ECO 4554-01

Economics of State and Local Government

Public Choice
Exercise 3 Answers

Instructions

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Formatting Quiz Answers: Dollars: No decimals unless non-zero and at least one digit to the left of
the decimal even if zero. If non-zero decimals (that is, cents), you must include two digits to the right
of the decimal. Include dollar sign and commas to separate thousands. Quantities: No decimals unless
non-zero and at least one digit to the left of the decimal even if zero. Include commas to separate
thousands. If decimals, two digits to the right of the decimal. Elasticities: Do not round intermediate
calculations. No decimals unless non-zero and at least one digit to the left of the decimal even if zero.
If decimals, round to two digits to the right of the decimal. Percentages, shares, and tax rates:
Express as percentage, not as decimal. No decimals unless non-zero and at least one digit to the left of
the decimal even if zero. If decimals, two digits to the right of the decimal. Include percent sign.

Introduction

The objectives of this exercise are to

• practice using linear demand functions to solve economic problems
• reinforce your understanding of the median voter theorem, the Lindahl equilibrium, and the
reversion model
• reinforce your understanding of the problems with simple majority rule

Before beginning this exercise, read Fisher, Chapter 3, and the Additional Reading Assignments for
Topic 2.

There are three representative individuals in the community. They have different incomes, but all
have the same preferences (demands). The community operates a recreational facility. The demand
functions are shown below where Q is the number of hours per week that the facility operates and
MB is the marginal benefit:

Huey: MB=120-6Q.

Dewey: MB=75-5Q.

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 ECO 4554-01: Economics of State and Local Government
Public Choice
Exercise 3 Answer

Louie: MB=24-2Q.

The marginal cost of operating the facility is $63 per hour.

Problems

1. Median Voter Theorem

a. Each individual’s preferred number of hours is the quantity at which his marginal benefit
equals his share of marginal cost. If marginal cost is divided equally among the three so that
each pays a tax-price of $21, what is each individual’s preferred quantity? [Recall that
consumers choose the quantity that makes their marginal benefit equal to the price they must
pay.]

b. Using simple majority rule, how many operating hours per week will be chosen?

Answers:

a. Set each person’s demand function equal to his tax-price ($21) and solve for Q:

High income: MB=120-6Q=$21⇒ Q=16.5

Middle income: MB=75-5Q=$21⇒ Q=10.8
Low income: MB=24-2Q=$21⇒ Q=1.5

b. The median voter is the middle income person, so the quantity chosen is his preferred
quantity, 10.8

2. Simple Majority Rule Does Not Necessarily Choose the Efficient Quantity

a. To determine the efficient quantity, you must know the marginal social benefit as well as the
marginal cost. To find the marginal social benefit function, add the individual marginal
benefit functions. [Remember that this is a public good so you are “adding vertically”. Each
individual’s quantity consumed is equal to the total quantity supplied so they all consume the
same quantity. The marginal social benefit of that quantity is the sum of the individual
marginal benefits.]

b. The efficient quantity is the quantity at which marginal social benefit equals marginal cost.
What is the efficient number of operating hours?

c. How does the efficient number of hours compare with the number of hours chosen by simple
majority rule?

Answers:

a. MSB=(120+75+24)-(6+5+2)Q=219-13Q

b. MSB=MSC or 219-13Q=63 so Q*=12

c. Simple majority rule chooses 10.8 hours which is less than the efficient number of
hours, 12.

3. Lindahl Equilibrium
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 ECO 4554-01: Economics of State and Local Government
Public Choice
Exercise 3 Answer

In a Lindahl equilibrium, each individual pays a tax-price equal to his marginal benefit. What is
the Lindahl equilibrium tax-price for each individual at the efficient quantity?

Answers:

For each person, substitute the efficient quantity for Q and solve for their marginal
benefits. With Lindahl tax-prices, each person’s tax-price equals his marginal benefit.

High income: $48

Middle income: $15
Low income: $0

With a set of Lindahl tax-prices, each individual prefers the efficient quantity. Therefore,
simple majority rule results in choice of the efficient quantity, but so does any other voting
rule. Simple majority rule is no worse, but also no better, than other voting rules. The
lesson of the Lindahl equilibrium is that, when the equilibrium quantity is determined by
simple majority rule voting, the closer the distribution of taxes is to the distribution of
benefits, the closer the equilibrium quantity is likely to be to the efficient quantity.

4. Simple Majority Rule Does Not Reflect Intensity or Strength of Preferences

a. Suppose Huey’s demand increases so that his demand function is now MB=150-6Q. If his
tax-price is still $21, what is his new preferred quantity?

b. How many hours are chosen now using simple majority rule?

c. How does the increase in Huey’s demand affect the quantity chosen by simple majority rule?

d. How would a change in Louie’s demand affect the quantity chosen by simple majority rule?

Answers:

a. 21.5

b. 10.8

c and d. A change in the preference intensity of either the high income or the low income
individual has no effect on the quantity chosen using simple majority rule. The middle
income individual still has the median preferred quantity, and therefore, his preferred
quantity is still the quantity chosen using simple majority rule. Changes in preference
intensity among non-median voters have no effect on the outcome (provided preferences
don’t change so much that the middle income person is no longer the median voter).

5. Monopoly Bureaucratic Voting Models

a. Dewey is the median voter. Draw a diagram showing Dewey’s marginal benefit curve and his
tax-price of $21. Indicate on your diagram his preferred quantity.

b. Suppose simple majority is the voting rule but voters can only vote on proposals presented to
them by the bureaucrats. If voters accept the bureaucrat’s proposal, that becomes the new
equilibrium quantity. If voters reject the proposal, the facility’s operating hours revert to last

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 ECO 4554-01: Economics of State and Local Government
Public Choice
Exercise 3 Answer

year’s level of 8. Indicate the reversion quantity on your diagram. Now, outline or shade in
the area that represents Dewey’s loss of consumer surplus if the quantity is 8 instead of being
equal to his preferred quantity.

c. What is the greatest number of hours that the bureaucrats can get the voters to approve?
Explain how you determine this quantity.

Answers:

a.

b and c. Dewey’s loss of consumer surplus if the quantity reverts to 8 instead of his
preferred number of 10.8 is area A. The loss would be the same if the quantity were
13.6, as shown by area B, which is just equal to area A. Therefore, Dewey is indifferent
between 8 and 13.6 because they both involve the same loss. So 13.6 is the largest
number of hours that the bureaucrats can get Dewey (the median voter) to approve.