ECO 4554

Economics of State and Local Government

Study/Test Questions
Topic 3: The Tiebout Hypothesis

These questions are designed as study questions to enhance your economic knowledge and your
analytical skills. I will also use them as test questions. Because you have the questions in advance, I
expect your answers on the tests to be well-organized, clear, coherent, and concise. You might write
trial answers to each question in advance, or at the very least, outline the answers. You may not bring
any written materials to the test, but if you’ve prepared answers in advance, you can immediately
begin writing and still write competent and thorough answers.

Feel free to consult one another on the questions. In fact, I strongly encourage you to discuss the
questions with one another. No matter how confident you are of your knowledge, your command of
the material and your preparation for the test can be enhanced by sharing your knowledge. Do not,
however, simply rely on your fellow students to provide you with the answers. When the time for the
test comes, you will be on your own.

Although in most cases, the questions do not specifically request that you illustrate your answer with
an appropriate diagram, diagrams are usually quite helpful both in undertaking the analysis and in
illustrating and explaining your answer. I expect you to know the relevant diagrams, to use them, and
to interpret them. I encourage you to include them in your answers.

3-1. For each item below, define the term or state the theorem or explain the concept.

• Tiebout hypothesis
• Fiscal zoning
• Capitalization

3-2. The Tiebout hypothesis requires that all of the following assumptions be satisfied.

1. Consumers are mobile and will move their residence to the community that
best satisfies their preferences.
2. Consumers are completely knowledgeable about the differences among
communities in public services and taxes.
3. Consumers have many communities from which to choose.
4. Employment opportunities do not restrict or limit the mobility of individuals
among communities.
5. There are no spillovers of public service benefits or taxes among
communities (no interjurisdictional externalities).
6. Each community attempts to attract a population that is exactly large enough
to take full advantage of any economies of scale in the supply of public
services without being so large as to encounter diseconomies of scale.

For each assumption, explain why the assumption is essential to the validity of the Tiebout
hypothesis. That is, explain why, if the assumption is not true, individual choice among
communities based on preferences for public services and taxes does not result in a Lindahl
equilibrium.

3-3. (Core Principle) Based on the Tiebout hypothesis,

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 ECO 4554: Economics of State and Local Government
Study/Test Questions: Topic 3

a. what is the efficient number of communities and what is the efficient size of each
community?

b. does metropolitan consolidation, where two or more cities merge into one or where a
county and one or more cities merge into a single government unit, increase or decrease
efficiency and why?

c. do limits on the use of fiscal zoning and laws and policies that make communities more
heterogeneous increase or decrease efficiency and why?

3-4. There are two communities: Hueytown, composed of $150,000 houses, and Deweyburg,
composed of $50,000 houses. Hueytown provides its residents with 3 acres per household of
parkland; Deweyburg provides 1 acre per household. Each household in Hueytown pays a
parkland maintenance fee of $1500 per year; each household in Deweyburg pays a parkland
maintenance fee of $500 per year. There are no interjurisdictional benefit or cost spillovers (no
spatial externalities).

At these prices, the residents of each community are just exactly satisfied with the amount of
parkland each community provides. The residents of each community are on their demand
curves. Residents of Deweyburg have no incentive to move to Hueytown because the higher
parkland fee in Hueytown exceeds the value to them of the additional parkland. Residents of
Hueytown have no incentive to move to Deweyburg because the value to them of the additional
parkland in Hueytown is worth the higher fee. The parkland fee is a perfect benefit tax, and the
result is a perfect Lindahl equilibrium.

a. If the parkland fee in each community were replaced by a property tax equal to 1 percent
of house value, how would it change the incentives for residents in each community to
relocate to the other community? What happens to the Lindahl equilibrium? Explain.

b. Would substitution of a property tax for the parkland fee affect the initial Lindahl
equilibrium if Hueytown enacted a zoning ordinance establishing a minimum house value
of $150,000 before it adopted the property tax? Explain.

c. Louieville has a mix of big houses and small houses. Like Hueytown, Louieville provides
a large amount of parkland per household and pays the costs of parkland from a property
tax. However, because of capitalization of fiscal differentials, residents of Deweyburg
who own small houses do not relocate to Louieville even though they would get more
parkland with no increase in their taxes. Similarly, residents of Louieville who own big
houses do not relocate to Hueytown even though they would pay less tax for the same
amount of parkland. Explain what “capitalization of fiscal differentials” means in this
setting. How does capitalization eliminate the incentive for Louieville’s residents to
relocate to Hueytown or for Deweyburg’s residents to relocate to Louieville?