ECO 226 Problems Chapter 10 Solution, Spring 2017

CHAPTER 10 Introduction to Government Finance ANSWERS TO TEXT PROBLEMS 1. Annual tax is $35,000. The extra tax on $10,000 additional income is $5,000. The average tax rate on $110,000 would be $40,000/$110,000 = 36.36 percent. 2. a. The restaurant worker has an average and marginal tax rate of 5 percent. b. The average tax rate for the bank manager is $1,500/$35,000 = 4.29 percent. The manager’s marginal tax rate is zero. c. The average tax rate for the CEO is $1,500/$500,000 = 0.3 percent. The marginal tax rate for the CEO is zero. 3. a. Because the price is zero, water will be consumed up to the point at which its marginal benefit is zero. At that level of output, the marginal cost will be five cents, so more than the efficient amount of water will be consumed because the marginal cost of water exceeds its marginal benefit. b. The user charge of five cents will reduce quantity demanded until marginal benefit equals five cents. At that level of output, net gains from water production will increase by 0.5(100,000)5 cents = $2,500 per month, which is equal to the welfare triangle. Tax revenues of $5,000 per month will be freed, because water production will fall by 100,000 gallons per month. In addition, the user charge will collect $20,000 monthly from the sale of 400,000 gallons of water each month. A total of $25,000 in tax revenue will therefore be freed as a result of the user charge. 4. If the marginal cost of entering the road is zero, it is a pure public good and the efficient price is zero. During rush hours, congestion implies that the marginal cost exceeds zero, and the road is a congestible public good for which a toll should be charged to achieve efficiency. An AVI system should set tolls according to the marginal congestion cost to achieve efficiency. 80