EC3200
UNIVERSITY OF WARWICK
Summer Examinations 2015/2016
Economics of Public Policy
Time Allowed: 1.5 hours
Answer
TWO questions. All questions carry equal marks. Answer each question in a separate
answer booklet.
Read carefully the instructions on the answer book provided and make sure that the particulars
required are entered on each answer book. If you answer more questions than are required and
do not indicate which answers should be ignored, we will mark the requisite number of answers
in the order in which they appear in the answer book(s): answers beyond that number will not
be considered.
1. Take an economy with two consumers, denoted A and B, one private good, x, and one
public good, G. Let each consumer have an income equal to M. The prices of both
private and public good are 1. Consumers’ utility functions are:
UA=log xA +log G, UB=log xB +log G.
(a) Assume that the public good is privately provided so G=gA +gB, where gA and gB are
A and B’s voluntary contributions towards the provision of G. Eliminating xA from
A’s budget constraint calculate dgB/dgA and find the locus of points along which the
indifference curves of A is horizontal, use this to sketch the indifference curve of A.
(10 marks)
(b) Calculate A’s choice of gA to maximise utility, given all the possible choices of B in
term of gB. Repeat the same exercise for B and calculate the level of private provision
of the public good.
(20 marks)
(c) Calculate the optimal level of G that maximises the utilitarian social welfare
function, and has the cost equally allocated. Contrast this with the private provision
level.
(20 marks)
1
(continued)
EC3200
2. Consider a consumer endowed with
l unit of labour who consumes two commodities,
denoted 1 and 2. In the absence of taxation the consumer has the budget constraint
p1x1+p2x2=wl, where w is the wage rate,
p1 and
p2 are commodities’ pre-tax-prices, and
x1 and
x2 represent commodities’ consumption.
(a) Show that an ad valorem tax levied at a rate
t on both commodities and on labour
raises no revenue. Explain the fact.
(30 marks)
(b) Show the equivalence between a uniform commodity tax at rate
t on the two
commodities and an income tax at rate t/(1+t) on wages.
(20 marks)
3. (a) Explain what is meant by the destination and origin principles of commodity
taxation. Give examples of situations where each of the two applies. What are the
efficiency properties of these two principles?
(20 marks) (b) Explain why tax competition between different countries can only occur under the
origin principle. What determines the equilibrium levels of tax? Is there any
evidence that commodity taxation occurs in practice?
(30 marks)
4. (a) What is the difference between source and residence-based taxes on capital income?
What is capital import neutrality and capital export neutrality?
(20 marks)
(b) Give a brief exposition of the Zodrow-Mieskowski model of capital tax competition.
In what way (if any) is the equilibrium level of taxation and public good provision
inefficient?
(30 marks)
2
(End)