Scope

The final part of the book, part IX, considers two applications of the theory. The discussion of cost–benefit analysis in chapter 25 draws on many of the earlier results to detail a methodology for evaluating when the implementation of a project—which can be interpreted as any change in policy—will increase social welfare. Chapter 26 completes the book with a discussion of the economics of climate policy. The focus in the chapter is on how the tools of public economics can be applied to policy in the presence of pervasive uncertainty.

Friedman, M. 1953.Essays on Positive Economics. Chicago: University of Chicago Press.

Koopmans, T. C. 1957.Three Essays on the State of Economic Science. New York: McGraw-Hill.

Two books that show how the tools of public economics can be applied to practical policy analysis are:

Mirrlees, J. 2010.Dimensions of Tax Design. Oxford: Oxford University Press.

Mirrlees, J. 2011.Tax by Design. Oxford: Oxford University Press.

The issues involved in comparing individual welfare levels are explored in:

Robbins, L. 1935.An Essay on the Nature and Significance of Economic Science. London: Macmillan.

Exercises

1.1 Should an economic model be judged on the basis of its assumptions or its conclusions?

1.2 Explain the economic implications of the imposition of quality standards for drinking water.

1.3 Can economics contribute to an understanding of how government decisions are made?

1.4 In the introduction to “The Economics of Welfare” (1928) Pigou states that:

When a man sets out upon any course of inquiry, the object of his search may be either light or fruit—either knowledge for its own sake or knowledge for the sake of good things to which it leads.

What should be the balance betweeen light and fruit in public economics?

1.5 What should guide the choice of economic policy?

1.6 Are bureaucrats motivated by different factors than entrepreneurs?

1.7 What restricts the policies that a government can choose? Are there any arguments for imposing additional restrictions?

1.8 The UK government scheme Sure Start helps children in disadvantaged areas to have an equal start in life with children from better-off backgrounds, by developing a “one-stop- shop” approach to local family support services. A government minister commented “In the years ahead, children who are healthier and more ready to learn, stronger families and communities, less crime and fewer school-age pregnancies will benefit us all.” Examine the efficiency and equity components of the minister’s comments.

1.9 “Physics is a simpler discipline than economics. This is because the objects of its study are bound by physical laws.” Do you agree?

1.10 If individual welfare levels cannot be compared, how can it be possible to make social judgments?

1.11 “Poverty should be reduced to lessen the extent of malnutrition and raise economic growth.”

Distinguish the positive and normative components of this statement.

1.12 “It is economically efficient to maintain a pool of unemployed labor.” Is this claim based on positive or normative reasoning?

1.13 “High-income earners should pay a high rate of tax because their labor supply is inelastic and the revenue raised can be used to assist those on low incomes.” Distinguish between the positive and normative components of this statement.

1.14 Bob Wailer was a talented singer from a very early age. With no training or practice he built a successful career as the enigmatic frontman of a punk revivalist band. From the day she could hold a bow Emma Libro was trained in classical violin. After many years of study and practice she finally obtained lead violin for the Exeter Philharmonic and a lucrative recording contract. Assume that Bob and Emma have the same income. Is it equitable for them to pay the same amount of tax?

1.15 Consider two methods of dividing a cake between two people. Method 1 is to throw some of the cake away, and share what is left equally. Method 2 is to give one person 75 percent of the cake and the other 25 percent. Which method do you prefer, and why?

1.16 A cake has to be apportioned between two people. One is well-nourished, and the other is not. If the well-nourished person receives a sharex, 0≤x≤1, a sharey= [1−x]²is left for the other person (some is lost when the cake is divided). Plot the possible shares that the two people can have. What allocation of shares would you choose? How would your answer change ify= [1−x]⁴?

1.17 A cake is to be divided between two people. Unfortunately, when the cake is sliced some is lost. Specifically, if the sizes of the two portions are denotedxandy, then the size of the slices satisfy the relationx^1/2+y^1/2=1.Graph the possible divisions of the cake and discuss how the balance between efficiency and equity will affect the choice of division.

1.18 Can an economic model be acceptable if it assumes that consumers solve computationally complex maximization problems? Does your answer imply that Tiger Woods can derive the law of motion for a golf ball?

1.19 To analyze the effect of a subsidy to rice production, would you employ a partial equilibrium or a general equilibrium model?

1.20 If the European Union considered replacing the income tax with an increase in VAT, would you model this using partial equilibrium?

1.21 What proportion of the world’s economies (by number, population, and wealth) can be described as “mixed”?

1.22 What problems may arise in setting economic policy if consumers know the economic model?

1.23 Should firms maximize profit?

1.24 To what extent is it possible to view the government as having a single objective?

1.25 Are you happier than your neighbor? How many times happier or less happy?

1.26 Assume that consumers are randomly allocated to either earn incomeM_ℓ or incomeM_h, whereM_h>M_ℓ. The probability of being allocated toM_ℓisπ. Prior to being allocated to an income level, consumers wish to maximize their expected income level. If it is possible to redistribute income costlessly, show that prior to allocation to income levels, no consumer would object to a transfer scheme. Now assume that there is a costfor each consumer of incomeM_hfrom whom income is taken. Find the maximum value ofπfor which there is still unanimous agreement that transfers should take place.

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