lecture on local government and public goods based on chapter 19 in urban economics by arthur...
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![Page 1: Lecture on Local Government and Public Goods Based on Chapter 19 in Urban Economics by Arthur O’Sullivan, 5 th edition Adapted and summarized by Austin](https://reader033.vdocument.in/reader033/viewer/2022042821/56649d6a5503460f94a48559/html5/thumbnails/1.jpg)
Lecture on Local Government and Public Goods
Based on Chapter 19 in Urban Economics by Arthur O’Sullivan, 5th edition
Adapted and summarized by Austin Troy,
University of Vermont
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What is the role of government?
• Stabilization: monetary and fiscal policy used to control unemployment and inflation
• Redistribution: Taxation and transfers used to remedy inequities
• Resource allocation: makes production decisions either directly (e.g. through municipal utility) or indirectly (e.g. through subsidies or taxes on allocations).
• See Musgrave and Musgrave (1980)
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Local Government
• Does not have the responsibility of fiscal stabilization for obvious reasons
• Does not have redistributive role because of mobility of citizens. Poor will immigrate and rich will emigrate to other city
• Both of these roles are better filled by national government
• Local government primarily fills third role
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When does local government intervene in resource allocation?
1. Provides goods produced under natural monopoly conditions
2. Provides goods that generate positive externalities
3. Provides public goods
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Externalities• Represent a “market failure”• Where one person or firm’s consumption of a good
creates benefits or costs for others• Individual makes a personally efficient decision (I.e.
consumes until MB=MC) but externality causes there to be a social cost or benefit that is not considered; socially inefficient
• Causes divergence between private and social benefits and/or costs
• The cost or benefit is not “internalized” by producer
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Positive Externalities (e.g.education)
Marginal social benefit
Marginal private benefit Marginal cost
E’ E*Subsidy am
t
E’=how much market would provide
E*=socially optimal amount
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Negative Externalities (e.g. pollution)
Marginal social benefit
Marginal private benefit
Marginal social cost
P’P*
P’=pollution produced in private market
P*=optimal pollution amount
K=amount of externality
Marginal private costK
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Natural Monopoly• Where production of a good subject to large
scale economics: that is, very big fixed costs, so those costs don’t get paid off until the scale of operation gets very large
• Natural monopolies have decline average costs throughout their range of production
• Private firms would underprovide service because high scale economies mean that average cost> marginal cost
• Marginal cost pricing means operates at loss• City must step in and make up deficit
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Natural Monopoly in Bus Service
Demand= Marginal social Benefit
LRAC
LRMC
Quantity
deficit
S’ S*= optimum
P’
P*
MR
Government sets this price
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Natural monopoly• In absence of regulation, firm produces S’ and
receives a price of P’• Problem is that firm producing at optimal point
(S*) will lose money because D curve shows people not willing to pay that much
• But there is a social cost to not having enough bus service, so to get residents to buy the socially optimal amount, P must be lower than market price; locality subsidize this difference
• If set at P*, then socially optimal amount of S* is demanded.
• Because falls below Av Cost, government must make up the difference, equal to rectangle
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Why Marginal Pricing?If profit = TR-TC, then want to produce where distance between two is maximized, which is where the slopes, or marginal values are the same
P
Q
TR
TC
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Marginal and Average Price• Normally looks like this: MC gets bigger
than ACP
Q
MCAC
In natural monopoly the range where people are willing to pay is in the downward sloping area
Normally MC=MR occurs where MC>AC but in Natural Monopoly large scale economies means one firm can set price higher and quantity lower that social optimum
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Public Goods Provision
• Local governments provide goods that the market cannot provide either because they cannot price it, charge for it, or exclude
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Public Good Characteristics
• Nonrivalrous: can be consumed by many at once, such as clean air– Pure local public is were MC of additional
user=0; does not decrease other’s utility– Semi-rivalrous: where is non-rivalrous at small
amounts or at certain times but not at others– E.g. streets may be non-rivalrous at certain
times of day but not others
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Public Good Characteristics
• Nonexcludable: impossible/impractical to exclude any from consuming– Examples: Defense, air waves, other examples?
• Hard to charge for the service• Can’t tell who is willing to pay and who is
not, who is benefiting and who not• Some are non-excludable by choice, because
alternative would be inequitable– Examples fire service
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Pure and Partial Public Goods
• A common situation is that goods are non-rival at smaller usage levels, but rivalrous at large usage levels
• Example: with a park, an additional household’s use does not diminish anyone’s enjoyment, until you reach carrying capacity C at which point each marginal user does impose additional costs
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Local Public Goods
• These are public goods where the benefit is confined to a contained geographic area, like a city.
• Ideally, the size of jurisdictions would be determined by the level of “localness” of the public goods being provided
• The more extensive the benefits, the larger the jurisdiction needed to internalize those
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Why provide certain public goods at the local level?
• Wallace Oates (1972) proposed three criteria:1. Diversity of Demand: “one size fits all” vs. local
diversity of preferences2. Externalities/spillovers: are external effects
locally contained or do they spill over?3. Scale economies: higher levels of government
can leverage bigger scale economies
• The test for local provision of a public good is whether 1 outweighs 2 and 3
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Tradeoff 1: Scale Economies v. Diversity of Demand
• Assume 1 public good (library service) and two municipalities in metro area
• High Demand in city H and low in L• No externalities/spillovers between towns• Scale economies: regional library can
produce unit “literary services” cheaper than local library
• Identical services in towns
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Who should make library allocation?
• If towns merge and form metro government, pool resources to build bigger library system, then good news is that cost/ unit service is lower, but bad news is that L is paying for more library service than they want and H is getting less library services/person than it had before.
• Only efficient to merge if savings due to scale economies are large relative to losses in efficiency from the uniformity of service provision
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Empirical Results
• Moderate scale economies in things like sewer and water provision, because capital intensive
• Police, fire and schools, have scale economies (gains to scale) occurring until about 100,000 people, at which point fewer gains to consolidation
• Some areas have regional government entities that provide services with large scale economies
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Tradeoff 2: Externalities vs. Demand Diversity
• Where service creates positive externalities that spill over into other jurisdictions, it will be underprovided, because they consider the costs but, not all the benefits
• Inefficiency occurs because boundaries of jurisdiction is too small to contain benefits
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Example: Water pollution
• Town X in the Champlain Valley will underprovide stormwater management services (unless mandated) because benefits are realized by all Lake Champlain users, and they only consider local benefits
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Example: Parks Provision
• Cities will tend to underprovide parks, because only consider benefits to local residents, when their parks could potentially be important resource for people regionally
• However, if a regional government takes over and DD is high, there will be too many parks for certain types of people and too few for others
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Diversity of Demand and Spillovers
Town S: small parks
Town M: medium parks
Town L: large parks
MLB(s) MSB(s) MLB(m) MSB(m) MLB(l) MSB(l)
S’ S* M’ M* L’ L*
If externalities small, S’ will be close to S*, M’ close to M*, etc. Then, municipal decisions are efficient. This is reinforced if DD is very large and S* is far from M* etc.
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Tradeoffs in level of PG provision: summary
• If DD is large relative to scale economies or spillovers, local is better
• If spillovers or scale economies are large relative to DD, then regional is better
• In previous slide, gaps between individual demanders are greater than gaps between MSB and MLB, so local provider is better
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Examples
• Which category do these services fall into and why?– Flood control– Structural fire protection– Wildfire protection– Air quality– University system– Highway patrol
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How much of a public good should a city provide?
• Park example: how big to make it?• Assumptions: decisions made by majority
rule, three-person city, no congestion, no spillover benefits
• Efficient amount: where MB of additional acre equals MC
• To get MB we add up everyone’s demand curves, which represent WTP
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How big should park be?Marginal social benefit= MB1+MB2+MB3
MB1
MB2
MB3
MC
70 acres
$60
Cost/acre
Here WTP > MC of additional acre
Here WTP < MC of additional acre
MB curves for three citizens
Ideal amount is 70 acres
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Methods for determining the amount of local public good
1. Benefits taxation: ideal, but impractical
2. Median voter: practical and common, but inefficient
3. Household mobility and sorting: practical and efficient under some conditions, but not necessarily equitable. We’ll talk about this after Spring Break
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Benefit taxation
• Tax people on their WTP for the optimum size of the good (e.g. park) ; the greater the WTP, the greater the tax
• This will yield optimum amount of the park, even if population is heterogeneous
• Impractical because must know shape of everyone’s demand curves and because there is no incentive for taxpayers with high WTP to reveal that willingness
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Median Voter Approach
• Assuming there is no interjurisdictional mobility
• Often such decisions made through vote• Will efficient size be chosen?• No, not when charged by benefits taxation• This is because the Q will be chosen where the
median voter’s private MB= marginal private cost, or tax
• MC= $60/acre so each citizen pays $20/acre
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Park provision under votingMarginal social benefit= MB1+MB2+MB3
MB1
MB2
MB3
Marginal socialcost
70 acres
$60
Cost/acre
$20
Marginal private cost
10 55 115
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Median voter rule
• In election between 115 and 55 acres, 55 would win because person 3 and person 2 would vote for it. In election between 10 and 55, 55 would win because person 1 and person 2 would vote for it.
• Where spending level vs. service is being voted on the median voter’s desired outcome gets the most votes.
• Inefficient because everyone pays equally, but some want it more than others
• The magnitude of persons 1 and 2’s preferences don’t matter because median will always win
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How do growth controls fit into this?
• Growth controls are another way for controlling the amount of public services provided by a municipality and the average cost to residents
• It is also a way of preventing transfers of wealth from existing residents to new.
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Inflation and Services• Imagine a community of 100 people and $10,000
repayment cost for municipal facilities= $100/household• Now another 100 move into town; without inflation, all are
equal. • But with inflation, the nominal cost of the new
infrastructure goes up to $20,000 for the same amount, which equals $200 per new resident.
• But that new burden must be shared equally, so everyone pays $150. Old residents are worse off
• Because new residents pay less than marginal cost, too many move to municipality and resource is congested
• Problem: no transparent means for charging marginal cost• Old way (and Prop 13 in CA): limit reassessments on
houses of long-time residents; only reassess for transfer.
From Fischel chap 15
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Inflation and services• Strong motivation for growth controls when inflation• The big question is: do the additional nominal costs of new
development outweigh the benefits of increased economies of scale in service provision?
• Keep in mind that this only applies to fixed capital cost services, not variable cost items, like salaries of teachers
• Also, there are devices for recovering some additional costs from new residents, like exactions and impact fees
• Fischel: key goal is to eliminate fiscal incentive to exclude by state aid to moving in of new people
• Reduce reliance on property tax to finance local services• Unintended consequence of inclusionary zoning is it gives incentive
for wholesale exclusion of all development.• Perhaps then inclusionary zoning is a ruse by many communities to
give appearance of complying with law while being able to exclude fully.
• How does Act 60 fit in?
From Fischel chap 15