DSE 2018 Question 22: Market failure, externalities and public goods
Consider a country with two citizens, 1 and 2. The government is considering a scheme that will cost 100. It does not know the citizens' true benefits B1 and B2 and must decide on the basis of reported benefits R1 and R2. It implements the scheme if and only if R1+R2≥100. If implemented, it imposes tax 100−R2 on person 1 and tax 100−R1 on person 2. Each citizen's reported benefit seeks to maximise the difference between her true benefit (known only to her) and the tax she must pay if and only if the scheme is implemented. The optimal choices of R1 and R2 must be such that
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Consider a country with two citizens, 1 and 2. The government is considering a scheme that will cost 100. It does not know the citizens' true benefits B₁ and B₂ and must decide on the basis of reported benefits R₁ and R₂. It implements the scheme if and only if R₁ + R₂ ≥ 100. If implemented, it imposes tax 100 - R₂ on person 1 and tax 100 - R₁ on person 2. Each citizen's reported benefit seeks to maximise the difference between her true benefit (known only to her) and the tax she must pay if and only if the scheme is implemented. The optimal choices of R₁ and R₂ must be such that (A) R₁ < B₁ and R₂ < B₂ (B) Nothing systematic can be said about R₁ and R₂ (C) R₁ = B₁ and R₂ = B₂ (D) R₁ > B₁ and R₂ > B₂
Also written as: Consider a country with two citizens, 1 and 2. The government is considering a scheme that will cost 100. It does not know the citizens' true benefits B_1 and B_2 and must decide on the basis of reported benefits R_1 and R_2. It implements the scheme if and only if R_1 + R_2 >= 100. If implemented, it imposes tax 100 - R_2 on person 1 and tax 100 - R_1 on person 2. Each citizen's reported benefit seeks to maximise the difference between her true benefit (known only to her) and the tax she must pay if and only if the scheme is implemented. The optimal choices of R_1 and R_2 must be such that
Market failure, externalities and public goods has come up 114 times in 7 exams since 2006.
What this question tests
This question is on Free riding and preference revelation, part of Market failure, externalities and public goods in Microeconomics.
Why people understate their value for public goods, and mechanisms that elicit the truth.
TestStop has 9 past-paper questions on this subtopic.
