PUBLIC POLICY AND ADMINISTRATION 220B -- APPLIED ECONOMIC ANALYSIS
PROFESSOR ROB WASSMER -- CAL STATE UNIVERSITY, SACRAMENTO -- SPRING 1998
MIDTERM EXAM

NAME: _____________________________________________________

STUDENT NUMBER: ___________________________________________

INSTRUCTIONS:

1. Print your name and student number in the spaces provided.

2. You will have 120 minutes to complete the exam. The suggested time to spend on each section is listed in parenthesis.

3. Read the instructions for each section and the questions carefully. Answer all questions in the space provided.

4. Your answers should make use of the tools of economics and material presented in this course -- include diagrams and/or formulas where appropriate.

5. The exam is worth a total of 220 points. The points given in each section are listed.

6. If you have any questions please ask.

7. Anyone caught cheating will have their exam confiscated and receive zero credit.

8. Good luck!

I. DEFINITIONS - 40 POINTS; 10 POINTS EACH - (20 MINUTES)

INSTRUCTIONS:

Define the term in the following manner - (1) a one sentence general definition or diagram, and (2) a few sentence explanation regarding its importance and/or relation to the material discussed in the course.

A. Musgrave’s Three Traditional Roles for Sub-National (State/Local) Government

B. Price and Income Elasticity for Total Local Expenditure (What it Measures and Range of Values)

C. Baumal Hypothesis (or the Cost Disease of the Service Sector)

D. The Monopoly Bureaucrat Model of Local Government Expenditure

II. SHORT ANSWER - 80 POINTS; 20 POINTS EACH - (40 MINUTES)

INSTRUCTIONS:

For each statement, indicate whether it is "true," "false," or "uncertain," and explain why? The explanation should be done in a short paragraph and utilize the specific concepts learned in class. The answer may also require a diagram or formula. The points awarded will be based primarily upon your explanation.

(1) "The only reason that Californians decided to radically alter their system of local property taxation was the Serrano Decision (made a few years earlier than Proposition 13) by the state’s Supreme Court."

(2) "The 1986 decision by the U.S. Congress to not remove the federal tax-free status of interest earned from the purchase of state and local bonds was optimal."

(3) "If the City of Sacramento ever builds a professional sport’s stadium, some of it should paid for by the fans that will attend the games."

(4) "The statutory incidence of a tax does not determine the economic incidence of a tax and I can prove it using a market diagram."

III. ESSAY - 100 POINTS - (60 MINUTES)

INSTRUCTIONS:

Read each question carefully. To receive full credit, be sure to answer each of the question's parts separately.

Consider a metropolitan area that contains three potential cities (Cities A, B, and C) and 300,000 people. Cities in the metropolitan area provide only police protection to their residents. This service exhibits the characteristics of a local public good. The 300,000 people are equally divided into groups of 100,000 each. The three groups can be classified as low-income, medium income, and high income. Low-income people have a low demand for local police expenditure, medium-income have a medium demand, and high-income have a high demand.

1. Initially assume that all 300,000 people live in City A (the Central City).

A. First describe the characteristics of a local public good.

B. Provide a diagram and describe a theoretical solution where all three types of demanders would desire the same level of police expenditure by City A. What is the real-world problem that arises if this theoretical solution is implemented?

2. Still assume that all 300,000 people live in City A but now a head tax is used to fund local police expenditure.

A. Do all the three types of residents agree upon the same level of police expenditure to provide? Show why in a diagram.

B. Assume that majority voting is used to determine the one level of police expenditure to be provided in City A. What are the conditions that are necessary to guarantee that this level will be the amount preferred by the medium-income group?

3. Remember that there are two other potential cities in this metropolitan area.

A. Do you expect the situation described in parts 1 and 2 to persist? Using the same type of diagram as above, show the expected solution with three different diagrams (one for each of the three cities: A, B, and C).

B. What are conditions that are necessary for this perfect "Tiebout Equilibrium" to occur?

C. What happens if instead of a head tax, local police expenditure in all three cities is financed by a property tax?

4. Assume that the low-income people remain in City A, medium-income go to City B, and high-income go to City C.

A. If City C spends 50 percent more per person on police services than City A, and City B spends 25 percent more per person on police services than City A, does this necessarily mean that people in City C will experience 50 percent less crime than people in City A and people in City B will experience 25 less crime than people in City A?

B. In regards to the local provision of police services by these three cities in this metropolitan area, there is probably some room for the state to provide intergovernmental grants to the cities. Describe a possible situation that would justify this and the types of grant that should be used to achieve the "greatest bang-for-the-buck".

5. Forget about three types of people being separated into three cities and now assume that initially all cities levy the same property tax rate and have the same crime rate.

A. Draw the three-city equilibrium diagram for the property markets that shows this situation.

B. Now assume that situations cause the crime rate to fall in City A, to remain constant in City B, and rise in City C. Show and describe the supply-side effects that this has in the above diagram.

C. Given that the supply-side effects in part B have occurred, in the diagram for Part A show and describe the demand side effects that that now occur. If these two effects continue, who will eventually bear the burden and benefit of this change in crime rates for equal property taxes? Is this group more likely to be low or high income?

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