Income Tax Credit has: a. decreased substantially since 1976. b. stayed about the same since 1976. c. increased in the early 1980s and then fell. d. increased substantially since the late 1980s.

ANSWER: d 49. Which individual would NOT be eligible for the Earned Income Tax Credit? a. a single mother of two, earning $49,000 annually b. a 20-year-old male who is not currently working c. a 32-year-old female without children, earning $14,000 annually d. a married couple with three children, earning $50,000 in total ANSWER: b 50. Which would result from implementing an Earned Income Tax Credit–like program for childless workers, according to research by Weissman (2016)? a. Labor participation rates among these workers would increase. b. These workers would seek higher-paying jobs. c. Labor participation rates among these workers would decrease. d. These individuals would no longer work.

ANSWER: a 51. Which would result from reducing the complexity of claiming the Earned Income Tax Credit? a. The amount of the credit would fall, on average. b. A greater number of ineligible taxpayers would receive the credit. c. The average amount of credit families receive would increase. d. A greater number of eligible taxpayers would apply for the credit.

ANSWER: d 52. Discuss the two major limitations of the basic theory of taxation's effect on labor supply.

ANSWER: The theory assumes an idealized view of the labor market such that individuals can adjust their hours freely and incrementally as tax policy changes. In most labor markets, however, individuals cannot adjust their hours of work freely to find the exact tangency between their indifference curve and budget constraint. Another constraint on increasing workers' hours is overtime pay rules, which mandate that workers paid by the hour be paid time-and-a-half if they work more than 40 hours per Copyright Macmillan Learning. Powered by Cognero.

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Chapter 21 week. These laws make it very expensive for firms to allow more than 40 hours of work per week, which means that they will be reluctant to allow workers to do so even if that is optimal for workers.

53. Discuss fundamental labor supply elasticity differences with respect to after-tax wages of primary earners and secondary earners.

ANSWER: The elasticity of labor supply with respect to after-tax wages is determined by the availability of substitute options for suppliers of labor. Traditionally, primary-earning males had few alternatives to work, given the expectation that primary earners in the United States would work full-time. Because secondary-earning females, however, had the traditional option of providing child care, their labor supply is more elastic. These findings are also sensible, given the hour constraints: men traditionally had the types of production-sector jobs for which hour constraints were important; they thus had little leverage for adjusting their hours to a desired level. Women, on the other hand, traditionally worked in service-sector jobs, for which work hours were more flexible.

54. The textbook discusses a paper by Nada Eissa and Jeffrey Leibman that examines the effect of the Earned Income Tax Credit on the single mother labor supply. The paper addresses the fact that some expansions of the program were modest for families with only one child but much larger for families with two or more children.

Thus, the researchers compared the change in the labor supply of single mothers with two or more children with the change in the labor supply of single mothers with only one child. (a) What type of empirical strategy is this? (b) What is the study, or treatment, group, and what is the control group? (c) Suppose that over this period, employers become more willing to hire and accommodate single mothers.

Would this fact bias the estimates? Explain.

ANSWER: (a) quasi-experiment or difference-in-difference (b) The study group is the group of single mothers with two or more children. The control group is the group of single mothers with only one child. (c) The only condition under which this fact would bias the estimates is if employer attitudes changed more with respect to one group—say, mothers with two or more children—than the other group—say, mothers with one child. As long as any change in attitude affected both groups in the same way over time, the difference-in-difference estimates would not be biased.

55. Suppose that, a policy maker has three options for expanding the Earned Income Tax Credit (EITC), using a given increase in the budget.

Option 1: Increase the compensation rate in the phase-in portion of the EITC schedule.

Option 2: Increase the maximum tax credit a person can receive.

Option 3: Lower the rate of reduction in the phase-out portion of the EITC schedule. (a) Suppose that the goal of the agency is to increase the size of the labor force. Which option would meet this goal in the most cost-effective manner? Explain. (b) Suppose that the policy maker chose option 2. Explain in terms of income and substitution effects how this choice would affect someone who is on the phase-out portion of the EITC schedule.

ANSWER: (a) Option 1 would be the best bet. Increasing the initial wage subsidy produces a substitution effect that raises the price of an hour of leisure for someone who wasn't working before, thus inducing the person to join the labor force. Just as significantly, since the target group is people who aren't in the labor force, option 1 does not have an income effect that would induce people to work less. (b) One effect of option 2 on this person is the income effect. Increasing the transfer to this person makes the person better off and able to purchase more of all goods, including leisure. Consequently, Copyright Macmillan Learning. Powered by Cognero.

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Chapter 21 the income effect will induce the person to work fewer hours. In addition, since the person loses a bit of the tax credit for each additional hour he or she works, the substitution effect continues to induce the person to work less. Consequently, the overall effect of option 2 on this person is an unambiguous lowering of their labor supply.

56. James and Kristine are married and have two children. James is the primary earner in the household.

Kristine is considering joining the labor force at $25 per hour for 40 hours per week. The total cost of child care would be $10 per hour for 40 hours per week. Kristine is indifferent between working and staying at home except for the financial impact. Assume that all of her income will be taxed at a 50% marginal rate. (a) Assume that child care is NOT tax deductible and that the value child care at home is NOT imputed as income and taxed. Will Kristine work or stay home, and how much better off is she by doing one rather than the other? Explain. (b) Now assume that the value of child care at home is imputed as income and taxed based on the market cost of providing that service. Does this affect the answer to part (a)? Explain. (c) Again, assume that child care is NOT tax deductible and that the value of child care at home is NOT imputed as income and taxed. However, suppose Kristine values staying at home with her children at some value x, where x is either positive, implying that she prefers staying home, or negative, implying that she prefers to work. What must x be such that Kristine is indifferent between staying home and joining the labor force?

ANSWER: (a) If Kristine works, she makes $1,000 per week, of which $500 is paid in taxes. Child care costs $400 per week. Consequently, Kristine will choose to work, since the value of working, $500, exceeds the $400 value of providing child care at home. (b) Now Kristine will owe $200 in taxes if she stays home and provides the child care herself: $200 = 0.50 × $400. Consequently, the value of staying home is now $200, whereas the value of working does not change from $500, so the answer to part (a) will not change. (c) From part (a), it is clear that if Kristine values child care for an additional $100 per week, the value of providing the child care herself increases to $500 and is equal to the value from working of $500. Consequently, x = 100.

57. (a) What can cause a tax wedge in the market for child care that puts market work at a disadvantage? (b) The text described two ways the government can remove this tax wedge. Identify them and discuss the advantages and disadvantages of both.

ANSWER: (a) Any time there is a difference between pre-tax and after-tax returns to an activity caused by taxes, a tax wedge exists. In this case, the tax wedge can be caused by the fact that child care services purchased in the market are taxed, whereas child care services provided at home are not taxed. (b) One solution to the tax wedge problem is to impute home earnings by assigning a value to the child care given at home. In this case, providing child care at home no longer has a tax advantage over purchasing the child care in the marketplace. However, this approach is likely to be difficult to implement because of the difficulty of assigning a value to a good with no clear market value. In addition, suggesting such a policy would probably not be politically feasible.

The other option is to make child care costs deductible. By not taxing work tied to the provision of child care—either directly if the child care is delivered at home or indirectly if the child care is purchased with income from other work—the tax wedge is effectively removed. This approach is less desirable from a government revenue perspective because by not taxing the provision of child care, the government loses revenues that it must recoup by raising other taxes, thus increasing deadweight loss. However, the advantage of this policy is that it is easy to implement both politically and practically.

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Chapter 21

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Chapter 22 1. What is the term for taxes levied on the returns from savings? a. payroll taxation b. capital gains taxation c. savings taxation d. capital income taxation ANSWER: d 2. Which of these BEST describes the intertemporal budget constraint? a. an amount equal to an individual's total income b. a measure of an individual's preference for consumption in one period relative to their preference for consumption in other periods c. a measure of the rate at which people can trade consumption in one period for consumption in another period d. the opportunity cost of first-period consumption ANSWER: c 3. An individual's savings is defined as the difference between: a. current income and current consumption. b. cumulative income and cumulative consumption to the present time, EXCLUDING interest gained or lost over that time. c. cumulative income and cumulative consumption to the present time, INCLUDING interest gained or lost over that time. d. lifetime spending and lifetime income.

ANSWER: a 4. According to the standard intertemporal choice model: a. people save in order to smooth consumption over time. b. people gain utility by working. c. for most people, it is optimal to set consumption equal to income in each year. d. a dollar received in 10 years is worth the same as a dollar received today.

ANSWER: a 5. Assume that a woman lives for two periods, period 1 and period 2. In period 1, she works, earns income Y, and saves S out of her income. In period 2, she does not work and consumes her savings plus whatever interest her savings has earned (r is the interest rate). How much does the woman consume in period 2 if S = 0? a. 0 b. Y − S c. Y + S d. Y(1 + r) ANSWER: a 6. Suppose that a man lives for two period, period 1 and period 2. In period 1, he works, earns income Y, and Copyright Macmillan Learning. Powered by Cognero.

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Chapter 22 saves S out of his income. In period 2, he does not work and consumes his savings plus whatever interest his savings has earned (r is the interest rate). What is the relative price of first-period consumption in this twoperiod model? a. S(1 + r)2 b. 1 + r c. Y − S d. Y(1 + r) ANSWER: b 7. Suppose the government were to eliminate taxes on interest from savings. According to economic theory, individuals: a. will definitely save more. b. might save more or less. c. will definitely save less. d. will definitely save the same amount as before.

ANSWER: b 8. Suppose that a woman lives for two periods, period 1 and period 2. In period 1, she works, earns income Y, and saves S out of her income. In period 2, she consumes her savings plus whatever interest her savings has earned (r is the interest rate). Suppose that the government taxes interest income at a rate of t. As a result of the tax the: a. woman must save more in period 1 to maintain a given level of consumption in period 2. b. woman can afford more consumption in period 2 for a given level of consumption in period 1. c. price of consumption in period 1 has risen. d. price of consumption in period 1 has not changed.

ANSWER: a 9. Assume that the nominal interest rate is 10% and that the inflation rate is 10%. If Wes saves $100, and the tax rate on interest from savings is 25%, what will Wes's nominal after-tax savings be one year from now? a. $10.50 b. $105.00 c. $107.50 d. $110.00 ANSWER: c 10. Suppose that Adelina lives for two periods, period 1 and period 2. In period 1, Adelina works, earns income Y, and saves S out of her income. In period 2, she is retired and consumes her savings plus whatever interest her savings has earned (r is the interest rate). How much does Adelina consume in period 1? a. Y b. 2Y − S c. Y − S d. Y(1 + r) Copyright Macmillan Learning. Powered by Cognero.

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Chapter 22 ANSWER: c 11. Suppose Roberto lives for two periods, period 1 and period 2. In period 1, Roberto works, earns income Y, and saves S out of his income. In period 2, he is retired and consumes his savings plus whatever interest his savings has earned (r is the interest rate). How much does Roberto consume in period 2? a. Y(1 + r) b. 2Y − S c. Y − S d. S(1 + r) ANSWER: d 12. Suppose that Mia lives for two periods, period 1 and period 2. In period 1, Mia works, earns income Y, and saves S out of her income. In period 2, she is retired and consumes her savings plus whatever interest her savings has earned (r is the interest rate). What is the opportunity cost of Mia's consumption in period 1? a. Y(1 + r)2 b. 1 + r c. Y − S d. Y(1 + r) ANSWER: b 13. Suppose that Hugo lives for two periods, period 1 and period 2. In period 1, Hugo works, earns income Y, and saves S out of his income. In period 2, he is retired and consumes his savings plus whatever interest his savings has earned (r is the interest rate). Suppose that the government taxes interest income at a rate of t. What is Hugo's consumption in period 2? a. S b. S(1 + r − t)2 c. S(1 + r − rt) d. S(1 + r − t) ANSWER: c 14. Suppose that the government starts taxing interest on savings. Savings will _____ through the substitution effect; savings will _____ through the income effect. a. increase; remain unchanged b. increase; decrease c. decrease; increase d. remain unchanged; increase ANSWER: c 15. Suppose the government eliminates taxes on interest from savings. Which of these would NOT follow from economic theory? a. People would save more as a result. b. People would save less as a result.

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Chapter 22 c. People would save less through the substitution effect. d. People would save more through the substitution effect.

ANSWER: c 16. It has been difficult to empirically find a connection between after-tax interest rates and savings, due to difficulty in: a. obtaining data on tax rates. b. measuring a given worker's wage. c. determining the appropriate interest rate to use. d. measuring the value of savings.

ANSWER: c 17. Which statement is TRUE? a. The nominal interest rate is approximately equal to the real interest rate plus the rate of inflation. b. The nominal interest rate measures a person's actual improvement in purchasing power due to savings. c. The real interest rate is approximately equal to the rate of inflation times two. d. The real interest rate is higher than the nominal interest rate when there is inflation.

ANSWER: a 18. Assume that the nominal interest rate is 10% and that the inflation rate is 10%. The real interest rate: a. cannot be determined from the given information. b. is 0%. c. is 10%. d. is 20%.

ANSWER: b 19. Assume that Wes lives for two periods, period 1 and period 2. And suppose that the nominal interest rate is 10%, that the inflation rate is 10%, and that the tax rate on interest from savings is 25%. If Wes has $100 in savings in period 1, then: a. Wes's real after-tax interest rate is negative. b. Wes's savings will have more buying power in period 2 than period 1. c. Wes's real after-tax interest rate is zero. d. Wes will not pay taxes on interest, since his real interest rate is zero.

ANSWER: a 20. If banks raise nominal interest rates to fully offset inflation, the purchasing power of savings will: a. remain the same when capital income is taxed. b. decrease when capital income is not taxed. c. increase when capital income is not taxed. d. increase when capital income is taxed.

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Chapter 22 ANSWER: c 21. According to _____ models, individuals save in part to smooth consumption over future uncertainties. a. precautionary savings b. intertemporal choice c. self-control d. liquidity constraint ANSWER: a 22. Which statement is TRUE? a. The precautionary saving model, unlike the intertemporal choice model, assumes that all saving is motivated by a desire to self-insure against risk. b. The precautionary saving model, unlike the intertemporal choice model, assumes that some saving is motivated by a desire to self-insure against risk. c. The precautionary saving model, unlike the intertemporal choice model, assumes that saving is motivated by a desire to smooth consumption. d. The intertemporal choice model, unlike the precautionary saving model, assumes that saving is motivated by a desire to smooth consumption.

ANSWER: b 23. Liquidity constraints are BEST described as: a. limits on how easily assets can be used for immediate cash needs. b. geographic and political barriers that limit a person's ability to invest overseas. c. government restrictions on minimum levels of saving. d. barriers to credit availability that limit a person's ability to borrow.

ANSWER: d 24. Suppose an individual saves money in a retirement account with many withdrawal restrictions at an interest rate of 5% while simultaneously borrowing money at 10%. This behavior is consistent with the: a. self-control model of saving. b. precautionary saving model. c. intertemporal choice model of saving. d. liquidity model of saving.

ANSWER: a 25. The precautionary saving model gains support from which finding? a. that expansions of social insurance programs lead to higher savings b. that expansions of social insurance programs lead to lower savings c. that greater economic uncertainty leads to random savings decisions d. that greater economic uncertainty leads to lower savings ANSWER: b Copyright Macmillan Learning. Powered by Cognero.

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Chapter 22 26. Which of these is a tax-preferred retirement savings vehicle offered by employers, where employers often match part or all of employees' contributions? a. a defined contribution pension plan b. a defined benefit pension plan c. Social Security d. a 401(k) account ANSWER: d 27. Which of these is a retirement savings account for the self-employed under which savings up to a specified amount can be saved each year tax-free? a. a defined contribution pension plan b. a Roth IRA account c. a SEP-IRA account d. a 401(k) account ANSWER: c 28. Which statement regarding tax-subsidized saving for retirement is TRUE? a. Tax subsidies for saving unambiguously increase saving. b. Tax subsidies for saving induce individuals to save more through the income effect. c. Tax subsidies for saving induce individuals to save less through the substitution effect. d. Tax subsidies for saving induce individuals to save less through the income effect.

ANSWER: d 29. What is an employer-sponsored plan in which the employer sets aside a certain proportion of a worker's earnings in an investment account that the worker will receive with investment earnings at retirement? a. a defined contribution pension plan b. a defined benefit pension c. a SEP-IRA account d. an Individual Retirement Account ANSWER: a 30. Which is NOT one of the four major forms of tax-subsidized retirement savings? a. defined contribution pension plans b. precautionary saving plans c. simplified employee pension plans d. 401(k) accounts ANSWER: b 31. Which is a tax-preferred retirement savings vehicle primarily for low- and middle-income taxpayers in which the taxpayers make pretax contributions and are then taxed on future withdrawals? a. a defined contribution pension plan b. a defined benefit pension plan Copyright Macmillan Learning. Powered by Cognero.

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Chapter 22 c. a 401(k) account d. a traditional Individual Retirement Account ANSWER: d 32. Which is an employer-sponsored plan through which retired workers receive a benefit from their firm that is based on their tenure at the firm and earnings? a. a defined contribution pension plan b. a defined benefit pension plan c. a SEP-IRA plan d. a 401(k) account ANSWER: b 33. Which is a tax-preferred retirement savings vehicle primarily for low- and middle-income taxpayers in which taxpayers make after-tax contributions but then make tax-free withdrawals later in life? a. a defined contribution pension plan b. a Roth IRA c. a SEP-IRA d. a 401(k) account ANSWER: b 34. Suppose an Individual Retirement Account (IRA) has a contribution limit of $4,000 per year and that, prior to passage of the law that established IRAs, Rachel was saving $5,500 per year. Which of these is the MOST likely effect of the law? a. She saves more through the income effect of the tax subsidy. b. The tax subsidy has an inframarginal effect on Rachel's saving. c. She saves less through the substitution effect of the tax subsidy. d. The tax subsidy has no effect on Rachel's saving behavior.

ANSWER: b 35. Suppose an Individual Retirement Account (IRA) has a contribution limit of $3,000 per year. Additionally, suppose that, prior to passage of the law establishing IRAs, Carlos saved $2,500 per year, whereas after passage of the law, Carlos saved $2,000 per year. Which statement is TRUE? a. The tax subsidy through the IRA had a marginal effect on Carlos's saving. b. The tax subsidy through the IRA had an inframarginal effect on Carlos's saving. c. The substitution effect of the tax subsidy exceeded the income effect. d. The income and substitution effects of the tax subsidy canceled each other out.

ANSWER: b 36. Suppose that an Individual Retirement Account (IRA) has a contribution limit of $3,000 per year.

Additionally, suppose that, prior to passage of the law establishing IRAs, Hamilton was not saving any of his income, whereas after IRAs became available, Hamilton saved $2,000 per year. Which statement is TRUE? a. The tax subsidy through the IRA had a marginal effect on Hamilton's saving.

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Chapter 22 b. The tax subsidy through the IRA had an inframarginal effect on Hamilton's saving. c. The income effect of the tax subsidy exceeded the substitution effect. d. The income and substitution effects of the tax subsidy cancelled each other out.

ANSWER: a 37. Which of these savings initiatives of President Obama was not implemented? a. a requirement for firms that do not have retirement plans to establish and automatically enroll employees in Individual Retirement Account–type accounts b. a reduction in the high fees that discourage small businesses from establishing savings plans c. eligibility of workers to receive portions of their tax refunds in the form of U.S. savings bonds rather than cash d. facilitation of efforts by workers to deposit wages earned from overtime or unused vacation time into their savings accounts ANSWER: a 38. Which of these is consistent with recent self-control research examining low-income taxpayers and tax refunds? a. Low-income individuals are more likely to deposit tax refunds in illiquid savings accounts than collect them in cash. b. Low-income individuals are more likely to give tax refunds to charity than collect them in cash. c. Low-income individuals prefer to have tax refunds paid in cash immediately rather than use them to pay future tax obligations. d. Low-income individuals prefer to use tax refunds to pay future tax obligations rather than have them paid in cash immediately.

ANSWER: c 39. Recent research by Somville and Vandewalle (2018) examines self-control problems and retirement savings in India. Their research shows that: a. defaulting individuals into savings account participation substantially increases savings rates. b. self-control savings problems are restricted to the United States. c. defaulting individuals into savings account participation has no impact on savings rates. d. self-control problems are more prevalent in India than in the United States.

ANSWER: a 40. Andrew is planning on depositing $7,000 in an Individual Retirement Account this year. How much of this amount can he deposit tax-free? a. $0 b. $700 c. $5,500 d. $7,000 ANSWER: c Copyright Macmillan Learning. Powered by Cognero.

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Chapter 22 41. Andrew wants to withdraw $1,000 from his Individual Retirement Account (IRA) this year to cover an unexpected medical expense. Which of these is TRUE regarding this withdrawal? a. Andrew will not be able to withdraw money from his IRA for any reason. b. Andrew will have to forfeit all interest earned on any money deposited in his IRA. c. Andrew will have to pay a 10% penalty. d. Andrew will have to pay only the regular income taxes on his withdrawal.

ANSWER: c 42. Andrew is planning to deposit $1,000 in either a regular bank account or an Individual Retirement Account (IRA). He will withdraw the money during retirement. His income tax rate is 20%, and the interest rate is 10%.

All else equal, in which account should he deposit his money? a. He should deposit it in the IRA because withdrawals are not subject to income taxes. b. He should deposit it in the IRA because he will earn interest on the entire $1,000. c. He should deposit it in the regular bank account because he will not pay taxes on the interest earned. d. He should deposit it in the regular bank account because the interest rate is higher.

ANSWER: b 43. Andrew is planning to deposit $1,000 in either a regular bank account or an Individual Retirement Account.

He will withdraw the money during retirement, which begins in one year. His income tax rate is 20%, and the interest rate is 10%. Which of these is TRUE? a. He will pay $16 in income tax in one year if he deposits his money in a regular bank account. b. He will pay $20 in income tax in one year if he deposits his money in a regular bank account. c. He will have $1,000 in his regular bank account in one year. d. He will have $1,100 in his regular bank account in one year.

ANSWER: a 44. Andrew is planning to deposit $1,000 in either a regular bank account or an Individual Retirement Account (IRA). He will withdraw the money during retirement, which begins in one year. His income tax rate is 20%, and the interest rate is 10%. Which of these is TRUE? a. He will pay $20 in income tax in one year if he deposits his money in a regular bank account. b. He will net $880 after taxation in one year if he deposits his money in an IRA. c. He will net $920 after taxation in one year if he deposits his money in a regular bank account. d. He will have $1,000 in his regular bank account in one year.

ANSWER: b 45. Andrew is planning to deposit $1,000 in either a regular bank account or an Individual Retirement Account (IRA). He will withdraw the money during retirement, which begins in one year. His income tax rate is 20%, and the interest rate is 10%. Which of these is TRUE? a. He will pay $10 in income tax in one year if he deposits his money in a regular bank account. b. He will net $920 after taxation in one year if he deposits his money in an IRA. c. He will net $864 after taxation in one year if he deposits his money in a regular bank account. d. He will have $1,000 in his regular bank account in one year.

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Chapter 22 ANSWER: c 46. Andrew is planning to deposit $1,000 in either a regular bank account or an Individual Retirement Account (IRA). He will withdraw the money during retirement, which begins in one year. His income tax rate is 20%, and the interest rate is 10%. Which of these is TRUE? a. He will pay $220 in income tax in one year if he deposits his money in an IRA. b. He will net $1,100 after taxation in one year if he deposits his money in an IRA. c. He will net $880 after taxation in one year if he deposits his money in a regular bank account. d. He will have $1,000 in his regular bank account in one year.

ANSWER: a 47. Between 2000 and 2020, assets in 401(k) accounts have: a. nearly quadrupled. b. barely recovered from the Great Recession. c. stayed fairly constant. d. become less popular.

ANSWER: a 48. More than _____ million people have 401(k) accounts. a. 58 b. 152 c. 237 d. 310 ANSWER: a 49. In 2020, assets in 401(k) plans were around $_____ trillion. a. 6.5 b. 1.7 c. 20.8 d. 28.3 ANSWER: a 50. A major appeal of 401(k) plans is that: a. taxes are deferred until retirement, so that the investor to earn interest on them in the meantime. b. during retirement, withdrawals are tax-free. c. deposits are fully insured by the FDIC. d. there is a separate, lower, tax table for withdrawals.

ANSWER: a 51. Which is NOT true about 401(k) retirement plans? a. Contributions to 401(k) plans result in a 26% tax credit.

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Chapter 22 b. Between 2000 and 2020, assets in 401(k) plans nearly quadrupled. c. Contributions to 401(k) plans are deductible from current taxable income. d. Withdrawals during retirement are taxable income.

ANSWER: a 52. Tax breaks for retirement savings are generally: a. regressive. b. progressive. c. proportional. d. capped.

ANSWER: a 53. Currently, people in the 80th to 99th income percentiles receive an average tax benefit of _____ of their pretax income from retirement savings, whereas those in the bottom quintile receive _____ tax benefit. a. 2.67%; essentially no b. 80–99%; a 0% c. essentially zero; a 2.67% d. 2.67%; about the same ANSWER: a 54. To encourage retirement savings, Democrats tend to promote: a. employer-sponsored pensions and the Social Security program. b. regressive tax breaks. c. privatizing Social Security. d. capital income taxation.

ANSWER: a 55. Individual retirement accounts are intended to be: a. a complement to Social Security. b. a substitute for Social Security. c. another name for Social Security. d. a strategy to make more funds available for investment.

ANSWER: a 56. During the election campaign, then-candidate Joe Biden's proposed change for 401(k) retirement accounts: a. included a 26% tax credit for contributions. b. would permit taxpayers to deduct contributions. c. increased incentives for high-wage earners and lowered incentives for low-wage earners. d. would have replaced the Social Security program with 401(k) accounts.

ANSWER: a Copyright Macmillan Learning. Powered by Cognero.

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Chapter 22 57. In the 2020 presidential campaign, critics of Candidate Biden's planned changes to the 401(k) retirement program claimed his plan would _____, which he clearly said he would not do. a. raise taxes on households making under $400,000 b. raise taxes on households making over $400,000 c. replace the current Social Security program with private accounts d. combine individuals' 401(k) accounts with Social Security accounts ANSWER: a 58. Suppose Jesse earns income equal to $82,000 in period 1 but that his income drops to $19,170 in period 2. (a) Sketch his intertemporal budget constraint, assuming a 6.5% rate of interest. Add an indifference curve that assumes he optimally chooses to save $40,000 in period 1. (b) Show the effect of a 50% tax on interest income, assuming the substitution and income effects cancel each other out.

ANSWER: (a) By saving $40,000, Jesse's period 1 consumption is reduced to $42,000 (Income – Saving), but his period 2 consumption is increased by (40,000)(1.065) = $42,600 to $61,770 when period 2 income (from savings + interest) is added. (b) The tax on interest has no effect if Jesse sets consumption equal to income in each period. If there is no saving, there is no interest income to tax. Therefore, the new budget constraint follows the old budget constraint until the points (82,000; 19,170). At that point, the new budget constraint pivots down. As saving increases, the after-tax rate of interest is now 3.25% instead of 6.5%, so the highest possible value of period 2 consumption (when savings is equal to $82,000) is 19,170 + (82,000)(1.0325) = $103,835. If the income and substitution effects cancel, then Jesse will continue to save $40,000 after the interest tax is imposed. Period 1 consumption is therefore unchanged, but period 2 consumption is reduced to $60,470 since the after-tax interest rate fell.

All of the answers can be shown in the following graph.

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Chapter 22

59. How does the precautionary saving model differ from the intertemporal choice model of saving? Discuss the importance of the functioning of credit markets with respect to the precautionary saving model.

ANSWER: The intertemporal choice model assumes that people save in order to smooth consumption over time. The precautionary saving model accounts for the fact that people also save for smoother consumption over future uncertainties. In principle, a person subjected to an adverse shock could borrow to smooth consumption. However, the precautionary saving model assumes that liquidity constraints in the credit market limit people's ability to borrow during an adverse shock. For example, banks may be unwilling to lend money to an unemployed person; as a result, the person saves instead.

60. Suppose that the government proposes to eliminate unemployment insurance. Which model, the intertemporal choice model of saving or the precautionary saving model, would predict the larger change in savings in consequence? Explain and be sure to note any empirical evidence that might be relevant.

ANSWER: The precautionary saving model would predict larger effects of this policy change since that model accounts for the fact that saving is motivated by a person's desire to self-insure against risk as well as to smooth consumption over time. The government's proposal in this case would increase the risks people face; people would thus increase saving to compensate for the increased risk. Empirical evidence is consistent with the precautionary saving model in this regard; several studies have found that as social insurance programs are expanded (reducing risks), savings are reduced.

61. Tatiana is going to save $1,000 of her income for one year, after which she will spend it along with any accumulated interest she earns. Assume that her marginal income tax rate is 50%. Consider these two options: Option 1: Invest in a regular savings account earning 10% interest.

Option 2: Invest in an IRA earning 10% interest.

Determine the after-tax value of her savings a year from now under both options. If the amounts are the same, explain why. If the amounts are different, explain why they are different.

ANSWER: Under option 1, Tatiana pays taxes both on her contribution of $1,000 and on the interest earned on her savings. Consequently, she invests $500. It earns $50 in interest, of which she pays $25 in taxes.

As a result, one year from now, she will have $525.

Under option 2, because she does not pay taxes initially on her contribution of $1,000; she earns $100 in interest. She pays 50% of the withdrawal in taxes, equal to $550. One year from now, she will have $550 (assuming that the money will be withdrawn after retirement).

With the IRA, she earns interest on income that would have been taxed away had she invested in a regular savings account. Even though she is taxed on that interest income eventually, the amount she accrues is higher. This difference will be compounded over time if she saves for more years.

62. Suppose that Lilistan has two types of citizens: low-income citizens (income = $20,000) and high-income citizens (income = $80,000). Interest income is taxed, and each type of citizen saves 10% of their income for retirement. The government is proposing to allow citizens to put money into an IRA, where the contributions would be tax deductible and interest would accumulate tax-free. Withdrawals would be taxed as income. The government wants to set a $5,000 annual limit on the accounts. Discuss the effect of this policy on the saving choices of both the low-income and high-income citizens in terms of both income and substitution effects as well as the overall effect.

ANSWER: The low-income citizens are now saving $2,000. Under the new policy, they would reshuffle and Copyright Macmillan Learning. Powered by Cognero.

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Chapter 22 save in the IRAs. Since they would not yet hit the $5,000, a substitution effect would induce them to save more (a marginal effect), since the opportunity cost of consuming today is higher than it was without the tax subsidy. However, the policy also would create an income effect, since people would have to save less to achieve a certain level of consumption in the future. This income effect would induce them to save less. Consequently, the net effect of this policy on low-income citizens would be ambiguous.

The high-income citizens are saving $8,000. Under the new policy, they would reshuffle $5,000 of this into IRAs. Since they meet the annual contribution limit, the creation of IRAs would not generate a substitution effect. However, by moving $5,000 to an IRA, a high-income person would accumulate more wealth over time because of the tax subsidy and therefore would have to save less to achieve a given level of consumption in retirement. High-income citizens would thus save less.

Consequently, the establishment of IRAs would unambiguously reduce the savings of high-income citizens.

63. Suppose that the President and Congress were to pass a law stating that future shortfalls in the Social Security program would be funded with across-the-board increases in income taxes at the time of the shortfalls (and well after their tenure as elected officials). How will this law affect the relative attractiveness of traditional IRAs versus Roth IRAs to a 25-year-old today? Explain.

ANSWER: Traditional IRAs allow a person to deduct current contributions, to allow interest to collect tax-free, and to pay taxes on the withdrawals. In contrast, Roth IRAs allow a person to save after-tax income and make withdrawals tax free. If one expects taxes to rise in the future, there is an increased incentive to use a Roth IRA because withdrawals in the future (when taxes are high) will be tax-free.

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Chapter 23 1. Which of these is NOT a characteristic of opportunity zones, as designated in the Tax Cuts and Jobs Act of 2017? a. They are subject to reduced capital gains taxation. b. They are insulated from political lobbying regarding projects undertaken in them. c. They were designed to increase investment in low-income areas. d. They initially received bipartisan support in Congress.

ANSWER: b 2. Opportunity zones, as designated in the Tax Cuts and Jobs Act of 2017, originally had bipartisan support.

However, they lost the support of most Democratic lawmakers because: a. projects in opportunity zones benefit many wealthy investors and high-income residents. b. the projects mostly benefit lower-income families and not the middle class. c. there have been insufficient opportunities for lobbying in the implementation of the tax breaks. d. too much potential tax revenue is being lost through the program.

ANSWER: a 3. In the United States, taxes on wealth include: a. income taxes and sales taxes. b. sales taxes and property taxes. c. property taxes and transfer taxes. d. transfer taxes and income taxes.

ANSWER: c 4. Suppose that the government taxes any positive return on an asset and allows a full deduction of a negative return against taxable income. Which statement is TRUE under this scenario versus one under which there are no taxes? a. These tax policies do not affect risk taking, provided the expected value of the investment is positive. b. These tax policies increase risk taking. c. These tax policies reduce risk taking. d. These tax policies do not affect risk taking, regardless of the expected value of the investment.

ANSWER: b 5. Suppose that there is a 50% chance that an investment of $1,000 rises in value to $1,200 and a 50% chance that the investment falls in value to $900. What is the expected return on the investment? a. −$100 b. $50 c. $100 d. $200 ANSWER: b 6. Suppose that there is a 25% chance that an investment of $1,000 will rise in value to $1,400 and a 75% chance that the investment will fall in value to $900. What is the expected return on the investment?

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Chapter 23 a. −$125 b. −$25 c. $25 d. $100 ANSWER: c 7. Suppose that there is a 75% chance that an investment of $1,000 will rise in value to $1,500 and a 25% chance that the investment will fall in value to $700. What is the expected return on the investment? a. −$125 b. $25 c. $200 d. $300 ANSWER: d 8. Suppose that there is a 25% chance that an investment of $1,000 will rise in value to $1,400, a 25% chance that the investment will remain at $1,000, and a 50% chance that the investment will fall in value to $500. The government introduces a 50% tax on returns to investment and allows a deduction against taxable income for any losses (assume that the tax rate is 50%). What is the expected return on the investment? a. −$75 b. −$125 c. $85 d. $150 ANSWER: a 9. Suppose that the government taxes income and investment earnings at 25% and allows half of investment losses to be deducted from taxable income up to a maximum of $3,000 per year. Which of these amounts is equal to the tax loss offset for someone who lost $5,000 on investments last year? a. $2,500 b. $3,000 c. $3,750 d. $5,000 ANSWER: a 10. In the United States, individuals are only allowed to deduct $3,000 as a tax loss offset. As a result of this policy, individuals are: a. more likely to engage in high risk investments. b. unlikely to engage in clearly losing investments. c. less likely to make any investments. d. likely to engage in clearly losing investments at a high frequency.

ANSWER: b 11. Suppose that there is a 25% chance that an investment of $1,000 will rise in value to $1,400, a 25% chance Copyright Macmillan Learning. Powered by Cognero.

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Chapter 23 that the investment will remain at $1,000, and a 50% chance that the investment will fall in value to $900. What is the expected profit associated with the investment? a. $25 b. $50 c. $75 d. $100 ANSWER: b 12. Suppose that the government introduces a 50% tax on returns to investment and allows a deduction against taxable income for any losses (assume that the tax rate on taxable income is also 50%). Which statement is TRUE? a. This tax policy reduces the incentive to invest in risky assets. b. If an investment loses money, the investor bears only half the loss. c. If an investment makes money, the investor keeps the entire payoff. d. The investor pays less in taxes if the return is positive.

ANSWER: b 13. Assume that investment earnings are taxed, that losses are deducted against taxable income, and that the tax structure is progressive. Which statement is TRUE? a. Positive returns are taxed at the same rate as the rate at which negative returns are deducted. b. Positive returns are taxed at a lower rate than the rate at which negative returns are deducted. c. Positive returns are taxed at a higher rate than the rate at which negative returns are deducted. d. There is a greater incentive to take on risk than if taxation were proportional.

ANSWER: c 14. Suppose there is a flat tax on income and that the costs of increasing human capital (e.g., tuition payments) are fully tax deductible. In this scenario: a. individuals are incentivized to acquire as much education as possible. b. individuals are incentivized to avoid education. c. comparative advantage would lead some individuals, but not others, to acquire education. d. individuals would seek to minimize income and education to avoid taxes.

ANSWER: a 15. Most countries have progressive taxes on income. Progressive taxation: a. incentivizes the acquisition of human capital. b. disincentivizes the acquisition of human capital. c. has no effect on the acquisition of human capital. d. has an ambiguous effect on the acquisition of human capital.

ANSWER: d 16. Which of these assets CANNOT have a capital gain? a. a share of a mutual fund Copyright Macmillan Learning. Powered by Cognero.

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Chapter 23 b. a piece of art c. a bank account d. real estate ANSWER: c 17. A capital gain is BEST defined as the: a. accumulation of assets that comes from increased saving. b. difference between an asset's purchase price and its sale price. c. portion of investment earnings that is not taxed. d. portion of investment earnings that is taxed.

ANSWER: b 18. Which of these assets could yield a capital gain? a. a savings account b. a bank certificate of deposit c. a house d. a checking account ANSWER: c 19. Taxation on accrual is BEST defined as: a. the extent to which taxpayers can deduct net losses on investments from their taxable income. b. taxes paid on an asset's return only when that asset is sold. c. taxes paid each period on the return earned by an asset in that period. d. capital gains tax cuts that apply only to investments made from this day forward.

ANSWER: c 20. Assets that earn interest are taxed on _____; capital gains are taxed on _____. a. realization; accrual b. accrual; realization c. accrual; accrual d. realization; realization ANSWER: b 21. The step-up of basis at death refers to a change in the basis of an asset from its: a. purchase price to its price at the time of the owner's death. b. price at the time of the owner's death to its purchase price. c. purchase price to its price at the time it is sold. d. price at the time it is sold to its price at the time of the owner's death.

ANSWER: a 22. Suppose that Shakia purchases a rare coin in 1975 for $20. On her death in 2021, the coin is worth $4,500.

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Chapter 23 Her son, Antoine, inherits the coin and sells it immediately upon his mother's death. The amount of capital gains on which Antoine would be taxed is: a. $0. b. $4,480. c. the inflation-adjusted difference between $4,500 in 2021 and $20 in 1975. d. $4,450.

ANSWER: a 23. Under most circumstances, capital gains on which asset are NOT taxed under U.S. law? a. residential homes b. original artwork c. stocks d. cryptocurrencies ANSWER: a 24. If an individual purchases an asset and sells it before he dies, the capital gains tax burden is based on the: a. sale price minus the basis. b. sale price. c. purchase price. d. basis.

ANSWER: a 25. Suppose a person buys a share of stock for $10. The day before the person dies, the stock is worth $20, as it is the day after the person dies. If the stock were sold the day before the person died, the basis would be $_____; if the stock were sold the day after the person died, the basis would be $_____. a. 10; 20 b. 10; 0 c. 20; 10 d. 20; 0 ANSWER: a 26. Fleur put $10 into a savings account. A year later, the account has $12 in it, all of which she withdrew. The tax rate on accrual is 50%, and the tax rate on realization is 25%. How much tax on accrual does Fleur owe? a. $6 b. $1 c. $2 d. No tax is owed.

ANSWER: b 27. Suppose a person buys a share of stock for $10. The rate of taxation on accrual is 50%, and the rate of taxation on realization is 25%. The day before the person dies, the stock is worth $20, as it is the day after the person dies. If the stock were sold the day before the person died, the government would receive $_____ in Copyright Macmillan Learning. Powered by Cognero.

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Chapter 23 taxes; if the stock were sold the day after the person died, the government would receive $_____ in taxes. a. 5; 5 b. 0; 5 c. 2.50; 0 d. 5; 2.50 ANSWER: c 28. Which statement about capital gains tax rates is TRUE? a. The top tax rate on capital gains is higher than the top tax rate on other income in the United States. b. There is widespread agreement concerning how capital gains should be taxed. c. The 2003 Jobs and Growth Act reduced the top tax rate applied to capital gains realized after May of 2003. d. Income on a capital gain is taxed the same as labor income in the United States.

ANSWER: c 29. Those who advocate reducing or eliminating the capital gains tax believe that: a. the tax discourages risk taking and that risk taking leads to economic growth and job creation. b. the tax encourages risk taking and that risk taking leads to more corporate bankruptcies. c. people who have a high tolerance for risk pay no attention to the effect of taxation on returns. d. there are equity reasons not to tax capital gains but not efficiency reasons.

ANSWER: a 30. The lock-in effect implies that individuals may: a. sell capital assets too quickly in order to avoid the risk that policy makers will increase the capital gains tax rate. b. delay selling capital assets to minimize the present discounted value of capital gains tax payments. c. sell capital assets just before they die, so that their heirs will not be forced to pay tax on the gains. d. leave cash to their children rather than capital assets in order to minimize the tax complications.

ANSWER: b 31. Some argue that capital gains tax reductions are NOT a cost-effective way to spur entrepreneurship because they: a. reward future risk taking without rewarding past risk taking. b. reward past risk taking without rewarding future risk taking. c. encourage irresponsible risk taking. d. reward not only future risk taking but also past risk taking.

ANSWER: d 32. A prospective capital gains tax reduction (i.e., a cut in the rate on investments made from today forward) would: a. reduce government revenues more than a similar reduction in the tax rate on all capital gains, including those on past investments.

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Chapter 23 b. reward past risk taking without rewarding future risk taking. c. have a larger marginal effect on risk taking than a similar reduction in the tax rate on all capital gains, including those on past investments. d. be much less costly than a similar reduction in the tax rate on all capital gains, including those on past investments.

ANSWER: d 33. The primary source of wealth for most entrepreneurs comes from: a. interest on the income earned early in the life of the business. b. an increase in the value of the business asset over time. c. tax deductions against other sources of income enabled by owning a business. d. tax credits earned by starting a business.

ANSWER: b 34. Proponents of a lower tax rate on capital gains argue that it would encourage entrepreneurial activity.

Opponents argue each of these EXCEPT that: a. there is a lack of clear evidence that taxing risk taking discourages risk taking. b. only a small fraction of capital gains accrues to entrepreneurs. c. entrepreneurs are relatively few in the United States, and most economic investment is undertaken by the government. d. most of the benefits of capital gains go to those who made investments in the past rather than those currently engaged in entrepreneurial activity.

ANSWER: c 35. A prospective capital gains tax reduction, that is, a cut in the rate on investments made from today forward, would _____ than a similar reduction in the tax rate on all capital gains, including those on past investments. a. have a smaller inframarginal effect on risk taking b. reduce government revenues by more c. have a smaller marginal effect on risk taking d. have a larger marginal effect on risk taking ANSWER: a 36. With a lower tax on capital gains, the government is effectively subsidizing all of these activities EXCEPT: a. new investments. b. investments that would have happened anyway, and are now taxed at a lower rate. c. investments made in the past. d. funds added to savings accounts.

ANSWER: d 37. Arguments against tax preferences for capital gains include which of these? a. Tax preferences for capital gains taxes make the tax system more regressive, as wealthier individuals are more likely to earn income through capital gains than are middle- and lower-income individuals.

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Chapter 23 b. Tax preferences for capital gains do not affect investment behavior and hence don't incentivize increased investment. c. Capital gains taxes mostly affect corporations, which can afford to pay higher taxes. d. Capital gains taxes lead to a weaker currency, which supports exporting industries.

ANSWER: a 38. A study by Agersnap and Zidar concludes that capital gains tax cuts have a relatively small (positive) effect on capital gains realizations in the long run. Their finding supports a policy of: a. decreasing the capital gains tax rate. b. leaving the tax rate on capital gains unchanged. c. increasing the capital gains tax rate. d. eliminating the tax on capital gains.

ANSWER: c 39. Which statement about transfer taxes in the United States is TRUE? a. The estate tax is not very progressive. b. Gifts of up to $100,000 per person per year are not taxed. c. Gifts of up to $15,000 per person per year are not taxed. d. Estate taxes were abolished in 2010 and have not been reinstated.

ANSWER: c 40. Which statement about transfer taxes in the United States is TRUE? a. One's estate is defined as whatever is left of one's wealth at death. b. For 2006 through 2009, the estate tax exempted the first $350,000 of one's wealth from taxation. c. Transfers to spouses on death are deductible from estate taxes. d. Wealthy individuals who will be subject to the estate tax cannot avoid taxation by transferring wealth to heirs before death.

ANSWER: c 41. Which statement regarding transfer taxes is NOT true? a. The gift tax and the estate tax are two types of transfer tax. b. Any gift above $15,000 is subject to a gift tax. c. The estate tax currently exempts the first $11.6 million of one's gifts and estate from taxation. d. The United States raises about 5% of its revenues from transfer taxes.

ANSWER: d 42. Arguments against the estate tax include all of these EXCEPT that: a. the estate tax amounts to double taxation. b. the estate tax primarily targets low-income families. c. to pay the estate tax, an heir may need to sell the asset. d. it is unfair, as only unsophisticated taxpayers are unable to avoid the tax.

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Chapter 23 ANSWER: b 43. A common method used by taxpayers to avoid the estate tax is to: a. create a trust prior to death to provide funds to beneficiaries. b. transfer all of an estate to beneficiaries prior to death. c. transfer all of an estate to a third-country tax haven prior to death. d. purchase government treasuries and transfer those assets to the beneficiaries after death.

ANSWER: a 44. Arguments in favor of the estate tax include all of these EXCEPT that it: a. is highly progressive, with the tax usually affecting only higher-income households. b. is needed to avoid excessive concentrations of wealth. c. incentivizes heirs to work hard and acquire education. d. provides a very large source of revenue to the government.

ANSWER: c 45. If a town is in a perfect Tiebout equilibrium (all residents value public goods at their tax cost), then: a. there is no burden associated with property taxation, as it is simply a price that residents voluntarily pay for public goods. b. the burden of property taxation falls on homeowners, as those with more expensive homes pay more in taxes. c. the burden of property taxation is much higher in communities with superior public goods (education and city services). d. the burden of property taxation is split between land and improvements (structures).

ANSWER: a 46. Henry George advocated a tax on land rather than labor and capital, maintaining that a tax on land, in contrast to taxes on these other factors: a. does not discourage effort. b. discourages effort. c. discourages people from owning land. d. has no effect on the decisions made by landowners.

ANSWER: a 47. Which of these is TRUE regarding property taxes? a. The federal government collects a large portion of revenue from property taxes. b. They are the single largest source of tax revenue at the local level. c. Local communities generate a very small portion of tax revenues from property taxes. d. Property tax rates are typically constant within states.

ANSWER: b 48. Which of these is TRUE regarding property taxes?

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Chapter 23 a. Property tax collection has fallen dramatically since the 1980s. b. State and local governments collected $564 billion in property taxes in 2019. c. Property taxes are levied on the market value of the property. d. The federal government collected about $500 billion in property taxes in 2019.

ANSWER: b 49. Which of these estate tax loopholes did the Obama administration attempt to close? a. nontaxation of estates passed to spouses b. the reduction in value for tax purposes of estates categorized as family businesses c. exemption of the first $11 million of an estate from taxation d. the tax deductibility of funeral expenses ANSWER: b 50. In 2017, Foxconn, a Taiwanese consumer electronics manufacturer, announced that it would build a manufacturing plant in Wisconsin. Which of these is TRUE of Foxconn's decision? a. It will take until at least 2143 for the state to recoup its lost revenue from the incentives it offered Foxconn. b. Foxconn chose to build in Wisconsin over other potential sites in the United States because of the tax incentives. c. Foxconn was offered about $100 million in tax breaks. d. The manufacturing facility that Foxconn is building in Wisconsin will cost about $1 billion to construct.

ANSWER: b 51. Under the traditional model of property tax incidence, who bears the burden of property taxes? a. local residents b. primarily renters c. capital owners d. no one ANSWER: a 52. Under the capital tax view of property tax incidence, who bears the burden of property taxes? a. local residents b. primarily renters c. capital owners d. no one ANSWER: c 53. Under the benefits tax view of property tax incidence, who bears the burden of property taxes? a. local residents b. primarily renters Copyright Macmillan Learning. Powered by Cognero.

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Chapter 23 c. capital owners d. no one ANSWER: d 54. Maria purchased a share of stock for $100. After one year, there is a 50% probability that the value of the stock will rise to $140 and a 50% probability that the value of the stock will remain unchanged. What is the expected return on this investment? (Show work.)

ANSWER: The expected return is (0.5)($40) + (0.5)($0) = $20.

55. Ali purchased a share of stock for $100. After one year, there is a 50% probability that the value of the stock will rise to $150 and a 50% probability that the value of the stock will fall to $80. What is the expected return on this investment? (Show work.) Now suppose the government has introduced a 50% tax on investment income with a deduction against taxable income for any losses. How does the tax affect the expected return on the investment? (Show work.)

ANSWER: The expected return is (0.5)($50) + (0.5)(−$20) = $15. With a 50% tax, Ali has a 50% probability of earning a $25 after-tax return and a 50% probability of incurring a $10 after-tax loss, so his expected return is now (0.5)($25) + (0.5)(−$10) = $7.50.

56. What are the two fundamental reasons a tax preference for capital gains is hard to eliminate for many capital goods?

ANSWER: First, it may not be possible to measure accruals for many assets. Although the government could tax the yearly accrual in the value of a stock by using the year-to-year change in the value of the stock, it is unclear how to estimate the year-to-year accrual in the value of a house or of a painting.

The second problem is that, even if the government could appropriately measure accruals, individuals may not be able to make the required tax payments, given the high volatility of asset prices. If, for example, the price of a stock were to rise significantly, the resulting capital gain may be so large that an individual could pay the annual tax only by selling some of the stock. It would be inefficient for individuals to divest themselves of productive assets simply to make tax payments.

57. What are the three ways in which capital gains are subsidized over interest-bearing savings accounts in the U.S. tax code?

ANSWER: First, while assets that earn interest are taxed on accrual, capital gains are taxed on realization. By paying taxes upon sale of the asset rather than as value is accrued, one can earn interest on what would have been paid in taxes had the money been invested in an asset that was taxed on accrual.

Second, the capital gains tax burden on an asset sold after the purchaser dies is based on the sale price minus the price of the asset at the time of death, not the purchase price.

Third, capital gains on houses have typically been excluded from taxation. Consequently, there is a tax incentive to invest in one's home rather than in another form of asset on which the capital gains (or interest) would be taxed.

58. Explain why a lower tax rate on capital gains might be justified as a way to protect investors against inflation. Is there an alternative approach to addressing the inflation problem? Explain.

ANSWER: If inflation is 10%, and the value of an asset (e.g., a share of stock) increases by 10% before the investor sells it, then the investor pays capital gains taxes on the 10% nominal increase in price, even though the stock is worth no more than it was originally worth in real terms. However, as the same is true for other types of savings, this argument does not justify tax policies that favor capital Copyright Macmillan Learning. Powered by Cognero.

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Chapter 23 gains over other types of capital income. The inflation problem can also be addressed by indexing the tax system.

59. Suppose Jack owns a warehouse in a rapidly expanding part of a town. Because of the location of the warehouse, it has increased in value from $300,000 (the price Jack paid for it) to $400,000 (the price Jack would get if he were to sell it). A doctor has recently told Jack that he has one year to live—and the doctor is always right about such things. The capital gains tax rate is 25%. Jack's wealth will be distributed among his children when he dies. The warehouse is not being used. Jack must decide whether to sell the warehouse now and pass the cash on to his children. Assume that there is no estate tax but that the capital gains tax code is the same as that in place in the United States. (a) What is the socially efficient thing for Jack to do? Explain. Be sure to describe the tax implications of the answer as well. (b) What should Jack to do? Explain. Be sure to describe the tax implications of the answer as well.

ANSWER: (a) The socially efficient option is to move assets to where they are most productive. Since Jack is not using the warehouse productively, he should sell it for $400,000. Jack would pay 25% of the $100,000 capital gain on the warehouse and would thus get to keep $375,000 from the sale. (b) Once Jack dies, the basis gets bumped up to the value of the asset at the time of death.

Consequently, Jack's children would not have to pay any taxes on the capital gains and would get to keep the entire $400,000, since there is no estate tax.

60. Discuss the views of supporters and opponents of estate taxes.

ANSWER: Warren Buffett, along with other wealthy Americans such as William Gates, Sr., and George Soros, has long been an outspoken critic of moves to repeal the estate tax, a tax levied on large estates upon the death of their owners. Buffett has argued that allowing children to inherit all of their parents' riches causes them to be spoiled and sapped of all motivation and that keeping the tax in force helps to preserve America's meritocracy. He has also said that "it's a very equitable tax. It's in keeping with the idea of equality of opportunity in this country, not giving incredible head starts to certain people." Many others have also defended the estate tax for its progressivity: they note that because of the high exemption levels, the tax affects only a very small number of the wealthiest citizens upon their death. Opponents of the estate tax, however, point out that much of the estate was already taxed when estate holders were alive, so it amounts to a double taxation of their income. This double taxation may lead the wealthy to earn and save less. Opponents of the estate tax also view it as a death tax, one that imposes a government penalty for the act of dying itself, an insult added to the ultimate injury.

61. A wealthy woman who is 60 years old wants to know how to pass on her wealth to her children without paying more than necessary in taxes. What are some good strategies for minimizing her tax burden?

ANSWER: First, she can make use of the annual gift that can be made to each child each year tax-free.

Currently the limit is $15,000 per person per year. In this way, she can give away some of her wealth to her children without being subject to transfer taxes. She can also look into setting up trust funds, a legal way of ensuring that her children get all the benefits tax free. Finally, point out that taxes are levied only on transfers of property and cash, not on services. Consequently, she could pay for family trips, for example, without being subject to transfer taxes.

62. Many county fairs have auctions at which the animals raised by children are sold to the highest bidders and the children get to keep the proceeds. For various reasons, the prices received by the children are typically much Copyright Macmillan Learning. Powered by Cognero.

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Chapter 23 higher than the market prices would be for similar animals. (a) Suppose many of the bids were won by the grandparents of the children. Why might this behavior be caused by the existence of transfer taxes? (b) On the other hand, perhaps the grandparents just wished to support the agricultural endeavors of their grandchildren. Describe a way in which an empirical researcher could distinguish between this explanation and the tax explanation in part (a).

ANSWER: (a) The grandparents may wish to transfer money to a child tax-free. By purchasing a product from the child (albeit at an inflated price), the grandparents avoid transfer taxes on that income. (b) If we were to observe that the grandparents who won the auctions gave less than $15,000 per year to the children who sold the animals, we might conclude that the grandparents were not trying to avoid taxes. In contrast, if the grandparents who won the bids were giving more than $15,000 per year to the children who sold the animals, we might conclude that the grandparents bid on the animals to avoid paying taxes on additional transfers.

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Chapter 24 1. In 1960, corporate income taxes accounted for about _____% of federal tax revenues. Currently, they are expected to average about _____% of federal tax revenues through 2030. a. 7; 25 b. 25; 7 c. 35; 12 d. 35; 4 ANSWER: b 2. Under the Tax Cuts and Jobs Act of 2017, the statutory corporate tax rate in the United States fell from 34% to ______%. a. 10 b. 18 c. 13 d. 21 ANSWER: d 3. The Tax Cuts and Jobs Act of 2017 sharply decreased the U.S. statutory corporate tax rate. A major argument of opponents this tax cut was that: a. most U.S. corporations already paid a significantly lower effective rate due to tax code loopholes. b. most European countries had higher corporate tax rates. c. the United States would lose a large amount of its tax revenues as a result of the tax cut. d. individual states would choose to keep the old tax rate, leading to differential corporate tax rates across the country.

ANSWER: a 4. _____ are people who have purchased ownership stakes in a company, and _____ are a group of people who meet periodically to review decisions made by a firm's management and report to the broader set of owners on management's performance. a. Corporate executives; shareholders b. Shareholders; corporate executives c. Corporate executives; the board of directors d. Shareholders; the board of directors ANSWER: d 5. The difference between S- and C-corporations is that: a. S-corporations are incorporated abroad, whereas C-corporations are incorporated in the United States. b. income from S-corporations is treated as personal income for tax purposes, whereas income from Ccorporations is subject to the corporate income tax. c. S-corporations are privately held, whereas C-corporations are publicly traded and owned by a number of investors. d. C-corporations have existed for more than ten years, whereas S-corporations are newly incorporated.

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Chapter 24 ANSWER: b 6. What is the major advantage of incorporation? a. The corporate structure solves the agency problem. b. The corporate structure renders income tax rates significantly lower than for other firms. c. The owners of an incorporated firm are not personally liable for obligations of the firm. d. For incorporated firms, expenses can be deducted from income.

ANSWER: c 7. The separation of ownership of a firm from control of the firm leads to: a. debt financing. b. equity financing. c. depreciation. d. an agency problem.

ANSWER: d 8. The agency problem arises when: a. the interests of the owners of a firm do not match those of the manager. b. a firm must use intermediaries, or agencies, for many of its transactions. c. government agencies, such as the IRS and FTC, alter a corporation's structure and activities. d. firms compete for workers (free agents) who have market power to set their own wages.

ANSWER: a 9. Which of these is NOT a source of investment financing for firms? a. debt b. equity c. retained earnings d. dividends ANSWER: d 10. Limited liability means that: a. there are tight limits on the damages that a firm can be forced to pay due to lawsuits over product safety. b. the owners of a firm cannot personally be held responsible for the obligations of the firm. c. a manufacturer guarantees the operability of a machine or tool only for a limited period of time after purchase. d. the owners of a firm are personally responsible for the obligations of the firm for only one year after bankruptcy.

ANSWER: b 11. _____ is the raising of funds by selling _____. a. Debt finance; bonds Copyright Macmillan Learning. Powered by Cognero.

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Chapter 24 b. Debt finance; stocks c. Equity finance; bonds d. Equity finance; IOUs ANSWER: a 12. Which term refers to the increase in the price of a share since its purchase? a. dividend b. capital gain c. pure profit d. economic profit ANSWER: b 13. Which term refers to the difference between a firm's revenues and its reported costs of production? a. dividend b. pure profit c. economic profit d. accounting profit ANSWER: d 14. Which statement about corporate taxation is TRUE? a. A tax on pure (economic) profit causes a firm to reduce output and employment. b. Currently, corporations are not part of the tax base in the United States. c. If corporations are not taxed on their earnings but people are taxed on corporate payouts, there is a subsidy to corporate earnings relative to other types of saving. d. If corporations are taxed on their earnings but people are not taxed on corporate payouts, there is a subsidy to corporate earnings relative to other types of saving.

ANSWER: c 15. An amount of money periodically paid to shareholders per share owned out of profits is a(n): a. dividend. b. capital gain. c. interest payment. d. accounting profit.

ANSWER: a 16. A return that exceeds a firm's payouts to its factors of production is: a. a dividend. b. a capital gain. c. pure profit. d. accounting profit.

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Chapter 24 17. The difference between a firm's revenues and its opportunity costs of production is: a. a capital gain. b. pure profit. c. economic profit. d. accounting profit.

ANSWER: c 18. Firms pay taxes on _____. An optimal tax on corporate profit would be levied on _____. a. economic profits; dividends b. economic profits; accounting profits c. capital gains; economic profits d. accounting profits; economic profits ANSWER: d 19. Corporate taxes can be calculated based on: a. Taxes = ([Revenues − expenses] × tax rate) − tax credits b. Taxes = ([Revenues − expenses] × [1 − tax rate]) − tax credits c. Taxes = ([Revenues − expenses] × [1 − tax rate]) + tax credits d. Taxes = ([Revenues − expenses] × tax rate) + tax credits ANSWER: a 20. The amount of money that firms can deduct from its taxes to account for capital investment depreciation is called: a. a depreciation credit. b. a depreciation allowance. c. economic depreciation. d. a depreciation schedule.

ANSWER: b 21. The rate at which capital investments lose their value over time is called _____. Deducting the entire cost of the investment from taxes in the year in which the purchase was made is called _____. a. depreciation; tax fraud b. depreciation; expensing investments c. an investment tax credit; depreciation d. an investment tax credit; tax fraud ANSWER: b 22. A straight-line depreciation schedule allows an asset to be deducted from earnings more _____ than an accelerated depreciation schedule and more _____ than expensing the investment. a. quickly; quickly b. quickly; slowly Copyright Macmillan Learning. Powered by Cognero.

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Chapter 24 c. slowly; slowly d. slowly; quickly ANSWER: c 23. Suppose a corporation purchases an asset for $100,000. Under straight-line depreciation, the corporation would be allowed to depreciate the asset over five years. Under accelerated straight-line depreciation, it would be allowed to depreciate the asset over two years. Now assume that the discount rate is 10%. What would the present discounted value of the tax deduction be under straight-line depreciation? a. $83,397.31 b. $90,909.09 c. $93,354.55 d. $100,000 ANSWER: a 24. Suppose a corporation purchases an asset for $100,000. Under straight-line depreciation, the corporation would be allowed to depreciate the asset over five years. Under accelerated straight-line depreciation, it would be allowed to depreciate the asset over two years. What must the discount rate be such that the corporation is indifferent between straight-line depreciation and accelerated straight-line depreciation? a. −10% b. 0% c. 5% d. 10% ANSWER: b 25. A profit-maximizing corporation would generally prefer _____ to _____. a. straight-line depreciation; accelerated depreciation b. expensing investments; accelerated depreciation c. straight-line depreciation; expensing investments d. no depreciation; straight-line depreciation ANSWER: b 26. Which kind of depreciation is the TRUE deterioration in the value of capital in each period of time? a. accounting depreciation b. depreciation allowances c. economic depreciation d. pure depreciation ANSWER: c 27. The vast majority of large corporations face which tax rate? a. 5% b. 10% c. 21% Copyright Macmillan Learning. Powered by Cognero.

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Chapter 24 d. 35% ANSWER: c 28. Which of these groups is unlikely to bear the burden of a corporate tax in the long run? a. consumers b. capital owners c. domestic workers d. foreign workers ANSWER: b 29. Because the demand for products produced by corporations is unlikely to be perfectly elastic, it is likely that a tax on corporate profit will result in _____ product prices, so that _____ of the tax burden falls on consumers. a. higher; some b. lower; none c. higher; none d. lower; some ANSWER: a 30. If corporations bear at least some of the tax burden when profits are taxed, workers are likely to bear some of the burden through _____ wages if the supply of labor is _____ elastic. a. higher; not perfectly b. higher; perfectly c. lower; not perfectly d. lower; perfectly ANSWER: c 31. Using a quasi-experimental methodology with detailed administrative data from Germany, Fuest et al.

(2018) found that about ______% of the incidence of corporate tax changes falls on wages. a. 10 b. 40 c. 50 d. 75 ANSWER: c 32. The marginal benefit of investment is generally assumed to be diminishing because the marginal: a. cost of capital is diminishing. b. product of capital is rising. c. product of capital is diminishing. d. cost of capital is constant.

ANSWER: c 33. Suppose there is a corporate tax on cash earnings minus labor costs. As a result: Copyright Macmillan Learning. Powered by Cognero.

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Chapter 24 a. the return per dollar of investment per period is smaller for a given level of investment than it would be without the tax. b. the marginal cost of investment is higher than it would be without the tax. c. firms invest more than they would without the tax. d. the return per dollar of investment per period is larger for a given level of investment than it would be without the tax.

ANSWER: a 34. What is the effective corporate tax rate when the value of the tax credit for each dollar of investment is $0.25, the tax rate on earnings minus labor is 35%, and the present discounted value of a $1 investment is $0.50? a. −11.53% b. −10% c. 10% d. 88.46% ANSWER: a 35. What is the effective corporate tax rate when the value of the tax credit for each dollar of investment is $0, the tax rate on earnings is 35%, and investments are expensed? a. −50% b. 0% c. 22.75% d. 35% ANSWER: b 36. A positive effective corporate tax rate means that the corporation invests _____ with taxes, deductions, and investment tax credits than it would without them. A negative effective corporate tax rate means that the corporation invests _____ with taxes, deductions, and investment tax credits than it would without them. a. more; more b. more; less c. less; more d. the same amount; less ANSWER: c 37. If a firm finances investment by selling bonds, then the: a. bondholders pay a dividend tax on the interest they later receive. b. bondholders pay personal income tax on the interest they later receive. c. firm pays a corporate tax on the amount it repays to bondholders. d. firm pays a corporate tax on the amount it borrows from bondholders.

ANSWER: b 38. The tax deductibility of depreciation allowances _____ the marginal cost of investment, all else equal; Copyright Macmillan Learning. Powered by Cognero.

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Chapter 24 taxing corporate investment _____ the marginal benefit of investment, all else equal. a. lowers; lowers b. lowers; increases c. increases; lowers d. increases; increases ANSWER: a 39. Suppose that, in a world without taxes, a firm finances an investment by selling equity shares on which it pays a dividend d per dollar invested. The total cost of a $1 investment in each period is: a. the rate of depreciation. b. d. c. the rate of depreciation plus d. d. d minus the rate of depreciation.

ANSWER: c 40. Which of these is NOT a reason a firm might finance investment through equity rather than debt? a. If a firm fails to make payments on bonds, it may face bankruptcy. b. Dividends and capital gains are taxed at a lower rate than interest payments. c. Equity offers more flexibility with respect to how claimants are paid. d. The downside risk of equity financing is limited, whereas the upside potential is considerable.

ANSWER: b 41. Using changes in firm investment decisions after episodes of bonus depreciation, Zwick and Mahon (2017) found that the elasticity of investment with respect to the effective tax rate is: a. 0.5%. b. 1.7%. c. 0.1%. d. 2.2%.

ANSWER: b 42. Which of these statements is TRUE? a. There has traditionally been a tax advantage to compensation through dividends rather than capital gains. b. Investors like to be paid in dividends, despite the tax inefficiency, in part because of an agency problem. c. High dividend taxes typically push firms to choose equity financing over debt financing. d. There is no reason for corporations or investors to prefer either paying dividends or reinvesting profits.

ANSWER: b 43. A tax system in which corporations are taxed by their home countries on their income regardless of where it is earned is called a _____ tax system. Since 2017, the United States has used a _____ tax system.

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Chapter 24 a. territorial; territorial b. territorial; global c. global; territorial d. global; global ANSWER: c 44. Under the previous global tax system, U.S. corporations were: a. not permitted to claim tax payments to foreign governments as a credit against U.S. taxes. b. permitted to claim tax payments to foreign governments as a credit against U.S. taxes. c. exempt from the corporate income tax if they have production facilities located abroad. d. required to pay both foreign taxes and U.S. taxes with no credits.

ANSWER: b 45. U.S. firms are taxed: a. by the U.S. government on profits earned abroad during the tax year in which the profits are earned. b. by the U.S. government on profits earned abroad only when the foreign country collects no taxes. c. only by the government of the country in which profits are earned. d. by the U.S. government on profits earned abroad at much higher rates than on profits earned domestically.

ANSWER: c 46. DEF Corporation's headquarters is located in the United States, but it earns revenue in many other countries, such as Germany. Under current U.S. tax law, DEF Corporation will pay taxes: a. on the revenue it earns in Germany to the German government. b. only in the United States. c. only in Germany. d. on revenue it earns in Germany to both the U.S. and German governments.

ANSWER: a 47. Which of these was NOT a feature of the Trump administration's 2017 tax law: a. a reduction in the corporate tax rate from 35 to 21% b. movement to a territorial tax system c. large tax breaks for unincorporated businesses d. an increase in the repatriation tax to 25.5% ANSWER: d 48. According to recent research on corporate tax incidence, which of these is TRUE? a. Corporate taxes are not shifted to wages. b. About 25% of corporate taxes are shifted to wages. c. 35 to 50% of corporate taxes are shifted to wages. d. About 75% of corporate taxes are shifted to wages.

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Chapter 24 ANSWER: c 49. According to past studies, the elasticity of investment with respect to the effective tax rate is −0.5. This means that as: a. taxes lower the cost of investment by 10%, investment increases by 5%. b. taxes lower the cost of investment by 10%, investment increases by 0.5%. c. investment falls by 10%, tax revenue increases by 5%. d. investment falls by 5%, tax revenue increases by 10%.

ANSWER: a 50. A recent study by Zwick and Mahon (2017) examined the response of firm investment decisions to two episodes of bonus depreciation. Which of these is consistent with their findings? a. Depreciation allowances do not significantly impact investment decisions. b. Firms' responsiveness to tax incentives is much lower than previously estimated. c. Reductions in bonuses are strongly tied to increases in investment. d. The elasticity of investment with respect to tax changes is larger than previously estimated.

ANSWER: d 51. DEF Corporation's headquarters is located in the United States, but it earns revenue in many other countries, such as Germany. Under a global tax system, DEF Corporation would pay taxes: a. on the revenue it earns in Germany to the German government. b. only in the United States. c. only in Germany. d. on revenue it earns in Germany to both the U.S. and German governments.

ANSWER: d 52. A Japanese company manufactures about $5 worth of component parts for its 3D printer in the United States. These parts are shipped to Japan and installed in the printers, which cost the company $200 per printer to manufacture. The printers sell in Japan for about $700 each. Japan's corporate tax rate is higher than in the United States, and the company inflates the cost of the component parts and transfers the majority of the profit to its U.S. subsidiary. Which tax problem does this illustrate? a. the agency problem b. a delay in the repatriation of profits c. the transfer pricing problem d. a reduction in vertical equity ANSWER: c 53. The 2017 tax reform added a new tax break for pass through organizational forms such as partnerships, sole proprietorships, and S-corporations. This tax break was an attempt to close the wedge between: a. wages and corporate profits. b. corporate and noncorporate forms. c. business profits and earnings.

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Chapter 24 d. domestic and foreign economic activity.

ANSWER: b 54. Which two tax wedges were the authors of the 2017 tax reform most concerned about? a. that between domestic and foreign economic activity and that between corporate and noncorporate forms of business b. that between corporate and noncorporate forms of business and that between high income and low income wages c. that between high income and low income wages and that between U.S.- and Mexican-based firms d. that between U.S.- and Mexican-based firms and that between corporate and noncorporate forms of business ANSWER: a 55. Due to the potential for corporations to manipulate transfer prices between subsidiaries to decrease their tax payments, most countries require corporations to follow what approach to valuing products exchanged between subsidiaries? a. an arm's length approach b. the opportunity cost method c. corporate inversion d. relabeling invoices so that products appear to be from subsidiaries in low-tax jurisdictions ANSWER: a 56. The U.S. Senate estimated that Apple paid only 2.2% in taxes on its $34.2 billion pre-tax profits in 2011 through various tax avoidance schemes. Through what country did Apple route most of its profits to avoid paying a higher tax rate? a. Japan b. Germany c. Singapore d. Ireland ANSWER: d 57. Strategies used by corporations to avoid U.S. corporate taxes include all of these EXCEPT: a. manipulating transfer prices between domestic and foreign subsidiaries. b. corporate inversion. c. relabeling invoices so that products appear to be from subsidiaries in low-tax jurisdictions. d. the use of straight-line depreciation rather than expensing investments.

ANSWER: d 58. The American Jobs Creation Act of 2004 created a one-year tax holiday in which corporations could repatriate foreign earnings and pay a significantly lower tax rate. The goal of this policy was to create jobs.

Evidence shows that overall, firms repatriated _____ amounts of earnings and created _____ jobs. a. small; many Copyright Macmillan Learning. Powered by Cognero.

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Chapter 24 b. significant; few c. small; few d. significant; many ANSWER: b 59. Corporations often prefer equity to debt to finance their investments because: a. equity is taxed at a lower rate than debt. b. new equity is a positive signal to investors and increases a firm's creditworthiness. c. equity provides greater flexibility to a firm with respect to how claimants are paid. d. equity holders are primary claimants in the event of bankruptcy.

ANSWER: c 60. All else equal, as the share of a firm's debt financing to equity financing rises, the conflict of interest between debt holders and equity holders: a. increases. b. decreases. c. is unaffected. d. vanishes.

ANSWER: a 61. Consider firms that finance investment through equity rather than debt. Two theories of why such firms may pay dividends rather than reinvest earnings, despite the tax advantage of the latter, are the: a. agency theory and the signaling theory. b. signaling theory and the opportunity cost theory. c. opportunity cost theory and the inflation theory. d. inflation theory and the agency problem theory.

ANSWER: a 62. According to the signaling theory of dividend payments, a firm may pay dividends rather than reinvest profits: a. because of their inherent tax advantage. b. to demonstrate to investors that the firm is doing well. c. to signal to politicians that it is rewarding investors. d. to avoid the agency problem of corporate management.

ANSWER: b 63. The benefits of corporate tax integration include all of these EXCEPT: a. ending tax favoritism in paying out corporate earnings to shareholders in one manner versus another. b. eliminating bias that the corporate tax may cause in the decision to move between corporate and noncorporate status. c. simplifying the corporate tax code and reducing deadweight loss.

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Chapter 24 d. rewarding corporate wage earners.

ANSWER: d 64. Why do governments levy corporate taxes on firms rather than tax the factors of production that make up those firms? Discuss the two fundamental reasons.

ANSWER: First, the government would like to tax pure profits—returns that exceed payouts to factors of production (labor and capital). A pure profits tax is more efficient than a tax on factors of production, as it does not distort decision making by producers, whereas taxes on labor or capital have distortionary effects, for example, on the labor supply. Another rationale for corporate taxation resembles arguments regarding capital gains: if corporations were not taxed on their earnings, individuals who owned shares in corporations could simply avoid taxes by having the corporations never pay out their earnings. These earnings would accumulate tax-free inside the corporation, leading to a large tax subsidy to corporate earnings relative to other forms of savings.

65. Suppose that under straight-line depreciation, a corporation would be allowed to depreciate a $10,000 asset over four years. Under accelerated depreciation, the corporation would be allowed to depreciate 75% of the asset's value immediately in the first year and the remaining 25% in the second year. Assume that the discount rate is 10%. Further suppose that the corporation normally makes $56,000 of annual profit, on which it pays a 21% tax every year. (a) What is the present discounted value of the tax deduction under accelerated depreciation? (b) How much higher is the present discounted value of the firm's profits under accelerated depreciation than under straight-line depreciation?

ANSWER: (a) The present discounted value of the tax deduction under accelerated depreciation is $7,500 + $2,500/1.1 = $9,772.73. (b) The present discounted value of the tax deduction under straight-line depreciation would be $2,500 + $2,500/1.1 + $2,500/1.12 + $2,500/1.13 = $8,717.13. Under accelerated depreciation, the present discounted value of taxes paid would be reduced by $2,052.27 (found by: 0.21 × $9,772.73).

Under straight-line depreciation, the present discounted value of taxes paid would be reduced by $1,830.60 (found by: 0.21 × $8,717.13). The difference is thus $221.67.

66. Rosario lives in a world in which there is no personal income tax, dividend tax, or capital gains tax.

However, there is a significant corporate income tax. A firm wants to finance a new investment, and Rosario would like to be the investor. How would she like the corporation to finance the investment? Explain.

ANSWER: Corporations can finance either by borrowing (through bonds) or by issuing equity (selling stock).

In this case, the corporation should sell bonds, since corporations do not have to pay tax on income that is distributed to bondholders. In contrast, if the corporation were to finance through selling stock, then it would have to pay corporate taxes on the income before distributing it to Rosario through either capital gains or dividends.

67. Why don't companies finance all of their investment with debt and thereby avoid corporate taxation?

ANSWER: The answer concerns the distinction between debt and equity: debt requires fixed payments, whereas equity offers more flexibility, that is, firms can pay out dividends if they wish to but are not required to. If a firm doesn't make its interest payments, it defaults on its debts and can be forced into bankruptcy. Equity finance, by contrast, can provide a buffer zone against the risk of bankruptcy; with equity, if times are bad, the firm can simply not pay a dividend rather than being forced into bankruptcy. The extra flexibility of equity can raise its value enough to offset its tax disadvantage.

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Chapter 24 This preference for equity is strengthened by an agency problem within firms: the conflict of interest between debt holders and equity holders. Debt holders do not like excessive risk, whereas returns for shareholders increase with risk. As a result of this agency problem, banks (and other lenders) will charge higher interest rates on loans to firms as their share of debt financing rises. These higher interest rates offset the tax advantage of debt so that firms now face a trade-off: more debt means a tax advantage relative to equity but potentially higher financing costs because banks fear making loans to debt-heavy firms.

68. Martin is a bank executive and that two corporations have asked the bank, through him, to buy bonds to finance the respective investments that they'd like to make. The first firm is financed 90% through debt and 10% through equity, while the second firm is financed 50% through debt and 50% through equity. Except for the finance structure and its implications (if any), assume that there are no differences between the two firms. (a) Suppose that Martin is unable to determine whether the project the first firm wants to finance is any better or worse than the project the second firm wants to finance. Suppose also that he wants to lend both corporations the money. Should he charge both of them the same interest rate? Explain. (b) Suppose that Martin were instead a firm manager. In which of the corporations would he rather manage?

Explain.

ANSWER: (a) As the share of debt rises for a given firm's financing, the debt holders bear more and more of the risk of projects that go bankrupt, while equity holders have a smaller and smaller risk from taking a gamble. For this reason, Martin should charge a higher interest rate to the first corporation. In that firm, the owners have less to lose by hiring people who want to take on risky projects that could turn out to be losing propositions. (b) Martin should choose to be a manager at the second corporation. If he were a manager at the first, he would be obligated to make relatively large interest payments to his bondholders every period; if he didn't, his corporation would go bankrupt. However, since the second corporation is financed less through debt and more through equity, these mandatory interest payments would be smaller. He would consequently be able to focus on the average performance of the firm over the long run and focus less on making large interest payments every period.

69. Under the previous tax system, how were tax payments made by U.S.-based corporations to foreign governments treated under U.S. corporate tax policy? How is this different under the current tax system?

ANSWER: Under the previous global tax system, U.S.-based multinational corporations received a credit for all taxes paid to foreign governments, which in principle should induce all firms to pay the same tax rate (the U.S. corporate tax rate), regardless of where they locate their subsidiaries.

Under the recent tax reform, the United States moved to a territorial tax system. Under this system, corporations earning income abroad pay tax only to the government of the country in which the income is earned, thus eliminating the need to receive credit for taxes paid to other countries.

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Chapter 25 1. Changes to the tax code made in 1993, 1997, 2001, 2003, 2012, and 2017 have: a. reduced the number of tax brackets. b. greatly limited tax loopholes. c. created more opportunities for tax evasion and avoidance. d. changed the structure of tax rates to a flat tax.

ANSWER: c 2. Tax _____ is legal; tax _____ is illegal. a. avoidance; compliance b. compliance; avoidance c. evasion; avoidance d. avoidance; evasion ANSWER: d 3. Tax _____ is willingness to pay taxes; tax _____ is the result of efforts to reduce one's tax burden within the limits of the law. a. compliance; avoidance b. compliance; evasion c. compliance; hedging d. avoidance; evasion ANSWER: a 4. What is the marginal benefit of evading taxes? a. the additional utility one gets from beating the system b. the marginal tax rate c. the total tax payment saved through evasion d. the additional utility one gets from beating the system plus the tax payment saved per dollar of evasion ANSWER: b 5. If both the penalty associated with tax evasion and the risk of being caught evading taxes increase, which is TRUE, all else equal? a. The marginal cost of evading taxes falls for any given level of unreported income. b. The marginal cost of evading taxes rises for any given level of unreported income. c. There is more tax evasion. d. The two changes cancel each other out, so there is no change in tax evasion.

ANSWER: b 6. Suppose the personal income tax rate is reduced and that the penalties associated with tax evasion decline.

All else equal, which must be TRUE? a. The marginal cost of tax evasion rises for any given level of unreported income. b. The marginal benefit of tax evasion falls for any given level of unreported income.

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Chapter 25 c. There is less tax evasion. d. The two changes cancel each other out, so there is no change in tax evasion.

ANSWER: b 7. Which statement is NOT true regarding the empirical evidence on tax evasion? a. In the United States, the tax gap—the difference between taxes owed and taxes paid—is fairly low, similar to other developed countries. b. Tax evasion is positively correlated with the level of economic development. c. Appeals to conscience have no effect on tax compliance in the United States. d. Audit threats led to higher reported income for lower- and middle-class families in the United States.

ANSWER: b 8. Which statement is NOT true regarding tax evasion? a. Tax evasion is inefficient. b. Tax evasion violates vertical equity. c. Tax evasion violates horizontal equity. d. Everyone engages in tax evasion.

ANSWER: d 9. An increase in the risk of getting caught evading taxes _____ the marginal cost of tax evasion; a reduction in the penalty associated with tax evasion _____ the marginal _____ of tax evasion. a. increases; decreases; benefit b. increases; decreases; cost c. increases; increases; benefit d. decreases; increases; cost ANSWER: b 10. Suppose the personal income tax rate rises and that the risk of getting caught evading taxes also rises. The marginal benefit of tax evasion _____ for any given level of unreported income, whereas the level of tax evasion _____. a. increases; may rise or fall b. increases; will likely rise c. decrease; will likely fall d. is unchanged; may rise or fall ANSWER: a 11. As concerns about tax fairness have increased, and the IRS commissioner vowed to prioritize enforcement, Congress: a. responded by increasing the IRS budget. b. decreased the IRS budget in inflation-adjusted terms. c. left the funding of the IRS unchanged in real terms. d. sought to disband the IRS and replace it with a new agency with broader enforcement powers.

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Chapter 25 ANSWER: b 12. Suppose that, as a result of an income tax rate increase, Cedric pays more tax on a given amount of income.

Through which channel does this tax rate change affect tax revenues? a. the reporting effect b. the income exclusion effect c. the compliance effect d. the direct effect ANSWER: d 13. Suppose that, as a result of a tax rate increase, Meri decides to work fewer hours. Through which channel does this tax rate change affect tax revenues? a. the reporting effect b. the compliance effect c. the direct effect d. the gross income effect ANSWER: d 14. Suppose that Aurora responds to an income tax increase by contributing more money to her individual retirement account. Through which channel does this tax rate change affect tax revenues? a. the reporting effect b. the income exclusion effect c. the compliance effect d. the direct effect ANSWER: b 15. Suppose that Nina responds to an income tax increase by claiming false deductions. Through which channel does this tax rate change affect tax revenues? a. the reporting effect b. the income exclusion effect c. the compliance effect d. the direct effect ANSWER: c 16. Suppose that Judit responds to an income tax increase by giving more money to charity, which is tax deductible. Through which channel does this tax rate change affect tax revenues? a. the reporting effect b. the income exclusion effect c. the compliance effect d. the direct effect ANSWER: b Copyright Macmillan Learning. Powered by Cognero.

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Chapter 25 17. Suppose that there is an income tax increase in the United States. Empirical evidence suggests that one channel through which tax rate changes can affect tax revenues will be LEAST responsible for eroding the tax base. What is it? a. the reporting effect b. the income exclusion effect c. the compliance effect d. the gross income effect ANSWER: d 18. Suppose Gilbert earns a salary of $100,000 per year on which he pays a flat tax of 10%, or $10,000. The government increases the tax to 15%, prompting Gilbert to cut his earnings to $90,000, contribute $5,000 to charity, which is tax-deductible, and underreport his income by $5,000. As a result of these changes, Gilbert's yearly tax bill is now: a. $8,000. b. $10,000. c. $12,000. d. $15,000.

ANSWER: c 19. Rona earns wages of $40,000 per year on which she pays a flat tax of 12%, or $4,800. The government raises the tax to 15%, compelling Rona to cut her work hours slightly, so that she now earns $38,000 per year.

Additionally, she arranges with her employer to transfer $5,000 of her earnings into health care benefits, and she starts to contribute $5,000 per year to charitable organizations, contributions that are tax deductible. Rona's yearly tax bill is now: a. $4,200. b. $4,800. c. $5,000. d. $5,500.

ANSWER: a 20. What likely accounts for the "missing mass" in the statistical distribution of taxpayers who itemize, as noted

by Benzarti (2020)? a. Taxpayers often hire tax preparers, who dislike itemizing. b. People are not always rational in assessing the costs and benefits of their actions. c. People obtain utility from paying more in taxes than they need to. d. Itemizing is costly.

ANSWER: d 21. Fundamental tax reform involves _____; it leads to _____. a. expanding the tax base and lowering tax rates; increased tax compliance, a simpler tax code, and improved tax efficiency b. narrowing the tax base and lowering tax rates; greater vertical and horizontal equity Copyright Macmillan Learning. Powered by Cognero.

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Chapter 25 c. narrowing the tax base and raising tax rates; greater vertical and horizontal equity d. expanding the tax base and raising tax rates; increased tax compliance, a simpler tax code, and improved tax efficiency ANSWER: a 22. Which is NOT a source of difficulty in maintaining a simple, broad-based tax code? a. the perception that voters prefer the attainment of social goals through tax expenditures or tax cuts over new government spending b. the fact that the winners from tax changes tend to be concentrated, well organized, and highly motivated, whereas the losers tend to be diffuse and politically weak c. the fact that economists favor complex tax systems with many credits and loopholes over simple ones d. the fact that tax reform incentivizes taxpayers to create tax shelters ANSWER: c 23. Which BEST describes tax shelters? a. homeless shelters paid for by voluntary donations on one's tax form b. special sections of the tax code that favor special interests that wish to minimize their tax burdens c. tax-exempt regions of the country d. activities whose sole reason for existence is to minimize one's tax burden ANSWER: d 24. Bertha, whose income places her in the highest marginal tax bracket of 37%, invests $250,000 in a wind farm that yields no income and is sold for $225,000 the following year. Bertha's investment entitles her to a 50% tax credit. What is Bertha's net gain or loss from the undertaking? a. −$30,500 b. −$25,000 c. $0 d. $21,250 ANSWER: d 25. Tax capitalization refers to: a. an emphasis on the importance of taxation over spending. b. a change in wages due to taxation. c. a change in the price of an asset due to a change in taxes levied on the stream of returns from that asset. d. the movement away from the taxation of income and toward the taxation of consumption.

ANSWER: c 26. Under the current U.S. tax code, saving in the form of real estate is: a. discouraged because of the high rate of taxation on capital gains in housing relative to the rate of taxation on other capital gains.

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Chapter 25 b. encouraged by the exemption from taxation of capital gains in housing. c. discouraged because of the high rate of taxation on all capital gains. d. encouraged because of the high rate of taxation on capital gains in housing.

ANSWER: b 27. Which would be an advantage of a consumption tax over the current tax system? a. A consumption tax is more complex. b. A consumption tax would increase vertical equity. c. A consumption tax would increase horizontal equity. d. A consumption tax would reduce incentives to save ANSWER: c 28. A consumption tax may foster increased productivity relative to the current income-based tax system by encouraging greater: a. savings. b. consumption. c. risk taking. d. tax compliance.

ANSWER: a 29. Which is NOT a way to resolve the regressivity problem associated with a consumption tax? a. taxing bequests as consumption b. moving to a progressive expenditure tax c. taxing consumption at a fixed rate, regardless of a taxpayer's income d. applying different tax rates to goods based on the income profiles of their likely consumers ANSWER: c 30. A value-added tax: a. is a consumption tax. b. generally costs less to administer than an income tax system. c. taxes goods at the point of sale on the final retail value of a good. d. is an income tax.

ANSWER: a 31. Transitioning from the current tax system in the United States to a cash-flow tax system would: a. encourage black market activities to avoid the sales tax. b. require giving large deductions to the richest people for saving. c. require verification of how much money people spend every year. d. require giving large deductions to the poorest people for spending.

ANSWER: b Copyright Macmillan Learning. Powered by Cognero.

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Chapter 25 32. In what way does our current tax system MOST closely resemble a cash-flow tax system? a. It is regressive. b. A large share of savings is tax-exempt. c. It relies on individual taxpayers' honesty when reporting their consumption expenditures. d. It levies a tax at each stage of the production process.

ANSWER: b 33. A sales tax is a tax on _____; a payroll tax is a tax on _____. a. capital gains; income b. consumption; consumption c. consumption; income d. income; income ANSWER: c 34. An excise tax is a tax on _____; a value-added tax is a tax on _____. a. capital gains; income b. consumption; consumption c. consumption; income d. income; income ANSWER: b 35. The share of total national revenue from consumption taxation is approximately _____% in the United States. a. 17.6 b. 26.7 c. 36.2 d. 46.0 ANSWER: a 36. The share of total national tax revenue from consumption taxation averages approximately _____% in OECD nations. a. 2.1 b. 15.7 c. 32.7 d. 52.0 ANSWER: c 37. Assume that two people have the same income. Under the U.S. tax code, someone who chooses to save some income to consume more later is taxed _____ than someone who chooses to spend all of one's income now, which is _____. a. more; efficient b. more; inefficient Copyright Macmillan Learning. Powered by Cognero.

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Chapter 25 c. more; vertically inequitable d. less; inefficient ANSWER: b 38. Compared to the current system, a consumption tax is expected to improve: a. efficiency and horizontal equity. b. horizontal and vertical equity. c. efficiency and vertical equity. d. efficiency, horizontal equity, and vertical equity.

ANSWER: a 39. A consumption tax levied on the increase in the value of a good at each stage of production is called a(n): a. expenditure tax. b. cash-flow tax. c. flat tax. d. value-added tax.

ANSWER: d 40. The flat tax was popularized by: a. Hall and Rabushka in 1981. b. Haig and Simons in 1986. c. Domar and Musgrave in 1944. d. Roth and Rossotti in 1997.

ANSWER: a 41. Which is NOT true under the Hall-Rabushka flat tax proposal? a. Labor earnings are taxed at a flat rate with an exemption to make the tax more progressive. b. A value-added tax is imposed on the difference between a firm's sales and its allowable deductions. c. Firms are allowed to deduct the value of purchased inputs and compensation to workers to arrive at the amount to be taxed under the value-added tax. d. Labor earnings are taxed at a flat rate, with no exemptions to make the tax proportional.

ANSWER: d 42. Making the transition from the current income tax system to a flat tax system would be likely to cause: a. vertical inequities during the transition, as high-income individuals lose access to tax loopholes. b. horizontal inequities during the transition, as tax preferences for homeownership and employerprovided health insurance are eliminated. c. reduced compliance because the current system is less complex. d. improvements in both horizontal and vertical equity.

ANSWER: b Copyright Macmillan Learning. Powered by Cognero.

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Chapter 25 43. The number of pages in individual tax return documents has: a. increased substantially since 1940, to 217 pages. b. decreased slightly since 1940, to 118 pages. c. stayed about the same since 1940. d. nearly doubled since 1940.

ANSWER: a 44. Empirical evidence regarding tax evasion indicates: a. significant understatement of income reported by third parties in response to tax increases. b. that appeals to conscience are effective in raising reported income and thus tax revenue. c. that audit threats have little effect on reported income. d. significant understatement of self-reported income in response to tax increases.

ANSWER: d 45. Recent research on the relationship between tax evasion and wealth showed that tax evasion and wealth are: a. uncorrelated. b. positively correlated. c. negatively correlated. d. positively correlated but only among households with less than $100 million in assets.

ANSWER: b 46. To reduce the compliance problem associated with the EITC, a recent Senate proposal would: a. significantly increase the length of the form recipients fill out. b. change it to a level credit for all families. c. require third-party verification. d. eliminate the credit from the tax system.

ANSWER: a 47. Which is TRUE regarding the current U.S. income tax system compared with the flat income tax system proposed by Robert Hall and Alvin Rabushka? a. The average tax rate for all households is much larger under the current system than it would be under a flat tax. b. The average tax rate for households earning $1 million is about the same under the current system as it would be under a flat tax. c. The average tax rate for a household earning $1 million is much smaller under the current system than it would be under a flat tax. d. The average tax rate for a household earning $1 million is much larger under the current system than it would be under a flat tax.

ANSWER: d 48. Suppose there are two types of people in the economy, honest types (HTs) and less-than-honest types (LTHTs). For simplicity, assume that the marginal tax rate on income is constant at 50%. Assume also that only Copyright Macmillan Learning. Powered by Cognero.

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Chapter 25 one type of cheating is possible and that it lowers taxable income by $5,000. Cheating can be caught only through audits, which are random and occur 10% of the time. The dollar penalty for cheating is Z. For the LTHTs, the marginal benefit of the cheating is measured in dollars saved. For the HTs, however, the marginal benefit of cheating is the dollars saved minus $1,500, since these people must compromise their integrity to cheat. (a) Find Z such that the HTs are indifferent between cheating and not cheating. (b) Find Z such that the LTHTs are indifferent between cheating and not cheating. (c) Find the range of Z (for example, Z > $3,000) such that the HTs will not cheat and the LTHTs will cheat.

ANSWER: (a) Both HTs and LTHTs save $2,500 (0.50 × $5,000) by cheating. However, the (marginal) benefit to HTs is only $1,000, since they pay a cost associated with compromising their integrity. The expected (marginal) cost of cheating is 0.10 × Z. Consequently, when Z = $10,000, the HTs are indifferent between cheating and not cheating. When Z > $10,000, the HTs will not cheat. (b) Again, the (marginal) benefit associated with cheating is $2,500 for the LTHTs, and the (marginal) cost associated with cheating is the risk of getting caught times the penalty, or 0.10 × Z. Consequently, for the LTHTs to be indifferent between cheating and not cheating, the fine of Z must be $25,000. At any fine less than $25,000, the LTHTs will cheat. (c) $10,000 < Z < $25,000.

49. Explain why a simpler tax system, such as Herman Cain's 9-9-9 Plan, has not received support from Democrats or Republicans.

ANSWER: Republicans were worried that granting the federal government the right to levy a broad sales tax, which currently is found only at the state and local levels, would enable much higher levels of national taxes. Liberals objected to the inequitable redistribution of the tax burden that would result from this proposal. Lower-income individuals consume a much higher share of their income than do richer individuals, and if the current progressive tax structure were replaced with a flat tax rate on all, the effective tax rate would rise for low-income payers and fall for high-income individuals.

50. Identify and describe two political reasons why the tax code is so complicated.

ANSWER: The first reason is that while the benefits to any given tax deduction, exemption, or credit are typically concentrated among relatively few taxpayers who are well organized, the costs are typically spread out over many taxpayers and thus are relatively small for any given taxpayer. As a result, there is much greater political pressure in favor of the deviation from the broad Haig-Simons base than against it.

The second reason is that there is much more political support for targeted tax cuts as a way of achieving certain goals than for new spending aimed at achieving the same goal.

51. Suppose that a nation is considering adopting, in place of the progressive income tax, a national sales tax of 25% on all goods. (a) If the politicians want to use a sales tax but also want the tax to be progressive, what could they do?

Evaluate this option in terms of optimal commodity taxation. (b) Would all groups be affected by the transition to a consumption tax in the same way? Explain.

ANSWER: (a) To make the sales tax more progressive, the sales tax rate could be higher for some goods purchased disproportionately by the rich than for necessities such as food and basic clothing.

However, this is exactly the opposite of what optimal commodity taxation theory indicates should be done, which is to tax goods with inelastic demand (like food and basic clothing) at higher rates than goods with elastic demand (like luxury goods).

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Chapter 25 (b) For groups whose incomes and consumption will occur largely in the future, a consumption tax would be similar to an income tax. However, some people have already paid taxes on their income and saved some of the after-tax income for retirement. Those people will be made worse off by a consumption tax since they will now pay taxes on their savings again when they spend it.

52. Suppose the government of Mascolia is considering replacing its income tax with a consumption tax.

Assume that the government's revenue requirements would be the same under either system. (a) How would the base of a consumption tax compare with the base of an income tax? Does this have implications for the magnitude of the tax rate on consumption versus the magnitude of the tax rate on income?

Explain. (b) Compare the income tax and consumption tax in terms of vertical equity, assuming that both tax all people at the same rate—for example, a 20% tax on income and a 20% sales tax.

ANSWER: (a) The tax base of a consumption tax would be smaller because, rather than taxing both consumption and savings, a consumption tax would tax only consumption. To make up for the smaller tax base, the government of Mascolia would have to tax consumption at a higher rate than it was taxing income to raise the same amount of revenue. (b) Vertical equity refers to equity between those with high incomes and those with lower incomes.

Those with low to moderate incomes will probably spend all their income over their lifetimes.

However, rich people are much less likely to spend all their income over their lifetimes and more likely to leave large bequests. Consequently, under a consumption tax in which estates are not taxed, rich people may pay a smaller fraction of their total lifetime income in taxes than would poorer people. For that reason, the consumption tax may be less desirable than an income tax in terms of vertical equity.

53. Suppose the government is considering replacing the current income tax system with either a national sales tax or a value-added tax. Would one of these alternatives be more desirable than the other in terms of compliance? Explain.

ANSWER: To replace the income tax system with a national sales tax, the sales tax rate would have to be set quite high—about 30 to 35%. Given a tax that high, there would be an incentive for people to make considerable efforts to avoid paying the tax. For example, retailers and buyers might be tempted to undertake black-market transactions.

In contrast, compliance under a value-added tax is self-policing. If a retailer attempted to inflate the price paid for an input to reduce the value added assigned to the retailer and lower the tax burden, the seller of the input would have to pay more tax. Consequently, the seller has an incentive not to allow such cheating. Similarly, if a wholesaler tried to reduce his tax burden by claiming he sold the product for less than he really did, the value added of the retailer would be increased, as would the tax load. As a result, all parties subject to a value-added tax have an incentive to ensure that the other parties pay their share.

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