ECON 342 Spring 2014 Problem Set #1 NOTE: For this problem set, questions 4, 7, 10, 12 and 16 will

be graded (4 point each.) Introductory Material 1. What do we mean when we say some questions in public finance are normative questions and some questions are positive questions? 2. Gruber, ch1, question 8.

Budgeting Basics 3. Gruber, ch 4, question 6. 4. Gruber, ch 4, question 7.

Theoretical Tools 5. When economists think about how consumers make decisions, we usually imagine that they are solving a constrained maximization problem. What do we mean by that? 6. Gruber, ch2, question 2. 7. Gruber, ch2, question 3. 8. Gruber, ch2, question 7. 9. Suppose the following represents the marginal benefit schedule of a typical consumer for apples (measured on a weekly basis): MBi = 10-2Qi a) How much value does the consumer derive from the first apple he consumes each week? b) How much value does the consumer derive from the second apple he consumes each week? c) If the economy was composed of 100 consumers identical to this one, write out a function for the demand function (QD = ?) and graph it. 10. Consider a free market for clothing, with aggregate demand and aggregate supply given by the following equations: QD = 1200 10P and QS = 20P. a) Solve for the equilibrium quantity and price. b) Calculate the producer and consumer surplus.

c) Suppose the government mandates a price ceiling of $30 per unit of clothing. Calculate the new levels of producer and consumer surplus. Calculate the size of the deadweight loss. 11. Consider a policy proposal that has different impacts on two groups of citizens. Type A citizens would suffer a loss of economic surplus equal to $200 if the policy is adopted, while Type B citizens would receive an increase in economic surplus equal to $150. There are equal numbers of each type of citizen, and no one else would be affected by the policy. a) Would the policy increase or decrease social efficiency? b) Would the policy increase or decrease social welfare? Explain your answer. 12. In class, we looked as a graphical example of a constrained maximization problem, where a consumer was choosing how much food (and how much other stuff) to consume. By thinking about indifference curves and budget constraints, we were able to predict how a consumers demand for food would be affected by changes in the price of food. In this question, I want you to apply the same analytic techniques to the issue of labor supply i.e. how does a worker decide how much to work? a) For this analysis, the key issue is that workers face a tradeoff between how much leisure they take and how much they can afford to consume. (Taking one more hour of leisure means working one hour less, which reduces the amount of consumption a worker can afford.) Write out an equation that captures a workers budget constraint. b) Draw a graph with hours of leisure on the x-axis and consumption ($) on the y-axis. On the graph, draw a line representing the workers budget constraint. Why is the slope of this line important? On your graph, show a set of indifference curves consistent with a worker who chooses to work H* number of hours. c) Now, suppose that a 50% wage tax is implemented, i.e. the workers (after-tax) wage is half as large as before. On a new graph, plot the old and new budget constraints and show (with indifference curves) how the choice of H* might change. d) Use the same graph, decompose the change in work hours into the change due to the substitution effect and the change due to the income effect. Given your findings, what can we conclude about the effect of a wage tax on labor supply?

Empirical Tools 13. Gruber, ch3, question 3. 14. A researcher conducts a cross-sectional analysis of workers and finds that a positive correlation between time spent on a computer at work and wages (i.e. people whose work is performed on computers tend to earn more). The researcher concludes that computer use increases wages and advocates a policy of computer training for all children. Is this the correct interpretation of these findings?

15. A four-year study in Tennessee randomly assigned children in kindergarten through third grade into classes of different sizes. The results of this experiment showed that students assigned to smaller class sizes had higher test scores (on average) than those assigned to larger class sizes. a) Is this credible evidence that smaller class sizes has a causal effect on student performance? (Explain why or why not.) b) Over the course of experiment, 10% of students were switched (by their school) from their initially assigned class. How might this bias the results of the study? 16. Gruber, ch3, question 7.