### Exam 1 of Public Sector Economics In Tutorial Library

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### TITLE: Exam 1 of Public Sector Economics

#### CLASS / COURSE: Public Sector Economics

QUESTION DESCRIPTION:

Exam 1

Public Sector Economics

Summer Semester

Part I: Answer any 3 of the following 5 questions. Your answer should clearly indicate whether a given statement is true, false, or uncertain, and you should write a paragraph or two defending your answer. (20 points each; 60 points total)

1.     The 1st fundamental theorem of welfare economics provides a rationale for laissez-faire economics. In your answer, you may want to include a clear statement of the theorem and explain what economists mean by laissez-faire economics.

2.     In a perfectly competitive, private goods economy, there is no role for government.

3.     Suppose that there are 12 bottles of cold beer and 9 hot slices of pepperoni pizza that need to be divided between 3 people. After some thought, the host divides beer and pizza equally among her two guests and herself. In other words, each person gets 4 bottles of beer and 3 slices of pizza. This is a Pareto efficient allocation.

4.     Suppose that the equilibrium market prices of food and clothing per unit is \$5 and \$10, respectively. John and Sally’s marginal rates of substitution for food and clothing are both equal to ¼. This is a Pareto optimal allocation of food and clothing between John and Sally because their marginal rates of substitutions are equal.

5.     A Pareto efficient allocation is the best way to distribute resources.

Part II: Complete the following table. I obtained the information for fiscal year 2006 from page 34 of your textbook. The information for fiscal year 2011 should be available in the FY 2011 Budget of the United States (http://www.gpoaccess.gov/usbudget/fy11/spec.html). Most of the information should be available from PDF file 26-14 Current Services Budget Authority and Outlays by Function, Category, and Program.

After completing the table, briefly describe any trends in federal government expenditures that you observe in this table. Due to inflation, it may be more revealing to discuss trends in terms of percent by subcategory. Also, discuss whether federal expenditures appear to target market failures. A well-known economist at MIT, Professor John Grubert, contends that a growing share of federal government expenditures is going to providing “insurance” to individuals. Based on the evidence in the table, discuss this observation. Can market failures be used to justify the federal government providing “insurance-like” products to individuals or should this be left to the private sector?

(40 points)

Expenditures by the federal government of the United States, in FY 2006 and FY 2010

 Category FY 2006 FY 2010 \$ (billions) Percent of subcategory \$ (billions) Percent of subcategory Expenditures on goods and services \$679 26 Defense spending \$576 85 Non-defense spending 103 15 Domestic transfers to persons 1,315 50 Social insurance Social security benefits 549 42 Medicare 376 29 Civilian and military retirement 99 9 Unemployment insurance 32 2 Agricultural support payments 21 2 Veterans benefits 64 5 Public assistance Food stamps 30 2 Housing Assistance 32 2 Supplemental security income 34 3 Earned income tax credit 36 3 Net interest payments 227 9 Grants-in-aid 434 16 Payments to individuals 277 64 TANF 21 8 Medicaid 181 65 Other 157 36 Total Expenditures 2,655 100

Instructions

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