University of Maastricht

Faculty of Economics and Business Administration

RESIT For students in

International Economic Studies

Algemene Economie

COURSE Public Finance and Public Choice (IES)

Overheidsfinanciën en Public Choice (AE)

CODE 1316

DATE 3 April, 1998

LOCATION Tongersestraat 53, Room 1001

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:

Economists are fond of the concept of 'Pareto-efficiency'. It allows for deriving the two celebrated fundamental theorems of welfare economics, but it contains some problems.

1a. Define Pareto efficiency (in words and in a mathematical equation).

1b. What are the two celebrated fundamental theorems of welfare economics?

1c. Explain two fundamental problems with the concept of Pareto-efficiency.

Question 2:

The 'Coase theorem' states that externalities are irrelevant.

2a. Define externalities (in words and in a mathematical equation).

2b. What is the central line of argument in the Coase theorem?

2c. Explain why and how this theorem makes externalities irrelevant.

2d. Which other policy measures are available to solve the externality problem?

Question 3:

In recent years, a 'theory of government failure' has been developed.

3a. Give a description of the concept of government failure.

3b. Present a taxonomy (or classification) of government failure.

3c. Show the analogy between market failure and government failure and discuss the problems with this analogy.

Question 4:

Taxation is said to induce 'efficiency losses' (consisting of excess burdens, welfare costs, etc.). The so-called Harberger-model attempts to analyse these efficiency losses in the framework of general equilibrium.

4a. Give a short presentation of the Harberger-model, using a general equilibrium analysis of a tax on the return to capital in the corporate sector.

4b. Present a short assessment of the pros and cons of the Harberger-model.

Question 5:

Income distribution is an eternal subject of public economics. However, normative principles for and positive accounts of redistribution should be separated.

5a. Present John Rawls' 'Theory of Justice' as an example of the normative approach.

5b. Present the 'negative income tax scheme' in the framework of a positive approach.

5c. Does a negative income tax fit into Rawls 'Theory of Justice'?

Question 6:

Housing is a policy field with a long tradition of government intervention. Consider the market for social housing, i.e. houses not owned by individual house-owners but rented from so-called 'social housing institutions'.

6a. Analyse the reasons for government intervention in the social housing system by applying the theory of public goods (as discussed in the first part of the course).

6b. Does the theory of public goods in your opinion provide sufficient argumentation for government intervention in social housing? Apply also a public choice approach in answering this question 6b! A personal view will be welcomed!

Question 7:

Business-cycles are a common phenomenon in market economies. Keynesian policies (fiscal and monetary policies) and functional finance are remedies to smoothen the business cycle (stabilisation branch of the public sector). However, in public choice theory a 'political business cycle' has been discovered.

7a. Explain the essentials of the political business cycle, as formulated in the so-called Nordhaus-model.

7b. Explain how according to public choice theorists Keynesian policies are the principal cause for the occurrence of a political business cycle.

7c. How can according to the same public choice theorists the political business cycle be coped with in representative democracy?

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?