Case: Within a small nation, there is a fixed population choosing between two locations - Abuja and Suleja. The population consumes a numeraire good and housing. Within each area, there is free entry of firms producing the numeraire good using both land and labour. The productivity level in Abuja is a function of Suleja's population. The productivity level in Suleja is fixed. There is a fixed amount of land in each area which can be used to produce either housing or the numeraire good. There is also free entry of firms producing housing, also using land and labour, and the productivity of firms in the housing sector is the same in each of the two areas. The numeraire good is traded freely on international markets and thus has a normalized market price of one. Housing, however, can only be purchased locally and its price is determined in equilibrium. Individual welfare is a function of consumption of the numeraire good, housing, and a public amenity. The amenity is produced by the public sector, where the level of the amenity is a function only of labour devoted to the public amenity divided by total population. This spending is financed by a lumpsum tax on residents and potentially also a housing tax.

Q1 Assume that government spending is exogenous and funded with area-specific lump sum taxes. Characterize the competitive equilibrium. The above set up provides many, but not all, of the assumptions necessary to solve the model. Specify any other assumptions.

Q2. Assume that localities can set tax levels using lump sum taxes. Derive the tax rates if they are trying to maximize area population and compare with the setting where they are maximizing average welfare of their citizens.

Q3. Assume localities are providing the local public good using local lump sum taxes to maximize population as in Q2. Is it ever Pareto improving to tax housing? Explain