Financial theory

• 1.     There are several functions of government, and the allocation function is one of them. What does the allocation function refer to?

  -       The allocation function of government refers to its role in distributing and allocating resources within the economy. This involves making decisions about how resources, such as goods, services, and factors of production, should be distributed among various individuals, households, firms, and sectors in the economy.

   
• 2.There are several functions of government and the redistribution function is one of them. What does the redistribution function refer to? 

  • The redistribution function of government refers to its role in altering the distribution of income and wealth in society. This is often done through taxation policies and social welfare programs to reduce economic inequalities.
• 3.There are several functions of government and the stabilization function is one of them. What does the stabilization function refer to? 

  • The stabilization function of government refers to its role in managing economic fluctuations and stabilizing the overall economy. This involves using fiscal and monetary policies to address issues such as inflation, unemployment, and economic recessions.
• 4.A public good has two defining features, which are more or less met in practice: non-rivalness and non-excludability? What does non-rivalness refer to? 

  • Non-rivalness refers to the characteristic of a public good where one person's consumption of the good does not diminish its availability for others. In other words, the use of the good by one individual does not reduce its utility or availability for others.
• 5.A public good has two defining features, which are more or less met in practice: non-rivalness and non-excludability? What does the non-excludability refer to? 

  • Non-excludability refers to the characteristic of a public good where it is difficult or costly for a producer to exclude individuals who have not paid for the good from enjoying its benefits. Once the good is provided, everyone can benefit from it, including those who did not contribute.
• 6. Does “national defence” meet both criteria of public goods? 

  • Yes, national defense is often considered a public good as it exhibits non-rivalness (the defense of one does not diminish the defense of others) and non-excludability (it is challenging to exclude individuals from national defense benefits once provided).
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  7.Can public goods be produced only by the government or can they be produced by private companies? 

  • Public goods can be produced by both the government and private companies. While some classic examples like national defense are often provided by the government, private companies can also produce public goods, especially those that involve technology, information, or innovation.
• 8.Market demand curves for public goods are made out of vertical summation of individual demand curves. Why is that so? (hint: the demand curve for public good as willingness to pay).

  • Market demand curves for public goods are made by vertically summing individual demand curves. This is because the demand for a public good is represented by individuals' willingness to pay, and aggregating these willingness-to-pay values gives the total social benefit at each quantity.
• 9.Name some advantages and disadvantages of private and of public production of public goods. 

  -Advantages of private production may include efficiency and innovation, while disadvantages may involve free-rider problems. Public production can ensure widespread access but may face bureaucratic inefficiencies and funding challenges.
• 10.Externality is a certain consequence of economic activity. Explain what is essential about any externality (what makes externality an externality?)

  • Externalities involve the uncompensated impact of economic activities on third parties. Essential features include the lack of market incorporation of all costs or benefits, the impact on parties not involved in the transaction, and the need for intervention to internalize costs or benefits.
• 11. A negative externality. Marginal private costs are therefore lower than marginal social costs. How would it change equilibrium production if marginal social costs were taken into account instead of private marginal costs?

  • If marginal social costs were taken into account instead of private marginal costs for a producer causing a negative externality, equilibrium production would shift to the level where marginal social costs equal marginal social benefits, leading to a more socially optimal outcome.
• 12. Suppose that property rights are well established, sources and the size of damage can be identified and that the transaction costs of negotiations are low so that a private response to externality is possible. Which party will pay for the reduction of the damage?

  In a situation with well-established property rights, identified sources, and low transaction costs, the reduction of damage in response to an externality can be achieved through private negotiations. The party causing the damage might compensate the party being damaged to reach an efficient solution.
• 13. notably if transaction costs of negotiations are low, if the source of damage is clear and if property rights are well established, an externality can be eliminated by private negotiations. What theorem is that? And who will pay for the externality?

  • The Coase Theorem states that if property rights are well-defined, transaction costs are low, and the source of damage is clear, private negotiations can lead to an efficient outcome without government intervention. The party causing the damage and the party being damaged can negotiate to reach an agreement that minimizes the total costs.
• 14. Suppose a Pigouvian tax of equal amount is imposed on a producer for producing every unit of production. How could it reduce or even eliminate the externality caused by the producer?

  • A Pigouvian tax is imposed on a producer for every unit of production that generates negative externalities. By internalizing the external costs, the tax increases the producer's marginal private costs, aligning them with the marginal social costs. This leads to a reduction in the quantity produced and moves the market closer to the socially optimal level, helping to reduce or eliminate the externality.
• 15. An excise tax imposed on gasoline is an example of indirect Pigouvian tax. Why and what consequence does this tax have on the negative externality? 

  • An excise tax on gasoline serves as an indirect Pigouvian tax. It is designed to internalize the negative externality associated with pollution from gasoline consumption. By increasing the price of gasoline, it reduces the quantity demanded, encouraging more fuel-efficient and cleaner alternatives.
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  16. Emission fees are a way to deal with a negative externality. Emission fee is imposed on a unit of emissions. How does it help to reduce or eliminate externality? You may use a graph if it is helpful (hint: compare the emission fee with marginal costs of emission reduction).

  • Emission fees impose a cost on each unit of emissions.

  By aligning the emission fee with the marginal costs of emission reduction, producers have an incentive to reduce emissions until the marginal cost equals the fee.

  This helps to internalize the external costs, leading to a more socially optimal level of emissions.
• 17. The advantage of using the emission fee approach to eliminate externality is that it implies that producers with different technologies of emission reduction reduce emissions differently. Explain how is that possible and why is it an advantage?

  • Different technologies of emission reduction lead to varying marginal costs for producers. The advantage of the emission fee approach is that it allows producers with different technologies to choose their optimal emission levels.
• 18.  Under a cap-and-trade approach to internalization of externalites, vouchers or allowances are used. Those who cause damage must use the vouchers to “pay” for the damages they cause. Explain how can this approach work to reduce emissions efficiently? A: Emitters must hold vouchers equivalent to their emissions. They can trade (buy or sell) these allowances. This approach creates a market for emissions, where those who can reduce emissions more efficiently can sell their allowances to those who find it more difficult.
• 19. Externalities can be sometimes positive. Give some examples of positive externalities and show in graph, how positive externalities are underproduced in a free market.

  -       Examples of positive externalities include education, vaccinations, and research and development. In a free market, these activities are underproduced because individuals or firms do not capture the full social benefits.
• 20. In majority voting there is a possibility that a so-called voting paradox emerges if the voting is used to decide between several possibilities. What is a voting paradox (also known as Condorcet’s paradox)?

  -        A voting paradox occurs when collective preferences among three or more options are inconsistent and cyclic. No option is consistently preferred by the majority, leading to a lack of a clear winner.