Econ131_PS4Sol S2010 - Econ 131 - Fall 2010 Professor:...

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Unformatted text preview: Econ 131 - Fall 2010 Professor: Camille Landais GSIs: Francois Gerard and Mark Borgschulte Problem Set 4 Due at start of Final Review Session, TBA. 1) Short Answers Explain you reasoning concisely and carefully. Credit is given based on your explanation. a) You are running for office against a candidate who proposes to initiate welfare reform that will give more money to the poor without reducing the incentive to work for anyone in the economy. How would you explain to your constituents that this is truly a promise that cannot be delivered? Answer. This statement relates to the Iron Law of Welfare, that is, it is impossible to introduce a welfare program without introducing a distortion somewhere in the economy. This can be illustrated in the budget constraint. Whenever we introduce an increase, at least one convex kink will be introduced when we return back to the original budget constraint. Individuals in this portion of the budget constraint may decrease labor supply. b) An optimal progressive income tax scheme features low marginal tax rates on low income people and high marginal tax rates on higher income people. True, False, or Uncer- tain? Answer. False. The efficiency cost of taxation is much higher for the rich, who have larger labor supply elasticities. An optimal progressive income tax schedule features a phased- out benefit for low-incomes, and decreasing marginal tax rates as you go up the income distribution. c) The EITC program in the US encourages labor supply since it gives a tax credit to poor people. True, False, or Uncertain? Answer. The EITC will unambisuously increase labor supply for the people whose earnings are such that they qualify for the subsdy. Hoever, for individuals in the phase-out region, labor supply may decrease. Thus, the program does not increase labor supply for everyone unambiguously. d) A large study is conducted to evaluate the effects of income taxation. Individuals are randomized into two groups and faced with different tax rates. The study finds that 1 individuals in both groups work the same number of hours per week on average. The study concludes that taxation barely distort behavior and do not create efficiency costs. Do you agree with this conclusion? 2 Answer. As Feldstein (JPE 1995) explains, there are multiple dimensions of labor supply not necessarily captured by hours worked that may be affected by taxes. Thus, even though hours worked may not change with higher taxes, other dimensions of labor supply such as effort may change so we cannot conclude that income taxes have no effects on labor supply. 2) Commodity Taxation Consider the following model for the toothbrush market in Berkeley. Suppose the aggre- gate demand for brushes in Berkeley is given by Q D = 900- P/ 2 where P denotes the price and Q denotes the quantity of brushes in terms of thousands of brushes demanded. The aggregate supply for brushes in Berkeley is given by Q S = P/ 4....
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This note was uploaded on 07/15/2010 for the course ECON 131 taught by Professor Karp during the Spring '07 term at University of California, Berkeley.

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Econ131_PS4Sol S2010 - Econ 131 - Fall 2010 Professor:...

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