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EC 1101 Study Questions
Fall 2012

Chapter 5 Market failures, public goods and externalities

1. Explain the functions of government in an economy. Why do governments intervene in markets?

2. (a) Using the concept of allocative efficiency, explain the meaning of “market failure” and “externality”. Why is this is a type of market failure? (b) Explain the difference between the market equilibrium output and the efficient level of output when there are (i) negative externalities and (ii) positive externalities. (c) Using diagrams provide an example of a negative externality (external cost) and a positive externality (external benefit) (other than the text examples). (d) What kinds of policies can governments use to correct negative externalities and what kinds to correct positive externalities? Use diagrams to show how the externalities are corrected.

3. (a) Explain the meaning of “rivalry” and “excludability”. (b) Use these concepts to distinguish between (i) private goods (ii) public goods. (c) Provide examples of each type of good.
(d) Explain how governments reallocate resources to correct for the market’s failure to produce public goods. (e) What is the free rider problem?
(g) Is U.S. border patrol a public good or a private good? Why? How about satellite TV? Explain.

4. Use the distinction between the characteristics of private and public goods to determine whether the following should be produced through the market system or provided by government: (a) French fries, (b) airport screening, (c) court systems, (d) mail delivery, and (e) medical care. State why you answered as you did in each case.

5. Explain the difference between progressive, proportionate and regressive tax systems.

6. Suppose in Fiscalville there is no tax on the first $10,000 of income, but a 20% tax on earning between $10,000 and $20,000 and a 30% tax on income between $20,000 and $30,000. Any income above $30,000 is taxed at 40%. If your income is $50,000, how much will you pay in taxes? Determine your marginal and average tax rates. Is this a progressive tax? Explain.

Chapter 27 Measuring domestic output and income

1. (a) Why is domestic output measured in value terms; i.e. why is it a monetary measure? (b) Why do economists include only final goods and services in measuring GDP for a particular year? Why don’t they include the value of stocks and bonds bought and sold? Why don’t they include the value of used furniture bought and sold?

2. What are transfer payments? Are they included in the measurement of GDP? Provide examples.

3. Use the concepts of gross investment and net investment to distinguish between an economy that has a rising stock of capital and one that has a falling stock of capital. “In 1933 net private domestic investment was minus $ 6 billion. This means that in that particular year the economy produced no capital goods at all.” Do you agree? Why or why not? Explain: “Though net investment can be positive, negative, or zero, it is quite impossible for gross investment to be less than zero.”

4. Why do national income accountants compare the market value of total outputs in various years rather than the physical volumes of production? What problem is posed by any comparison over time of the market values of various total outputs? How is this problem resolved?

5. (a) Calculate value added in the following production process. Firm| Sales| Value added|
Firm A| $700|  |
Firm B| $1100|  |
Firm C| $1700|  |
Total|  |  |
(b) Why is total value added equal to the selling price of firm C?

6. Explain why an economy’s output, in essence, is also its income.

7. (a) Define GDP. (b) Define and explain the difference between the expenditures approach and the income approach to measuring GDP.

8. Define net exports. Explain how a nation’s exports and imports each affect domestic production. How are net exports determined? Explain how net exports might be a negative...
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