University of Maastricht

Faculty of Economics and Business Administration

EXAM For students in

International Economic Studies

Algemene Economie

COURSE Public Finance and Public Choice (IES)

Overheidsfinanciën en Public Choice (AE)

CODE 1316

DATE 19 December, 1997

LOCATION Randwyck

TIME 13.00-16.00 hrs

This EXAM consists of:

4 pages (this front page included)

8 questions

You may USE only:

-blanco paper

-writing tools

NORM:

You can earn 80 points in total and 10 points per question.

Rating is on an eight point-scale: 0-8.

45 points is a 6-, is a 6, is sufficient for passing this part of the exam.

For second year-students, the rating of the paper assignment (maximum 20 points) will be added to calculate a final rate.

For third-year students and above, the rate on the eight point-scale will be translated tot a rate on a ten point-scale: 1-10 (multiplier: 10/8 or 1.25).

PUBLIC FINANCE AND PUBLIC CHOICE

This exam consists of EIGHT essay questions. You should answer ALL questions! You have three hours in time for answering. Because the number of questions has been reduced from ten in previous years to eight this year, you should have plenty of time for answering!

Please write in very clear hand writing and be CONCISE, but COMPLETE in your answers (remember the answer formats for the exams of the previous year!). IES-students must write their answers in English language! AE-students may choose to use either English or Dutch language!

Question 1:

Because of several technical problems with the classical Pareto-criterium, economists (e.g., Kaldor, Hicks, Scitovsky) have invented the so-called 'Neo-Paretian criterium' for welfare improvements. This criterium is also known as the 'compensation-principle'.

Please explain this compensation-principle in relation with the concepts of CV (compensating variation) and EV (equivalent variation):

1a. According to Hicks.

1b. According to Kaldor.

1c. According to Scitovsky.

Question 2:

The 'theory of public/private goods' may serve as the theoretical basis for government intervention in the market system.

2a. Present the two technical characteristics of a pure collective good and explain why market provision of such a pure collective good causes serious problems.

2b. Present a 'taxonomy' (i.e., a 'classification') of (pure and quasi-) collective goods based on these two technical characteristics.

2c. What other economic arguments, in addition to the collective good-problem, which may be applied to defend government intervention in the market system?

Question 3:

Voting is an important mechanism for decision making in the public sector. 'Majority voting rules' are applied most.

3a. Explain the majority voting rule.

3b. Summarise and explain the so-called Arrow-paradox.

3c. Present some solutions to this paradox. What is your own opinion about these solutions and about the relevance of the Arrow-paradox?

Question 4:

Taxation induces 'efficiency losses' (distortions, resulting in excess burdens, welfare costs, etc.).

4a. Present a graphical partial equilibrium analysis for an excise tax (tax per unit) and a compensated demand curve.

4b. Explain how price-(in)elasticities of demand and supply determine the quantity-reactions of consumers and producers to such an excise tax.

4c. Explain in four graphical partial equilibrium analyses, representing the extreme cases of inelastic/elastic demand and elastic/inelastic supply, how the tax burden of this excise tax is divided between consumers and producers.

Question 5:

The modern public sector consists of more than just one scale-level of government, on which public goods and services are provided. The theory of fiscal federalism provides arguments for the optimal scale-level.

5a. Explain the 'decentralisation theorem' developed by Oates.

5b. Explain the 'economic theory of clubs' developed by Buchanan.

5c. What is the relationship between both theories within the framework of fiscal federalism?

Question 6:

Personal income is formed in a dynamic process of market forces and government interventions. In every stage of the so-called 'income formation process', market activities and government measures influence income distribution patterns.

6a. Present a so-called 'balance-sheet' of the income-formation process.

6b. Explain with this balance-sheet how government intervention in the market process induces efficiency-losses, which increase with every subsequent stage of the income formation process.

6c. Explain in more detail the problems which arise from charging 'income-prices' for public goods, and what could be done about them.

Question 7:

Economists also have modelled 'bureaucratic behaviour', i.e. behaviour in bureaucratic organisations.

7a. Explain the Niskanen-model of bureaucracy.

7b. Discuss the two sources of bureaucratic power.

7c. Discuss the three possible solutions to bureaucratic power and explain which solution (and why) might work best.

Question 8:

Cullis and Jones end their text book with a chapter on the 'traditional approach' to public finance and the 'public choice approach'.

8a. What are the main differences between both approaches?

8b. What does public choice-theory add to the economist's view on the role of economic policy advises and advisers in democratic processes of (economic) policy-making?