ECN 131 Midterm 2 Answer Key - KeyUniversity of Califomia,...

ECN 131 Midterm 2 Answer Key
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Unformatted text preview: KeyUniversity of Califomia, Davis Dr. Janine LF. WilsonDepartment of Economics Winter 2012Economics 131Midterm 2You will have 1 hour and 20 minutes to complete the following exam. Only lowtechcalculators are allowed. Please label work clearly and explain steps thoroughly in order toget full credit.Part 1: Problems1. Optimal Commodity TaxationSuppose that there are two goods in the economy: Wheat and cotton. They are neithercomplements nor substitutes. Ad valorem commodity taxes are imposed. Thecompensated demand elasticity for Wheat is -0.5 and the cempensatcd demand elasticityfor Cotton is -l .5.a. (8 points) If the government of the above economy followed optimal commoditytax principals, what should they consider when setting their ad valorem tax rates?(State the key objective of using optimal commodity tax principles as dened byFrank Ramsey.)"W13 t sacrament @0006 6655? images oc. 'i"C;'F..:i~; cm on (ix-hes :12 that Jrhf: Ginooi icxrg3\i'\(:_x\ (7,. &x\ wet opt \O": +0 margkmi Wrm 6. in o 6: (Lwtiicl is racism .h. (6 points) Using the Inverse Elasticity Rule and the information that the advalorem tax rate on Wheat is 30%, calculate the optimal commodity tax on Cotton.15:25- where, 4c. "\5 them misc."-4.. l n. )4 (1 \ .9) \Q QM CO *3 I ,jffx. {ids paceeke-Ammo O? (in? 10.? {i ., ato. 1: %_E. pixgxogme. (6 points) State the criterion of vertical equity; JCC. @3er with o. c YCEACW 053* KW u. 3 i : g 3> L O 15<' .-.. - " .1: ~. t~ ' . m3, O CX?5?\(,P(\CK \) . _ 9. (permit tows 3d. (6 points) Suppose that all consumers have identical preferences and income.Given tax rates which satisfy the Ramsey Rule, is the criterion of vertical equityviolated? Explain why orwhy not. _ _ .. nit vs \1 my:st m Weir share vs DOEPFOWSW-\-o --\t:\:}\ "\f. (LYN more .13 \5 (1335 \iio\dtd 30!; Na. hose, oils-Joiiitkci Hme) and \ it'in6916)? #006 has lent, iikii '\{"\C L")lsubg) :. L5?; LSi-c:{G ( one VJCNKA hGNEJ W: kahky \O 1;ka N193; iii"mt-s7) mic-- 2.1ngrid makes SlOthour for every hour that she works. She can work up to 2,000 hours peryear.a. (4 points) Draw Ingrids budget constraint below with hours of leisure on the x-axis and consumption on the y-axis. , {f 1-,. U...)_ 1lists; . ' i lmfdun W37 I' . ii thanI - p), v I 15lin1 limpet-v,- lb 0 " 1 . _ _ 047 _ \N 3 005'Ir Mitt will} #0.. 04- S, f _ , ,6. mg 030 301950 .. 9) 0 I" _ b. ('6 points) Assume a tax system has just been implemented where those are threePlddr \dx'illdb ' marginal tax rates; for earnings between ll and $10,000 the marginal tax rate is. ; ibimg 3%, for earnings between $10,000 and $40,000 the marginal tax rate is 20%, and"if: 10;} Q} qe (W, for earnings above $40.0001he marginal tax rate is 30%. Now draw Ingrids newiwq 000 budget constraint on the original graph. (label carefully the y-intcrccpts, x-" l mtcrcepts and the slopes)li'jbtiiis : 1% Mia;' " ' 'flefnr' c. (6 points) What are the income and substitution clients of the tax in words (I do' " M. 141000, not want a one word answer; please explain [he logic behind the effect). \ w f H _ .-_-_- . ,.. . __ ,. m _ - " r- ' (- (f-'5.)10 (0 rim-3 om-E3 ctltttklij J_QCQ\ (j-ixlliik \Exi k-N : 1 {WA3" NBC-3C) (5;) v I \r- 7":- - (_ I ('lf'l [ti H1; (100 c: " THC;- C! )_$:3:}_JJYOU\ 01; A km:"-3" 3' m gmo cc.)er my . luck I5" W (@1 \{is'-(Luna NO W -d. (6 points) Before the tax was introduced Ingrid was working 300 hoursfyear andafter the tax she worked 250 hoursayear. Which eect dominated income orsubstitution? Assuming that Ingrid is a married woman, is this change what youwould have predicted giVen what we know about elasticity of hours worked withrespect to changes in wages}? I I. Q\l\5 or 1mm: : \eqifiu m\\~<:I( We 00% Jill-i is}; micsl \siti. ti-JG l? (5* \t; 3- WA- ~;t=:_<;cu3gc. sow-'13 woe-.2 r_\\x<1f~l R" hWXQ \1~~JC;:-<\<-~x<s<, kinks-f i Mi *0 -\K\ \ 6 QR.\,\(.Q'__\'\'1\"I\ Uij,4 t _. tr. \f 2) (Ni (1:. _ - u\ I. '3 j;Y; 9K) f 3 \ a r a l \ _." lei monsoon \W C\ l -- ~ -' u4 1 "1-161 . _ _ 1X( it RC.-l(;.(3F 3.Larry lives for two periods (now and later). He will earn $150,000 now and $0 later.The real interest rate in the market is 10%.e. (4 points) Draw the intertemporai budget constraint of Larry with now on the x-axis and later on the y-axis. Label the budget constraint careJlly including theslope. - - N FC- it t ( \ Ht)th -\ENSIOBD J0) =- Loss 5; \(95 I000 \3 IL 3 \\ at - ' ' c er a. INR5 eoconkg ow:V?) dedd f. (6 points) A tax of 5% is imposed on all interest income. Graph the newintertemporal constraint faced by Larry if he were to save in his period now.(label the slope of the constraint)T; 507::5* r o Art/(v13) _\bOIOO (\ \Lvoroswas (sorooor r#150 000 U "r 0,0615) :. 3 maa))'g. (6 points) Describe the income and substitution effects of the imposition of the taxassuming that he is a saver (describe in words the mechanism behind each effect).Can we deduce whether he would spend more or less in period now?Icome 6%8r1 Nit WC W , be. @1365 poorer30 C00 Some?) \6496 now, he Saves more Sdm%-Ro:ged '- The, @CcrechQ m theYCmm 33-0 5mm 5 decreases Hoe,C" ??O(JVU (\Vlw 01 C\K-{\ OCEAN was \esf: 11.Part 11: Short Answer* 05703): 0.07.3WQQWEA-gglboo} WC siege : d[ \w (\ ,.F--"'-\$" he 30!; 313"?(6 points) Now assume that Larry is offered an IRA that he can withdraw from ater" where the burden of the tax is now only 50% of the original burden on hisrst $5,000 of savings. Staph the new constraint. What would be the income andsubstitution effect of this new policy (describe in words the mechanism behindeach effect and your assumptions regarding Larrys savings choices). Can wededuce whether he would spend more or less now? v .oqd mcuib_._..-_.... _ arm-erese~-..- _and consume-J more) .-XNi Victor-46c; bane HWe,ka Wm, he. Emits new: mtg-Inc: exist}(19(69le JAI Tcm ,LI (whoa meme I p?!'iiiia \csc NEW. C /wk1. (10 points)The Earned Income Tax Credit (EITC) .\ Y; (<3 bv\\" f) a. WhatistheElTC? , . .\ 3N6. . "51:66 o Kincaid 4L7.{;\\.}C.\:\(::) ame}? \; WE s e)! 0%: x. {wtWt, We) 1 fl K35pr 05 't ' f) \camd (a ugh 9)Ml gifsfwnl 319%?) O 1 Cjw k:exam Qor wcr \ . -. . .b.In theory, does the EIT'C increase or dectease labor supply? Describe in " '*Cu:1} AixxnCi-c?) no how much was Emmi? _. _ h6g0: KAN: Cred. LV W3Kiwi-CKOCGC, _ IA i \uimprmk{job civic; - 00% 1)l., b (-0005 a _ I E) ASEHQHQC \(Mic H. .j,chow 50?:va _ u xC- N income {:3}; @di, _ M so nit - 'mCQiYY ifkaigw LS' ' 2. (15 points) Tax benets of saving for retirementa. Explain in detail two different vehicles offered to workers to save for retirement.Be sure to include why these are advantageous to workers.1' ' UOKQQ320% A0 \ (mWei163"\ZLK E1 ZR *7: MUTE}? mach 56m; idea W xii-0 gem}New. 6m NWE. mmej Nsch j0&8 k0 \(}~.7{.Ef_ii. .er-x b. Wiil you use either of these vehicles when you begin to earn an income? Why orWhy not? Please explain in detail.New Art: 058, ECOWINC ("..<1f1)(3("\\{IN "\Cabide jOUV Dijkmm....
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