ECO 4554-01

Economics of State and Local Government

Optimal Jurisdictions
Exercise 5

Instructions

Your answers must be clearly written and legible. What you submit must be a finished product, not a
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Formatting Quiz Answers: Dollars: No decimals unless non-zero and at least one digit to the left of
the decimal even if zero. If non-zero decimals (that is, cents), you must include two digits to the right
of the decimal. Include dollar sign and commas to separate thousands. Quantities: No decimals unless
non-zero and at least one digit to the left of the decimal even if zero. Include commas to separate
thousands. If decimals, two digits to the right of the decimal. Elasticities: Do not round intermediate
calculations. No decimals unless non-zero and at least one digit to the left of the decimal even if zero.
If decimals, round to two digits to the right of the decimal. Percentages, shares, and tax rates:
Express as percentage, not as decimal. No decimals unless non-zero and at least one digit to the left of
the decimal even if zero. If decimals, two digits to the right of the decimal. Include percent sign.

Introduction

The objectives of this exercise are to

• reinforce your understanding of the implications of the Tiebout hypothesis.
• illustrate the conflicts that arise among the different criteria for optimal size of jurisdictions.

Before beginning this exercise, read the assignment in Fisher, Chapter 5, and review the lecture notes
for Topic 3. You may also wish to review the Economist’s Toolkit on identifying and computing
deadweight loss.

Problems

Tiebout and Returns to Scale

1. Figure 1 shows the average total cost (measured in hundreds of dollars per person) to a
community of providing police protection as a function of the community’s population (measured
in thousands of people).

a. Based on the criterion of maximizing economies of scale (minimizing average total cost),
what is the optimal size of a community for the provision of police protection?
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 ECO 4554-01: Economics of State and Local Government
Optimal Jurisdictions
Exercise 5

b. Suppose there are two types of individuals, represented by Dewey and Louie. Dewey is a
“law and order type”, who has a strong preference for police protection (measured as number
of daily police patrols). Louie is a “do your own thing free spirit type”, who prefers a minimal
amount of police protection. There are 15,000 people of each type. Based on the Tiebout
hypothesis, what is the optimal size of a community for the provision of police protection?

2. The table below and Figure 2 show the demand for and cost of police protection. At a cost of
$100 per person, what is Dewey’s preferred quantity of police protection? What is Louie’s
preferred quantity?

Quantity (Daily Dewey’s Huey’s Average Total

Police Patrols) Marginal Marginal Cost=Marginal
Benefit Benefit Cost
0 $170 $130 $100
1 $160 $120 $100
2 $150 $110 $100
3 $140 $100 $100
4 $130 $90 $100
5 $120 $80 $100
6 $110 $70 $100
7 $100 $60 $100
8 $90 $50 $100
9 $80 $40 $100

3. Suppose everyone lives in the same community so as to take maximum advantage of the
economies of scale. The community’s voting rule is that, in case simple majority rule results in a
tie between preferred quantities, the quantity provided is the average of the two preferred
quantities. Therefore, the quantity provided in this community is 5 daily police patrols. Calculate
Dewey’s loss of consumer surplus from underproduction of police protection relative to his
preferred quantity. Calculate Louie’s loss of consumer surplus from overproduction relative to his
preferred quantity.

4. Now, suppose there are two communities, one composed of the Dewey-types and one composed
of the Louie-types. These two communities are optimal sized based on the Tiebout criterion, but
they are smaller than the optimal size based on economies of scale. Therefore, their cost to
provide police protection is no longer $100 per capita, but rather $110 as shown in Figure 3.

a. What is Dewey’s preferred quantity at $110?

b. What is Louie’s preferred quantity at $110?
c. Calculate Dewey’s loss of consumer surplus from the higher cost of police protection relative
to his most preferred quantity at the $100 minimum cost? Also, calculate Louie’s loss of
consumer surplus from the higher cost of police protection. [Note: At the higher cost, each
individual’s preferred quantity is less than it would be if the police protection were produced
at minimum cost. So, the loss of consumer surplus now has two pieces. First, there is a loss
on the quantity they actually consume because of the higher cost (your answer in either a or b
above). This is the rectangular area that shows the difference between $100 and $110
multiplied by the number of units they consume. Then, there is the loss on the units not
consumed. This is the usual deadweight loss triangle between $100 and $110 and between the
quantity they consume at the higher cost (your answer in either a or b above) and the quantity
they would choose at the lower cost (your answer to 2 above).]

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 ECO 4554-01: Economics of State and Local Government
Optimal Jurisdictions
Exercise 5

5. You can have one large community providing an inefficient quantity of police protection but at
the lowest possible cost. Alternatively, you can have two smaller Tiebout communities, each
providing the quantity of police protection that is efficient for its residents but at greater-than-
minimum cost. Can you suggest one or more ways that this conflict between returns-to-scale
optimality and Tiebout optimality can be overcome? That is, can you suggest one or more ways
that simultaneously satisfy all three of the following conditions:

• Dewey lives in a community of no more than 15,000 where the quantity of police
protection is exactly equal to his preferred quantity;
• Louie lives in a community of no more than 15,000 where the quantity of police
protection is exactly equal to his preferred quantity;
• police protection is supplied to both communities at the minimum average total
cost of $100 per person?

Tiebout and Interjurisdictional Externalities

Education provided to students in Hueytown not only benefits Hueytown’s residents but also confers
external benefits on residents of Deweyburg because, for example, some students educated in
Hueytown may eventually relocate to Deweyburg. All the voters in Hueytown have the same demand
for education for their children. All the voters in Deweyburg have the same demand for education of
Hueytown’s children. The data are shown in the table below and in Figure 4. The quantities are in
hundreds of high school graduates per year and the dollars are in thousands of dollars per graduate.

Quantity Hueytown’s Deweyburg’s Marginal Social Marginal

(Number of High Marginal Marginal Benefit Cost
School Graduates Private Benefit, External Benefit, (MSB=MB+MEB) (MC)
Annually in MB MEB
Hundreds)
0 $9 $7 $16 $8
1 $8 $6 $14 $8
2 $7 $5 $12 $8
3 $6 $4 $10 $8
4 $5 $3 $8 $8
5 $4 $2 $6 $8
6 $3 $1 $4 $8

6. If the interjurisdictional externality is uninternalized, the residents of Hueytown choose the

private equilibrium number of high school graduates. Calculate the loss in social surplus from the
underproduction of high school graduates.

7. Suppose now that Hueytown and Deweyburg were consolidated into one large community in
order to internalize the interjurisdictional externality. Everyone in the community pays the same
tax-price for education, equal to one-half the marginal cost ($4,000). At this price, what is
Hueytown’s preferred number of high school graduates in the consolidated community? What is
Deweyburg’s preferred number of high school graduates in the consolidated community?

8. Suppose the rule is that, when simple majority rule results in a tie between preferred quantities,
the quantity provided is the average of the preferred quantities. Calculate Hueytown’s loss of
consumer surplus from underproduction of high school graduates in the consolidated community.
Calculate Deweyburg’s loss of consumer surplus from overproduction of high school graduates.

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 ECO 4554-01: Economics of State and Local Government
Optimal Jurisdictions
Exercise 5

9. Suppose now that the two communities were not consolidated, but that the state government
subsidizes Hueytown’s cost to educate its children. The state taxes the residents of Deweyburg an
amount equal to their marginal external benefit. It uses the revenues to provide an
intergovernmental grant to Hueytown to increase the number of high school graduates.

a. What happens to Hueytown’s demand (marginal benefit) curve for high school graduates
when they receive the education subsidy from the state?
b. With the grant, what number of high school graduates do the residents of Hueytown choose?
(That is, what is their new preferred quantity?)
c. How much of the marginal cost of this number of graduates is paid by the residents of
Hueytown?
d. How much of the marginal cost is paid in tax by the residents of Deweyburg?

10. Complete the following statement and explain your answer: Where interjurisdictional
externalities exist, consolidation of communities results in an (efficient, inefficient) equilibrium,
and intergovernmental grants without consolidation result in an (efficient, inefficient)
equilibrium.

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ECO 4554-01: Economics of State and Local Government
Optimal Jurisdictions
Exercise 5

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ECO 4554-01: Economics of State and Local Government
Optimal Jurisdictions
Exercise 5