Public Economics: HW1

March 10, 2021

Problem 1. Collect data about tax revenue in Russia (or your other home country) to
construct a pie chart that shows the share of different types of taxes in the total tax revenue
(similar to the pie chart in Introductory lecture slides on page 15). Please use the data for
the latest available year. Indicate this year. Note that the structure of taxes collected in
Russian Federation is different from the one in the United States. Briefly describe what you
have learned about the structure of taxes in the Russian Federation from your pie chart.
Solution.

A significant proportion of revenue to the state comes from the oil and gas industry (20%).
A slightly smaller share falls on VAT (18%). Approximately the same contribution is made
by corporate and personal income taxes, 12% and 10% respectively. Section named ”other”
1
turned out to be so huge because it includes compulsory social insurance contributions.
1
https://www.minfin.ru/ru/statistics/conbud/

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 Problem 2. Consider an economy consisting of 1 million consumers whose utility func-
1000
tions are Ui = xi − (i = 1, .., 106 ), where xi is the consumption of private good (books)
G
and G is the consumption of public good (benches). Income of each consumer is 1000. The
prices of one book is 4 and the price of one bench is 10.
a. How many benches will be produced if public good is privately financed (competitive
equilibrium).
b. Write down the Samuelson Rule for optimal public good provision. Show that this
equation unambiguously determines the optimal number of benches. What is this number?
Solution.
a. Define by gi the contribution to the public good by consumer i. The budget constraint
P 6
of consumer i is then 4xi + 10gi = 1000. Note that G = 10 i=1 gi . Consumer i’s problem is
then
1000
max 250 − 2.5gi − .
gi gi + g−i
The FOC for this problem is
1000
−2.5 + =0
(gi + g−i )2
⇒ G2 = 400 ⇒ G∗ = 20.
b. To calculate the Pareto efficient amounts of public good, let us apply the Samuelson
P 6 P106 UG 109 pG 10
condition. First, 10i=1 M RSG,xi = i=1 = 2
. Second, M RTG,x = = . From
Uxi G px 4
P106 2
i=1 M RSG,xi = M RTG,x we have G = 4 · 10 .
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Hence, G∗ = 20000.
Problem 3. Consider an economy consisting of three consumers whose utility functions
are Ui = 5lnxi + lnG (i = 1, 2), where xi is the consumption of private good (books) and G is
the consumption of public good (benches). The prices of both goods are equal to 1. Income
of the first consumer is 460 and income of the second and the third consumers is 420.
a. Determine the amount of public good provided in competitive equilibrium (i.e., private
provision without government).
b. Determine the Pareto optimal amount of public good.
c. [Optional - - it can give you up to 2 points if you miss points on the other problems]
Calculate the individual Lindahl prices for each consumer.
Solution.
a. Define by gi the contribution to the public good by consumer i. The budget constraint
of consumer i is then xi + gi = Yi where Y1 = 460 and Y2 = Y3 = 420. Note that G =
g1 + g2 + g3 . Consumer i’s problem is then

max 5ln(Yi − gi ) + ln(gi + gi ).

gi

2
The FOC for this problem is
5 1
− + = 0.
Yi − gi gi + gi
Solve the system of equations
460 − 5g2 − 5g3


 g1 =

 6
420 − 5g1 − 5g3

g2 =
 6
g3 = 420 − 5g1 − 5g2



6
g1 = 53.75, g2 = g3 = 13.75 ⇒ G∗ = 81.25

b. To calculate the Pareto efficient amounts of public good, let us apply the Samuelson
UG x1 + x2 + x3 pG
condition. First, 3i=1 M RSG,xi = 3i=1
P P
= . Second, M RTG,x = = 1.
Uxi 5G px
Hence, 5G = x1 + x2 + x3 .
The social budget constraint is x1 + x2 + x3 + G = 1300. Combining it with the Samuelson
650
condition, we obtain G∗ = .
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c. To calculate Lindahl prices, we need to find such p1 , p2 and p3 that p1 + p2 + p3 = 1
650
and each individual chooses Gi = G = when he solves
3
max 5ln(Yi − pi Gi ) + ln(Gi ).
Gi

The FOC
5pi 1 Yi Yi
− + = 0 ⇒ pi = = .
Yi − pi Gi Gi 6Gi 6G
460 420
The above equation gives p1 = and p2 = p3 = . Using now p1 + p2 + p3 = 1, we get
6G 6G
650 23 21
G∗ = , and p1 = and p2 = p3 = .
3 65 65
Problem 4. Consider an economy consisting of five consumers. Their utility functions
are Ui = xi − 0.5(αi − G)2 , where xi is the consumption of private good by consumer i
(i = 1, .., 5),G is the consumption of public good and α1 = 30, α2 = 27, α3 = 24, α4 = 21,
and α5 = 18. The price of public good is 40 and the price of private good is 1.
a. Determine the Pareto efficient amounts of consumption of public good.
b. Calculate privately financed amount of public good (competitive equilibrium). Would
there any public good produced?
Solution.
a. To calculate the Pareto efficient amountsP
of public good, let us apply the Samuelson
5
P5 P5 UG αi − 5G pG
condition. First, i=1 M RSG,xi = i=1 = i=1 . Second, M RTG,x = = 40.
Uxi 1 px
Hence, 120 − 5G = 40, G∗ = 16.

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 b. Define by gi the contribution to the public good by consumer i. The budget constraint
of consumer i is then xi + 40gi = Yi . Note that G = 5i=1 gi . Consumer i’s problem is then
P

max Yi − 40gi − 0.5(αi − gi − g−i )2 .

gi

The FOC for this problem is

−40 + αi − gi − g−i = 0 ⇒ G = αi − 40.

There is no competitive equilibrium because, due to the specificity of the function, the utility
from using the public good cannot be greater than 0, thus, each individual would prefer the
size of the public good equal to his alpha, so that the public good does not harm him. But,
since each individual has his own alpha value, there is no single value of public good that
would satisfy every individual. In this case, we cane assume that everyone is highly likely
to be greedy enough to invest something for the good of society (it can only harm him) and
put all his income into consumption of a private good that positively affects his utility. So,
there is no public good production.