The rest of these instructions duplicate those for the earlier
exams.
The following 3 questions cover some of the material that is relevant for the final exam. While these exact questions will NOT be on the exam, questions that are similar to (at least) some of them will be. Therefore, seeing these questions will help you prepare for the exam.
Answers and explanations for all 3 questions are found at the bottom of this page. The link after each question takes you to the relevant answer. Please note that while checking the answer to question 2 (for example), you may also be able to see the answer to question 3. If you prefer not to see an answer before you've read the corresponding question, you may wish to look over all 3 questions before checking any answers.
Please note that studying for the final exam should entail more than merely reviewing these 3 questions. The exam itself will have 45 questions, and there are topics covered on the exam that do not appear in the sample questions. Also note that you do not receive any direct credit for accessing this page, nor is the page set up to report a score based on your answers.
| Person | Value |
|---|---|
| A | 250 |
| B | 240 |
| C | 220 |
| D | 80 |
| E | 50 |
Assume that when a person in this community votes, he or she cares
only about (i) the private value that he or she will receive from
the project and (ii) the private cost that he or she will have to
pay if the project is approved. The person votes in favor of the
project if and only if private value exceeds private cost (and
votes against the project otherwise). Complete the following. We
can state that the project described above would ______ under a
majority-rule voting system; we can also state that approving this
project would be socially (or economically) _____.
answer and explanation
Question 1 answer is:
c. consumers will pay somewhat more than $5 per unit; producers will receive somewhat less than $5 a unit.Explanation: When no tax is imposed on a good, the market equilibrium outcome is found where the supply curve and the demand curve cross. When a tax is imposed, the market equilibrium shifts to the point at which the supply and demand curves are separated by a vertical distance that just equals the amount of the tax.
The reason that this is the equilibrium outcome was explained in class (and in the book). Basically, the explanation is that the equilibrium quantity is found at the level of output at which the "amount consumers are willing to pay to buy the good" minus the "tax" exactly equals the "amount producers must receive to produce the good." This point is found when the distance between demand and supply equals the size of the tax.
Once the equilibrium outcome has been found, the "price that consumers pay" and the "price that producers receive" when the tax exists are the points on the demand and supply curves at the equilibrium quantity. Starting at the no-tax equilibrium, therefore, one can picture finding the "with-tax consumer price" by sliding to the left along the demand curve; to find the "with-tax producer price," picture sliding to the left along the supply curve.
Since the question states that the supply curve slopes up and the demand curve slopes down, this leftward movement towards the with-tax equilibrium must cause the consumer price to rise somewhat above the $5 no-tax price, and the producer price to fall somewhat below the $5 no-tax price.
A major point of this analysis is that, when supply slopes up and demand slopes down, a tax on a particular good will not be felt only by the consumers, or only by the producers of the good. Rather, after the market has adjusted to the tax, its effect will be split -- both consumers and producers will end up worse off than they were before the tax was imposed. Consumers will be paying a higher price for each unit they buy, and producers will be receiving a smaller amount for each unit they sell (where the gap between "consumer price" and "producer price" equals the amount of the tax). Furthermore, the market will adjust in such a way that the ultimate consumer and producer prices are the same no matter whether the tax is originally imposed on sellers or on buyers.
[Note: In saying that "both consumers and producers end up worse off than they were before the tax was imposed" we are only considering the effects of raising the tax revenue, and are not considering whatever benefits may be produced when the government spends its tax revenue on various activities.]
[Note also: It is not impossible for producers alone (or consumers alone) to be hurt by a tax. If (for example) the supply curve were perfectly horizontal (or perfectly elastic), then the "consumer price" would rise by the full amount of the tax. Whenever demand slopes down and supply slopes up, however, the effect of the tax will be somehow split between consumers and producers.]
Question 2 answer is:
b. $1500Explanation: If a certain type of spending is "tax deductible," the amount spent in that way is subtracted from a person's "taxable income" before that person's "taxes owed" is computed. In this particular case, a $2000 tax-deducible contribution means that the person's taxable income is $2000 lower than it would be otherwise.
Since taxable income is falling, the amount of taxes that the person is required to pay will also fall. To figure out the effect on taxes owed, you have to have information on the appropriate tax rate, which is the marginal tax rate. The marginal tax rate should be used since it measures how a change in taxable income affects taxes owed, which is what you want for this question.
In the above question, information on only the marginal tax rate was given, but a person will also face an average tax rate, which may well differ from the marginal tax rate. Since the average tax rate does NOT explain how a change in taxable income affect taxes owed, it should not be used in a question like this.
Returning to the question, a $2000 tax-deductible contribution lowers taxable income by $2000. With Fred paying taxes at a 25% marginal tax rate, a $2000 drop his income reduces his taxes owed by $500. [This is because $2000 × .25 = $500.] Thus, when Fred gives $2000 to charity, the amount he must pay in taxes falls by $500.
Since the contribution of $2000 saves Fred $500 in tax payments, the contribution really "costs" Fred only $1500.
Question 3 answer is:
b. be approved ; inefficientExplanation: In the situation described above -- majority-rule voting and each person basing his or her vote on personal costs and benefits -- we determine whether or not a project would be approved by deciding how each person would vote. The question states that each person considers only his or her own personal value and cost when deciding how to vote.
The question states that the project costs $1000, and that each person must pay $200 if the project is approved. Comparing this number to those in the table shows that personal value exceeds personal cost for persons A, B, and C (while personal cost exceeds personal value for persons D and E). Thus, persons A, B, and C vote in favor of the project, and the project is approved by a 3-2 vote.
To determine whether it would economically efficient or economically inefficient to approve the project, we compare the Total Social Value of the project to its Total Social Cost. If the project's Total Social Value exceeds its Total Social Cost, we say that approving the project is socially-efficient (but if TSV < TSC, then the project is inefficient).
Total Social Value is determined by simply adding up the Value that each of the members of the community receives from the project. When this is done, we see that Total Social Value equals $840. The Total Social Value of the project is therefore less than the Total Social Cost, and we conclude that approving the project would be inefficient.