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Chương Cost – Benefit analysis Truste
d
3) A project yields an annual benefit of $25 a year, starting next year and
continuing forever. What is the present value of the benefits if the interest rate is
10 percent?
[Hint: The infinite sum x + x2 + x3 . . . is equal to x/(1 - x), where x is a number less
than 1.]
Generalize your answer to show that if the perpetual annual benefit is B and the
interest rate is r, then the present value is B/r.

The present value of the perpetual annual benefit = B/(1 + r) + B/(1 + r) 2 + … =

B (r + 1 - r)/r = B/r.

Áp dụng: The present value of $25/.10 = $250.

4) Suppose that you are planning to take a year vacation to bike across the United
States. Someone is willing to sell you a new bicycle for $500. At the end of the year,
you expect to resell the bicycle for $350. The benefit to you of using the bicycle is
the equivalent of $170.
a. What is the internal rate of return?
b. If the discount rate is 5 percent, should you buy the bicycle?

a. The internal rate of return is the discount rate that would make the project’s net present
value (NPV) equal zero. To solve for the internal rate of return, , set the present value
of benefits minus the present value of costs equal to zero. If we assume the benefit of
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using the bicycle is immediate (and worth $170), there is also the benefit of re-selling
d
the bicycle for $350, but it can’t be re-sold until next year, so must be discounted.
Therefore, NPV is 170 + [350/(1+)] – 500 = 0. Solving this expression for  yields 
= 6 percent. If we assume that the benefits of the vacation will not be enjoyed for one
year, then NPV is [(170+350)/(1+)] –500 and setting this expression equal to zero and
solving for  yields  = 4 percent.

b. If the discount rate is 5 percent, purchasing the bicycle is a good idea if  is 6 percent,
but a bad idea if  is 4 percent.

5. Bill rides the subway at a cost of 75 cents per trip, but would switch if the price
were any higher. His only alternative is a bus that takes five minutes longer, but
costs only 50 cents. He makes 10 trips per year. The city is considering renovations
of the subway system that would reduce the trip by 10 minutes, but fares would
rise by 40 cents per trip to cover the costs. The fare increase and reduced travel
time both take effect in one year and last forever. The interest rate is 25 percent.
a. As far as Bill is concerned, what are the present values of the project’s benefits and
costs?
b. The city’s population consists of 55,000 middle-class people, all of whom are
identical to Bill, and 5,000 poor people. Poor people are either unemployed or have
jobs close to their homes, so they do not use any form of public transportation. What
are the total benefits and costs of the project for the city as a whole? What is the net
present value of the project?
c. Some members of the city council propose an alternative project that consists of an
immediate tax of $1.25 per middle-class person to provide “free” legal services for the
poor in both of the following two years. The legal services are valued by the poor at a
total of $62,500 per year. (Assume this amount is
received at the end of each of the two years.) What is the present value of the project?
d. If the city must choose between the subway project and the legal services project,
which should it select?
e. What is the “distributional weight” of each dollar received by a poor person that
would make the present values of the two projects just equal? That is, how much must
each dollar of income to a poor person be weighted relative to that of a middle-class
person? Interpret your answer.
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a. Bill is willing to pay 25 cents to saveTruste
5 minutes, so he values time at 5 cents per
minute. The subway saves him 10 minutes d per trip, or 50 cents. The value of 10 trips
per year is $5. The cost of each trip is 40 cents, or $4 per year (10 trips per year). The
annual net benefit to Bill is therefore $1. The present value of the benefits = $5/.25 =
$20; the present value of the costs is $4/.25 = $16.
b. Total benefits = $20x55,000=$1,100,000.
Total costs = $16x55,000 = $880,000.
Net benefits = $220,000.
c. Costs = $1.25 x 55,000 = $68,750.
Benefits =($62,500/1.25) + ($62,500/1.252) = $90,000.
Net benefit = $21,250.
d. The subway project has a higher present value. If a dollar to the “poor” is valued the
same as a dollar to the “middle class,” choose the subway project.

e. Let  = distributional weight. Set:

220,000 = -68,750 + [(62,500/1.25) + (62,500/1.252)]

 = 3.21
This distribution weight means that $1 of income to a poor person must be viewed as
more important than $3.21 to the middle class for the legal services to be done.

6. Suppose that the government is debating whether to spend $100 billion today to
address climate change. It is estimated that $700 billion of damage will be averted,
but these benefits will accrue 100 years from now. A critic of the proposal says
that it would be far better to invest the $100 billion, earning an average real
return of 5 percent per year, and then use the proceeds in 100 years to repair the
damage from climate change. Is this critic correct?

$100 billion invested for 100 years at 5 percent per year would generate over $13
trillion, a lot more than the $700 billion in damage caused by the climate change.
There might be other considerations offered when evaluating this proposal, but the
critic is correct from a financial standpoint.
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9. According to Viscusi and Gayer [2005], regulations in the United States vary
greatly in the cost per each life they save. For example, the regulation to install
passive restraints in vehicles has a cost per life saved of $600,000, whereas the
regulation to remove asbestos in workplaces has a cost per life saved of $180
million. What does this information imply about whether the regulations pass a
cost-benefit test? How might resources be shifted between these regulations in
order to reduce cost or save more lives?
Viscusi (2006) finds the value of a life between $4 and $10 million.

Therefore, the passive restraints in vehicles passes cost benefit analysis, but the
asbestos removal does not. This implies that resources could be shifted from asbestos
removal to vehicle restraints to reduce costs or save lives.

Chương Income Redistribution

2. Suppose there are only two people, Simon and Charity, who must split a fixed
income of $100.
For Simon, the marginal utility of income is MUs = 400 - 2Is while for Charity,
marginal utility is
MUc = 400 - 6Ic where Ic, Is are the amounts of income to Charity and Simon,
respectively.
a. What is the optimal distribution of income if the social welfare function is
additive?
b. What is the optimal distribution if society values only the utility of Charity?
What if the reverse is true? Comment on your answers.
c. Finally, comment on how your answers change if the marginal utility of income
for both Simon and Charity is constant: MUc = 400 , MUs =400
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a. Trusteequal; the constraint is I s + Ic = 100. So,
To maximize W, set marginal utilities
400 - 2Is = 400 - 6Ic, substituting Ic = 100d- Is gives us 2Is = 6 (100 – Is). Therefore, Is =
75, Ic = 25.
b. If only Charity matters, then give money to Charity until MU c = 0 (unless all
the money in the economy is exhausted first). So, 400-6I c = 0; hence, Ic = 66.67. Giving
any more money to Charity causes her marginal utility to become negative, which is
not optimal. Note that we don’t care if the remaining money ($33.33) is given to
Simon or not.
If only Simon matters, then, proceeding as above, MUs. =0 if Is = 200; hence, giving all
the money to Simon is optimal. (In fact, we would like to give him up to $200, nghĩa là
nếu cho thêm được ngoài 100$ thì sẽ tiếp tục cho Simon.)
c. MUs = MUc for all levels of income. Hence, society is indifferent among all
distributions of income.

6. An economy consists of two individuals, Lynne and Jonathan, whose utility

levels are given by UL and UJ, respectively.
a. Suppose that the social welfare function is W = UL + UJ
True or false: Society is indifferent between giving a dollar to Lynne and a dollar
to Jonathan.
b. Now suppose that, instead, the social welfare function is W = UL + 8UJ
True or false: Society values Jonathan’s happiness more than Lynne’s.
c. Now suppose that, instead, the social welfare function is W = min[UL, UJ]
True or false: In this society, the optimal distribution of income is complete
equality

a. False. Society is indifferent between a util to each individual, not a dollar to

each individual. Imagine that UL=I and UJ=2I. Then each dollar given to Jonathan
raises welfare more than the same dollar given to Lynne.
b. True. The social welfare function assumes a cardinal interpretation of utility so
that comparisons across people are valid.
c. False. Departures from complete equality raise social welfare to the extent that
they raise the welfare of the person with the minimum level of utility.
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8. Sherry’s utility is US and her incomeTruste
is YS. Marsha’s utility is UM and her
d
income is YM. Suppose it is the case that:

Define the Pareto efficient redistribution, and explain why the concept is
relevant in this situation.
Suppose that initially Sherry and Marsha both have incomes of $100. Assuming
that the social welfare function is additive, what happens to social welfare if $36 is
taken away from Marsha and given to Sherry?

Pareto efficient redistribution is a reallocation of income that increases (or does not
decrease) the utility of all consumers. With these two consumers, Marsha’s utility
increases as Sherry’s utility increases. Thus, it may be possible to reallocate income
from Marsha to Sherry and raise both of their utility.
With Sherry’s initial utility function of U S=100YS1/2, her utility with $100 of income is
US=100($100)1/2, or US=1,000. With Marsha’s initial utility function of
UM=100YM1/2+0.8US, her utility with $100 of income is U M=100($100)1/2+0.8(1,000), or
UM=1,800. If the social welfare function is additive, then initial welfare is
W=US+UM=1,000+1,800=2,800.
If $36 is reallocated from Marsha to Sherry, then Sherry’s income is now $136 and
Marsha’s is now $64. With Sherry’s utility function, her utility with $136 of income is
US=100($136)1/2, or US=1,166.190. With Marsha’s utility function, her utility with $64
of income is UM=100($64)1/2+0.8(1,166.190), or UM=800+932.952=1,732.952. In this
case, Sherry’s utility increases from 1,000 to 1,166.190, while Marsha’s utility falls
from 1,800 to 1,732.952. Social welfare increases with this redistribution, going from
2,800 to 2,899.142. Thus, this redistribution increases social welfare, but is not Pareto
efficient redistribution.

Chương Taxation and Income distribution

1. In 2009, it was proposed that the state of Nevada create an entertainment tax
that “would require the state’s 25 legal brothels to give the state some money on a
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per-transaction basis” [Friess, 2009]. Truste
Discuss the likely incidence of such a tax.
Use an appropriate diagram as the basisd for your discussion.

The market initially is at P1Q1. Adding a per-customer tax on strip clubs would
be a tax on a commodity. Because the producer would be paying the tax, the
effective supply curve for suppliers would be S 1. The producers are happy and
the market clears only when PS is paid by the customers for quantity Q 2. Of this
price, PS-PC is the tax paid, where customers pay PS-P1 of the tax and the
suppliers pay P1-PC. The incidence depends on the relative elasticities of supply
and demand. Here, the curves are drawn such that the consumers and suppliers
face roughly the same incidence. However, if one believed that the supply was
relatively more inelastic, then the strip clubs would face a higher incidence.

S1
Price
S

PS

P1

Q2 Brothel
Q1 Transactions
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d

2. Consider a society with only two people—one rich and one poor—who have the
same utility functions. These utility functions exhibit diminishing marginal utility.
Suppose that taxes are set such that the total amount of utility that each person
loses is the same. Does it follow that the tax will be progressive? Explain.

No, it does not follow that the tax will be progressive. If both lose the same amount of
utility, the rich person will pay more because of diminishing marginal utility of income.
But, a progressive tax requires that a higher proportion of income (the average tax rate)
be taken from the rich person. This tax plan only requires that the absolute amount be
higher, not the proportional amount. For instance, if the marginal utility were
decreasing, but very close to constant, then the rich and poor would pay very close to
the same amount in taxes. This amount would be a much larger share of the poor
person’s income.
Cho hàm QD = 2000-200P, QS= 200P. CP áp mức thuế đơn vị $2 lên người bán.
Tính sản lượng cân bằng khi chưa có thuế, khi có thuế. Tính doanh thu thuế.

a. Set 2000 – 200P = 200P, so P = $5 and Q = 1000 packs

b. 2000-200P=200(Pcons – 2)
Producer receives $4 per pack; consumer pays $6 per pack.
Quantity sold = (200)(4) = 800 packs.
Tax revenue = (tax/pack)(no. of packs) = (2)(800) = $1600
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7. Suppose that the income tax in a certain nation is computed as a flat rate of 5
percent, but no tax is levied above $50,000 in taxable income. Taxable income, in
turn, is computed as the individual’s income minus $10,000; that is, everyone gets
a $10,000 deduction. What are the marginal and average tax rates for each of the
following three workers? (Evaluate the marginal tax rate at each person’s current
income level.)
a. A part-time worker with annual income of $9,000.
b. A retail salesperson with annual income of $45,000.
c. An advertising executive with annual income of $600,000.

a. A part-time worker with annual income of $9,000 pays no taxes since everyone gets
a $10,000 deduction. Her marginal tax rate is 0% and her average tax rate is 0%.
b. A retail salesperson with annual income of $45,000 has taxable income of $35,000
and pays $1750 in taxes (5 percent of taxable income). As a percentage of income, the
average tax rate is 3.89% ($1750 is 3.89% of $45,000). Her marginal tax rate is 5%.
c. An advertising executive with annual income of $600,000 pays $2,000 in taxes since
no tax is levied above $50,000 in taxable income (đánh thuế trên 40 ngàn, do khấu trừ
thêm 10 ngàn trước khi bắt đầu tính thuế). As a percentage of income, the average tax
rate is 0.33%. Her marginal tax rate is 0%.
The tax is initially progressive, but because of the cap on taxable income, becomes
regressive.

Chương Taxation and Efficiency

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Trustea large excess burden?
1. Which of the following is likely to impose
a. A tax on land. d
b. A tax of 24 percent on the use of cellular phones. (This is the approximate sum
of federal and state tax rates in California, New York, and Florida.)
c. A subsidy for investment in “high-tech” companies.
d. A tax on soda bought in a cup or glass but not bought in a bottle or can. (Such a
tax exists in Chicago.)
e. A 10-cent tax on a deck of cards that contains no more than 54 cards. (Such a
tax exists in Alabama.)
f. A tax on blueberries. (Such a tax exists in Maine.)

a. The supply of land is fixed, or perfectly inelastic, so there is no excess burden because
the lower price that sellers receive does not cause quantity supplied to fall.

b. The use of cell phones is probably fairly price-elastic, which implies that the excess
burden could be large.

c. It is possible that companies could identify themselves as high-tech in order to receive

the subsidy. Thus, the supply is quite elastic, and there will be substantial excess
burden.

d. Consumers and sellers will likely agree to avoid cups and glasses in order to avoid the
tax. A tax that is easily avoided does not have much of an impact, except to create
some inconvenience, and does not raise revenue.

e. Card companies can easily increase or decrease the number of cards in a pack, avoiding
the tax and reducing the excess burden.

f. There are many good substitutes for blueberries. Therefore, their demand is quite
elastic, and a tax on them will have a substantial excess burden, relative to the size of
revenues collected.

2. Suppose that your neighbor is willing to pay you $100 to do some home repairs
for her. You would be willing to do the job for $80, so you strike a deal. Now
suppose that the government levies a tax of $25 on all home repair transactions.
You pack up your gear and leave your neighbor’s home, because it is no longer
worthwhile for you to do the job. As a result of your leaving the job, you do not
have to pay the $25 tax. Relate this scenario to the concept of excess burden.
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d

Prior to the tax, you and your neighbor are both made better off by the trade. After the
introduction of the tax, the work does not get done even though you would be willing
to accept the wage that your neighbor is willing to pay. This loss of a potentially
beneficial trade that is not compensated by an increase in tax revenue (in fact, no tax is
collected) is exactly the idea of excess burden.

9. In the United Kingdom, each household that owns a television pays a

compulsory levy that is equivalent to $233 per year. The total revenue collected,
which is over $7 billion annually, goes to the British Broadcasting Corporation.
Do you think that such a tax is likely to have a substantial excess burden relative
to the revenues collected?

It is likely that the demand for owning at least one television is quite inelastic. It
follows that the excess burden from a $233 per year television tax is small relative to
the revenues that are collected.