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Unformatted text preview: Professor Emmanuel Saez Economics 131 GSI: Mark and Francois Problem Set 2 Due Monday March 8th in class. Question 1 Short Answer: Please be succinct (less than 3 sentences). A) True/False/Uncertain: We know from the Median Voter Theorem that policies will converge on those policies preferred by the average citizen. False. First, in the MVT voters’ preferences not citizens’ preferences are what matter. Second the MVT says under certain assumptions policy will converge on the policy preferred by the median voter, not the average, when there are single peaked preferences. Note: Median and average are mathematically 1 and substantively DIFFERENT. You should not use them interchangeably!! A key feature of the median voter theorem is that the median does not take the strength of preferences into account, while the average does. B) True/False/Uncertain: The wage is a good proxy for opportunity costs of labor. See Gruber Ch8 discussion. C) Think about the following local public good – is the tiebout model likely to hold? 1. Local free food shelter program for the homeless. [more homeless may come] 2. Local police enforcement in Berkeley. [externality Oakland] 3. Local high quality public school, without zoning. [Since we have property tax people will buy small houses and send their kids to school – financing problem, in Tiebout lump sum taxes] 4. Local high quality public school, with zoning. [Solves this by imposing de facto lump sum] D) True/False/Uncertain: The Contingent Valuation approach is likely to provide a good estimate of the valuation of a public good for individuals. See Gruber Ch8 discussion. Question 2 Consider a project to start an internet café. It costs $200,000 to buy the computers, all of which are purchased in the first year. The café provides an income of $50,000 a year 1 Mathematically the median will equal the average when you have a symmetric distribution. for five years. At the end of the 5 th year the computers are obsolete and must be thrown away. It costs $20,000 to dispose of the computers. a) Should the project be undertaken at a 0% discount rate? 10%? 20%? You need to compute NPV of costs and benefits. NPV of costs= 200000+20000/[(1+r)^5] NPV of benefits= 50000/[(1+r)^1]+ 50000/[(1+r)^2]+ 50000/[(1+r)^3]+ 50000/[(1+r)^4]+ 50000/[(1+r)^5] With these calculations, (replacing “r” by 0, 0.1, 0.2) the project is only valuable with a 0% discount rate. b) Suppose that the cost of computer disposal is uncertain and that there is a fiftyfifty chance that the cost will be $10,000 and $30,000. How does this uncertainty affect the costbenefit calculation in part a, assuming that the entrepreneur is: (1) riskneutral and (2) riskaverse?...
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 Spring '07
 KARP
 Economics, Tiebout model, police protection, street cleaning

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