topic #1: introduction to public financeen)pf_l2_2018.pdf · topic #1: introduction to public...
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Topic #1:
Introduction to Public FinanceMarket Failure and Public FinancePROF. ANDREEA STOIAN, PHD | LECTURE 2
Content
Introduction to
Public Finance
Market failure
Public goods
Externalities
Income distribution
Stabilizing, regulatory and control
role of the government
Learning outcomesStudents will be able to:
• Describe how government affects the circular flow of income and expenditure in a
mixed economy
• Define public goods and discuss their characteristics
• Explain the difference between pure public goods and pure private goods
• Describe the provision of government goods and services through political institutions
• Discuss cooperative methods of supplying pure public goods and the characteristics of
the Lindahl equilibrium
• Analyze the free-rider problem
• Define an externality, and explain how positive and negative externalities can prevent
efficiency from being achieved
• Describe how corrective taxes and subsidies can be used to internalize externalities
• Explain the Coase theorem and its significance
The goal of Public Finance
Content
The study of the role of thegovernment in theeconomy in order to properunderstand it
It develops principles forunderstanding the role ofgovernment in theeconomy and its impact onresource use and the well-being of citizens
Definition “Is the field of economics that
studies government activities and the alternative means of financing government expenditures
you will learn about the economic basis for government activities
You will understand the impact of government expenditures, regulations, taxes, and borrowing on incentives to work, invest, and spend income
David Hyman (2005)
0
10
20
30
40
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60
CO
L
IRL
KO
R
CR
I
CH
E
RU
S
LTU
LVA
USA
JP
N
ISR
EST
LUX
PO
L
CZE
GB
R
ISL
ESP
DEU
NLD
SV
K
SV
N
PR
T
NO
R
HU
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SW
E
ITA
AU
T
BEL
DN
K
GR
C
FR
A
FIN
Government size
OECD, 2015
What is the role of the
government?
Candidate 1
The role of the
government is not to
create wealth. The role of
the government is to
create an environment in
which the entrepreneur is
willing to take risk and to
be able to get a return on
the risk taken.
Candidate 2
o Set in motion programsthat help people go tocollege, buy a newhouse, and build theirwealth
o Plans invest in people
o Investing more in publicschools and expectingmore in return
Government and circular flow of
income and expenditures
Government
Output market
Firms
Input market
Households
?Problem that causes
the market economy
to deliver an outcome
that does not maximize
efficiency
Market
failure
Market failure (I)
Markets
Individual well-being
Invisible hand
Efficient allocation
(Pareto optimality)
Market failure (II)
Monopoly ExternalitiesAsymmetric information
Market failure (III)
MarketIndividual well being
Social responsibilityPareto optimality
Market Government Pareto optimality
Market failure (IV)C
om
pe
titiv
e m
ark
et
eq
uili
briu
m
Should be the most efficient outcome for society when all individuals would make ‘collective decisions’
Ma
rke
t fa
ils in
de
live
rin
g t
he
m
ost
eff
icie
nt
ou
tco
me
to
so
cie
ty
Due to choices based on ‘individual rationality’
Go
ve
rnm
en
t in
terv
en
e in
a
ch
iev
ing
th
e m
ost
eff
icie
nt
ou
tco
me
fo
r th
e s
oc
iety
By making collective decisions aiming at the ‘social welfare’
Supplementary reading:
http://www.econlib.org/library/Buchanan/buchCv3c4.html#Ch. 4, Individual Rationality
in Social Choice
Market failure (II)
People’s needs
Individual needs
Private goods
Market
Collective (social)
needs
Public goods Government Market
Public goods
Definition Goods with benefits that cannot be
withheld from those who do not pay and are shared by large groups of consumers are public goods.
Public goods are usually made available politically through the ballot box as people vote to decide how much to supply rather than through the marketplace, where those who care to pay the price can buy as much as they like for their own exclusive use.
Government provision of public goods implies that the goods are freely available to all rather than being sold in markets.
The costs of making the good available are usually financed by taxes.
Characteristics
Non-rival in consumption
a given quantity of a public good
can be enjoyed by more than one
consumer without decreasing the
amounts enjoyed by rival
consumers
Non-excludable
it is too costly to develop a means
of excluding those who refuse to
pay from enjoying the benefits of a
given quantity of a public good
Pure public goods vs.pure private
goods
•a given quantity is consumed by all members of a community as soon as it is produced for, or by any one member
•the marginal cost of distributing a pure public good to an additional consumer is zero for a given amount of the public good
Pure public goods
•are rival in consumption and their benefits are easily excluded from those who choose not to pay their market price
•a unit of a pure private good can be enjoyed only by a single consumer
The more units of a given mount available to be consumed by one person, the less is available to rival consumers
Pure private goods
Classifying goods
•Non-rival,
•Non-excludable
•Non-rival,
•Excludable
•Non-excludable, Rival
•Excludable, Rival
.............. ..............
............................
Congestable and price-excludable
goods
• Are those for which crowding or congestion reduces the benefits to existing consumers when more consumers are accommodated
• The marginal cost of accommodating an additional consumer is not zero after the point of congestion is reached
Congestible
• Are those with benefits can be priced
• Their provision results in positive externalitiesPrice-excludable
Provision of goods
•Pure public goods
•Congestible public goods
•Price-excludable public goods
•Pure private goods
Market&Government Market&Government
Market&GovernmentMarket&Government
Demand for public goods
Market demand for a Pure Private Good is
derived by adding quantities demanded at each
price.
Demand for a Pure Public Good is derived by adding how
much people will be willing to pay at each quantity
Efficient output of a pure public
good
The socially optimal level of the public
good requires that we set the Marginal
Social Benefit of that good equal to its
Marginal Social Cost. MSB = MSC
𝑀𝑆𝐵 = σ𝑘=1𝑛 𝑀𝐵𝑘 =𝑀𝐵𝑖 + σ𝑗=1
𝑛−1𝑀𝐵𝑗
Example:
Optimal quantity and voluntary contributions
Number
of
security
guards
per
week
1 2 3 4
MBA $300 $250 $200 $150
MBB 250 200 150 100
MBC 200 150 100 50
𝑀𝐵𝑖$750 $600 $450 $300
Lindhal equilibrium
through voluntary
contributions
The amount contributed per unit of the public
good by each person must be adjusted so that
each individual desires the identical amount of
the public good
The sum of the amounts contributed by each
member of the community per unit must equal
the marginal social cost of producing the
public good
All individuals must agree voluntarily, with no
coercion whatsoever, on the cost-sharing
arrangement and the quantity of good
The equilibrium must occur under the
unanimous consent
It ensures the efficient outcome
Provision of the local goods
The free-rider problem1
. •A free-rider is a person who seeks to enjoy the benefits of a public good without contributing anything to the cost of financing the
•The free-rider problem stems from the incentive people have to enjoy external benefits financed by others, with no cost to themselves
2. •Free riding can be a
reasonable strategy for any one individual , provided that no penalty exists and that only few individuals choose this strategy
3. • If all members of the
community choose the free-rider strategy , then no production of the public good would be forthcoming
Prisoners’ dilemma
Strategy B contributes B does not
contribute
A contributes 5,5 5,10
A does not
contribute10,5 0,0
online.ase.ro PROFESSOR’S QUESTION