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**Unformatted text preview: **Key University of Califomia, Davis Dr. Janine LF. Wilson Department of Economics Winter 2012 Economics 131 Midterm 2 You will have 1 hour and 20 minutes to complete the following exam. Only lowtech calculators are allowed. Please label work clearly and explain steps thoroughly in order to get full credit. Part 1: Problems 1. Optimal Commodity Taxation Suppose that there are two goods in the economy: Wheat and cotton. They are neither complements nor substitutes. Ad valorem commodity taxes are imposed. The compensated demand elasticity for Wheat is -0.5 and the cempensatcd demand elasticity for Cotton is -l .5. a. (8 points) If the government of the above economy followed optimal commodity tax principals, what should they consider when setting their ad valorem tax rates? (State the key objective of using optimal commodity tax principles as dened by Frank Ramsey.) "W13 t sacrament @0006 6655? images ' oc. 'i"'C;'F..:i~;" cm on (ix-hes :12 that Jrhf: Gino oi 'i'cxr"g3\i'\(:_x\ (7,. &x\ wet opt \O": +0 margkmi W rm 6. in o 6:" (L'wtiicl is racism . h. (6 points) Using the Inverse Elasticity Rule and the information that the ad valorem 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 pace eke-Ammo O? (in? "10.? {i ., a to. 1: %_E. pixgxogm e. (6 points) State the criterion of vertical equity; JCC. @3er with o. c" YC'EACW 053* KW u. 3 i" : g 3> L O 15 <' .-.. - " .1: ~. t~ ' '. m 3', O ' CX?5?\(,P(\CK \) . _ '9. (permit tows 3 d. (6 points) Suppose that all consumers have identical preferences and income. Given tax rates which satisfy the Ramsey Rule, is the criterion of vertical equity violated? Explain why orwhy not. _ _ ' .. n it "vs \1 my:st m Weir share vs DOEPFOWSW -\-o --\t:\:}\ "\'f. (LYN more . 13' \5 (1335 \iio\dtd 30!; Na. hose, oil's-Joiiitkci H me) and \ it'in 6916)? #006 has lent, iik'i'i '\{"\C L") lsubg) :. L5? ; LS'i-'c :{G (C. no 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 per year. a. (4 points) Draw Ingrid's budget constraint below with hours of leisure on the x- axis and consumption on the y-axis. , {f 1-,. U. ..)_ 1 lists"; . ' i' ' lm'fdun "W37" I' . ii than I ' - p), v I 15lin "'1 "limpet-v,- lb '0 " "'1 ' . _ _ 047 _ \N' 3 005 'I'r 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 three Plddr' \dx'illd'b ' marginal tax rates; for earnings between ll and $10,000 the marginal tax rate is . ; ibi'mg "3%, for earnings between $10,000 and $40,000 the marginal tax rate is 20%, and "if: 10;} Q} qe (W, for earnings above $40.0001he marginal tax rate is 30%. Now draw Ingrid's newi wq 000 budget constraint on the original graph. (label carefully the y-intcrccpts, x- " l ' mtcrcepts and the slopes) "li''jbtiiis : 1% Mia"; ' " ' 'fl'efnr' c. (6 points) What are the income and substitution clients of the tax in words (I do ' " M. 141000, not want a one word answer; please explain [he logic behind the effect). \ w f H _ ' ' .-_-_- . ,.. . __ ,. m _ - ' "' r- ' ' (- "(f-'5.) 10 ('0 " rim-3 "om-E3 ctltttk'lij J_QCQ\ (j-i'xlliik ' \Exi k-N' : 1' {WA 3" NBC-3C) (5;) v I ' \r- ' '7'":- - (_ I ('l'f'l [ti H1; (100 c: " THC;- C! )_$:3:}_JJYOU\ 01'; A km: "-3" ' 3'" m gmo cc.)er my . luck" I 5"" "W (@1 \{is'- (Luna NO " W - d. (6 points) Before the tax was introduced Ingrid was working 300 hoursfyear and after the tax she worked 250 hoursa'year. Which e'ect dominated income or substitution? Assuming that Ingrid is a married woman, is this change what you would have predicted giVen what we know about elasticity of hours worked with respect to changes in wages}? I I. Q \l\5 or 1mm: : \eq'ifiu 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" h'WXQ' \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 -- ~ -' u 4 1' "1-161 . _ _ 1 X(' it R'C.-l(;.(3 F 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 the slope. - - N F C'- it t s50.me ( \ Ht)th - \EN'SIOBD J0) =- Loss 5; \(95 I000 \3 I L 3 \\ a t - ' ' c er a. I "NR5 eoconkg "ow: V?) 'dedd f. (6 points) A tax of 5% is imposed on all interest income. Graph the new intertemporal 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 (\ \Lvorosw as (sorooo'r r #150 000 U "r 0,0615") :. 3 maa) )' g. (6 points) Describe the income and substitution effects of the imposition of the tax assuming 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 poorer 30 C00 Some?) \6496 now, he Saves more Sdm%-Ro:ged '- The, @CcrechQ m the YC'mm 33-0 5mm 5 decreases Hoe, C" ??O(JVU (\'Vlw 01 C\K-{\ OCEAN ' was \esf': 11. Part 11: Short Answer '* 05703): 0.07.3 WQQWEA-gglboo} WC siege : d[ \w (\ ,.F--"'-\$" he" "30!; 31'3"?" (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 his rst $5,000 of savings. Staph the new constraint. What would be the income and substitution effect of this new policy (describe in words the mechanism behind each effect and your assumptions regarding Larry's savings choices). Can we deduce whether he would spend more or less "now"? v .oqd mcui'b _._..-_'.... _ arm-erese~-..- _ and consume-J more) .- X'Ni "Victor-46c; bane H We,ka Wm, he. Emits new: mtg-Inc: exist} (19(69le JA'I Tcm ,LI (whoa meme I p"?! 'iiiia \csc NEW. C / wk 1. (10 points)The Earned Income Tax Credit (EITC) .\ "Y; "(<3 bv\\" f) a. WhatistheElTC? , . .\ 3N6. ' . "5 1:66 o Kincaid 4L7.{;\\.}C.\:\(::) ame}? \; WE" s e)! 0%: x. {wtWt, We) 1 fl K35"pr 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 " '* C u :1} AixxnCi-c'?) no how much was Emmi? _. _ ' h6g0": KAN: Cred. L'V W3 Kiwi-'CKOCGC, _ I A 'i \uimprmk {job civic; - 00% '1) l. , b (-0005 a _ 'I E) ASEHQHQC \(M'ic H. .j, chow 50?:va _ u x C- N income {:3}; @di , _ M so nit - 'mCQiYY ifkaig'w L'S' ' 2. (15 points) Tax benets of saving for retirement a. Explain in detail two different vehicles offered to workers to save for retirement. Be sure to include why these are advantageous to workers. 1' ' U'OKQQ 320% A0 \ (m Wei163' "\Z'LK E1 "ZR * 7": MUTE}? mach 56m; "idea W xii-0 gem} New. 6m NWE. mmej N'sch j 0&8 k0 \(}~.'7{.Ef_ ii. . er-x " b. Wiil you use either of these vehicles when you begin to earn an income? Why or Why not? Please explain in detail. New Art: 058, ECOWINC ("'..<1f1)(3("\\{IN "\'Ca bide jOUV Dijkmm....

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