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c) Explain why this policy choice demonstrates a trade-off between equity and efficiency.
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'Equity-Efficiency Tradeoff'- An economic situation in which there is a perceived tradeoff between the equity and efficiency of a given economy. This tradeoff is commonly viewed within the context of the production possibility frontier, where any additional gains in production efficiency must be offset by a reduction in the economy's equity.
Within this equity and efficiency tradeoff, equity refers to the economy's financial capital, while efficiency refers to the future efficiency in the production of goods and services. This theory asserts that, in order for a nation to become wealthier, it must save its equity. However, these additional savings will hurt the development of more efficient production in the future.
D) Explain the Earned Income Tax Credit. Explain why the EITC may provide equity with small losses in efficiency.
Earned Income Tax Credit (EITC) A federal income tax policy that subsidizes the wages of low-income earners. The EITC subsidizes the wages of low-income earners to accomplish two goals: redistribution of resources to lower-income groups and increases in the amount of labor supplied by these groups.
The EI TC program has grown from less than $1 billion in 1976 to nearly $45 billion today. Numbers are measured in current dollars.
The EITC exacerbates the marriage penalty by combining both spouses’ incomes to determine eligibility for the credit. Two fairly low incomes can combine to equal a total family income high enough to place the family in the phase-out portion of the EITC. In that situation, adding a second income to the first puts the second income in the range of a very high marginal tax rate. This effect could result in a labor supply reduction for secondary earners in these families. To counter this effect, the EITC could be amended so that the average of the two spouses’ salaries determined the family income, it could provide for a much longer plateau before phase-out for two-earner families, or it could be applied to individual incomes, regardless of marital status, rather than to family income.
VARIANT 28
Social Insurance vs. self -insurance: How much consumption smoothing? Consumption-smoothing benefits of unemployment insurance?
Self-insurance The private means of smoothing consumption over adverse events, such as through one’s own savings, labor supply of family members, or borrowing from friends. Unemployment insurance example: Individuals do not generally have a private form of unemployment insurance, but they do have other potential means to smooth their consumption across unemployment spells: They can draw on their own saving; They can borrow, either in collateralized forms or in uncollateralized forms; Other family members can increase their labor earnings; They can receive transfers from their extended family, friends, or local organizations.
Why Do Individuals Value Insurance? Expected utility model. The role of risk aversion.
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Insurance is valuable to individuals because of the principle of diminishing marginal utility. Recall that we typically assume that the marginal utility derived from consumption falls as the level of consumption rises: the first pizza means a lot more to you than the fifth. This intuitive assumption means that, given the choice between two years of average consumption and one year of excessive consumption and one year of starvation, individuals would prefer the former. Individuals prefer two years of average consumption because the excessive consumption doesn’t raise their utility as much as the starvation lowers it. Expected utility model The weighted sum of utilities across states of the world, where the weights are the probabilities of each state occurring. Risk aversion The extent to which individuals are willing to bear risk.
Arguments for government funding of medical care rest on equity concerns. Explain how medical care can be a public good. If medical care is a public good, explain how this would lead to a market failure in that individuals would receive less medical care than is efficient.
Government plays an important role in the various medical markets and either directly or indirectly influences the health of the population in a number of ways. For example, regulatory and taxing policies affect the production or consumption of certain products (such as prescription drugs, narcotics, alcohol, and tobacco) and thereby beneficially or adversely affect the population's health.
The public policy and current political action around changing the system overlooks two important technical fallacies: That health care is most efficiently distributed by a free market mechanism; and, That medical services are an ordinary commodity.
The commercial market model is a failing economic and public policy ideology used to rationalize and justify corporate control of the health care system to profit from the enterprise. Medical services are not an ordinary commodity but more like a “public good” which should be financed using a regulated public utility model.
A “public good” is a product or service which benefits everyone in the community. Public goods are characterized by: value that has benefit to the community as a whole beyond any purchase price paid, often requiring large initial investment costs that are generally too expensive for any individual or private corporation to afford and earn a reasonable return, requiring a higher level of administration than any individual or company can arrange and having value that accrues over time and is difficult to price properly. Public goods have “externalities,” that is, value that accrues to people who benefit by other’s consumption of them without paying for it themselves.
There are two separate reasons to intervene, market failure and equity. Taking market failure first, there are a variety of failures in health care and insurance markets such as asymmetric information, market power, and principal agent problems. These can be solved by the private sector in some cases, but in others government intervention is required. But even if the private sector or the government can solve the market failure problems adequately, there's no guarantee that the resulting distribution of health care services will be equitable. We don't expect the private sector to, for example, make sure that everyone can live on the coast and have an ocean view if they so desire, we use market prices to ration those goods, but we may want to make sure that everyone can get health care when they have serious illnesses. So equity considerations may prompt the government to intervene and bring about a different distribution of health care services than would occur with an efficient market. Both reasons, equity and efficiency, can justify government intervention into health care markets. I think equity is of paramount importance when it comes to health care, so for me that is enough to justify government intervention, and the existence of market failure simply adds to the case that government intervention is needed.
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№2
2.1 E
2.2 B
2.3 A
2.4 A
2.5 B
2.6 A
2.7 B
2.8 E
2.9 E
2.10 E
№3
3.2 If the tax is on the sale of rutabagas, the buyer bears the statutory incidence, since the
“sticker price” of rutabagas does not include the tax. Economic incidence is determined by
relative elasticities. In this case, the quantity supplied is more responsive to a change in
price, so the less elastic consumers will bear most of the economic incidence.
To calculate the relative burdens, solve the equilibrium condition with and without the
tax. Without the tax: 2,000 – 100 P = – 100 + 200 P. Price = $7.00. With the tax, the price the
supplier receives is reduced by $2.00. The equilibrium condition is
2,000 – 100 P = - 100 + 200(P – 2) (The firm keeps $2 less per rutabaga)
2,000 – 100 P = 200 P – 500
2,500 = 300 P, Price = $8.33.
The consumers’ tax burden = (posttax price – pretax price) + tax payments by consumers,
here $8.33 – $7.00 + 0 ≈ $1.33. (Used to pay $7.00 now pay $8.33)
The producers’ tax burden = (pretax price – posttax price) + tax payments by producers,
here $7.00 – $8.33 + $2.00 ≈ $.67. In this case the consumer bears a larger share of the tax
burden than the producer. (Used to receive $7, now keep 8.33 – 2 = 6.33 or.67 less.)
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