Lecture Title

1
Review 2
Professor Jane Leuthold Department of
Economics University of Illinois
Economics 214
2
Terms for review ...

• Cost-Benefit Analysis
• Direct and indirect benefits and costs
• Present value
• Social rate of discount
• Internal rate of return
• Benefit-cost ratio
• Social programs
• Lorenz curve
• Poverty threshold
• Negative income tax (NIT)
• Earned income tax credit (EITC)

• Replacement rate
• Fully funded
• Benefit sharing
• Asset-substitution, bequest, and
  induced-retirement effects
• Third party payments
• Moral hazard
• Deductibles and coinsurance
• Tax expenditures
• Adverse selection

3
B/C Analysis

• When selecting among two or more projects, you
  should always select the project with the highest
  benefit cost ratio. True, False, Uncertain?
  Explain why and define underlined term.
• You win the lottery and are told you will receive
  100,000 for each of the next ten years. Your
  friend offers to buy your ticket from you for
  900,000. Should you say yes? Explain.

4
B/C Analysis

• A government project is economically feasible if
  the social rate of discount is less than the
  internal rate of return. True, false, uncertain?
  Explain why and define the underlined term.

5
B/C Analysis
NPV

• What does NPV stand for and how is it calculated?
• Why does NPV decrease as the discount rate
  increases?
• What is the internal rate of return for this
  project?
• What is the undiscounted net present value of
  this project?
• Is this project economically feasible?

100
5
10
Discount rate ()
6
B/C Analysis

• Which project has the higher net present value?
• Which project has the higher undiscounted present
  value?
• Which project has the higher internal rate of
  return?
• If you cant do both projects, which project
  should you choose?

NPV
100
67
5
Discount rate ()
10
20
7
Public assistance as a public good
MB MC

• What characteristics of public assistance make it
  a public good
• If the MC of providing a unit of public
  assistance is 75, how much public assistance
  should be provided?

100
50
MBL
MBC
100
Public assistance
C conservative Lliberal
8
Public assistance as a public good cont.
MB MC

• What distribution of the tax costs would lead to
  unanimous agreement on the efficient level of
  public assistance?
• If people are taxed uniformly, will they be happy
  with the efficient level of public assistance?

150
MB
100
MC
75
50
MBL
MBC
100
Public assistance
9
Income inequality
100
If this is the Lorenz curve for 1980, where would
you draw the Lorenz curve for 2000? Which is
greater, the Gini coefficient for 1980 or the
Gini coefficient for 2000? Explain.
Line of Equality
Cumulative of income
1980
Cumulative of families
100
10
Negative income tax (NIT)

• If tN .33 and A 9000, what do B and C equal?
• If A 17,000 and C 34,000, what does tN
  equal?
• How does doubling A affect B if tN is held
  constant?

Earnings NIT
C
A
B
Earnings
11
Negative income tax
Suppose a negative income tax makes transfers
according to the following formula NIT
8,800 - .4 E

• What is the income guarantee, implicit tax rate,
  and break-even income for this program?
• Graph this program with E NIT on the vertical
  axis and E on the horizontal axis.

12
NIT and EITC compared
E NIT
NIT 8,800 - .4 E
How does this NIT compare with the EITC (Earned
income tax credit) that is part of the present
income tax system?
45o
E
13
Social security

• The net replacement rate (NRR) in Social Security
  is greater for the rich than for the poor. True,
  false, uncertain? Explain why.
• The asset-substitution effect associated with
  Social Security causes workers to save more over
  their lifetimes. True, false, uncertain?
  Explain why.

14
Social Security

• Which of the following have a higher average rate
  of return under social security? Why?
• Smokers or nonsmokers?
• Marrieds or singles?
• One-earner or two-earner families?
• Blacks or whites?
• Is this fair?

15
Health care

• Premiums for catastrophic health insurance are
  higher than premiums on ordinary health
  insurance. True, false, uncertain? Explain.
• Health insurance co-payments encourage greater
  efficiency in the health care market? True,
  false, uncertain? Explain.

16
Health care
Would a co-payment lead to greater efficiency in
these two markets? Explain.
P
P
D
D
MC
MC
Annual check-ups
C
By-pass operations
C
17
Health care in your town
Price

• You live in a town with only one health care
  provider. How will this affect the price and
  efficiency of health care services in your town?

DMSB
SMSC
AR
MR
Health care
18
Third-party payments
Price

• If third-parties pay the full cost of medical
  care, what amount will be purchased, how much
  will be spent, and what will be the efficiency
  loss?
• How would a required 25 co-payment change your
  answer to this question?

100
SMSC
DMSB
50
0
50
Medical care
19
Taxes and health insurance
Price

• If you are in the 50 tax bracket, how will the
  deductibility of health insurance affect the
  quantity you purchase and the amount you spend on
  health insurance?
• What is the consequence of this tax feature on
• Government revenue?
• Efficiency?

DMB
MC
100
10
5
Health insurance
20
Next time ...
Office Hours 1-230 Wednesday Thursday, Nov
2 Exam, 130 Wohlers Hall 1-220 pm Next week
Introduction to taxation
Happy Halloween