Part 2: A Framework for the Analysis of Public Expenditure - PowerPoint PPT Presentation

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Part 2: A Framework for the Analysis of Public Expenditure

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Title: Part 2: A Framework for the Analysis of Public Expenditure


1
Part 2 A Framework for the Analysis of Public
Expenditure
  • Part 1 discussed WHEN to have government
    intervention.
  • Part 2 discusses HOW government can intervene.

2
Part 2 A Framework for the Analysis of Public
Expenditure
  • Chapter 4 Public Goods
  • Chapter 5 Externalities
  • Chapter 6 Income Redistribution
  • Chapter 7 Cost-Benefit Analysis

3
Chapter 4 Public Goods
  • Public Goods no one wants to pay for them, but
    everyone benefits from them.
  • How does the government decide WHICH public goods
    are provided and HOW MUCH IS provided?
  • Should the private market be used to provide or
    produce government commodities?

4
Chapter 4 Public Goods
  • What is a Public Good?
  • Efficient Provision of Public Goods
  • The Efficiency Conditions
  • Public Goods and Distortionary Taxation
  • Private Provision of Public Goods
  • Free-Riders
  • Privatization

5
Theory - What is a Public Good?
  • A PURE PUBLIC GOOD has two features
  • Nonrival once provided, another person can
    consume it at no additional cost
  • Nonexcludable once provided, it is impossible
    or highly expensive to prevent anyone from
    consuming it

6
Pure Public Good Examples
  • National Defense is a good example of a pure
    public good
  • Nonrival all Canadians benefit
  • Nonexcludable its impossible to prevent a
    Canadian from benefitting
  • Other examples Conventional Radio, A Beautiful
    View, A Canada-Wide Sunglass dome designed to
    block harmful sun rays (Canadome)

7
What is a Private Good?
  • A PRIAVATE GOOD has two features
  • Rival once consumed, another person cannot
    consume it
  • Excludable others can be prevented from
    consuming it
  • Food (ie pizza or sushi) is a good example of a
    private good. Once I eat it, its gone and
    youre left hungry.

8
Pure Public Good Issues
  • 6 Issues arise out of Pure Public Goods
  • Different Values
  • Public Goods Arent Absolute
  • NONRIVAL ? NONEXCLUDABLE
  • Unconventional Public Good
  • Private Provision
  • Private Production

9
1) WHILE EVERYONE CONSUMES THE SAME AMOUNT,
PEOPLE MAY VALUE IT DIFFERENTLY
  • -National defense protects everyone equally.
    Paranoid people love it and peace activists hate
    it.
  • -The Canadome is popular among people concerned
    with cancer and unpopular with people wanting
    tans. It affects everyone, however

10
2) PUBLIC GOODS ARE NOT ABSOLUTE
  • -technology and the market can affect a public
    good. A free TV station becomes private if you
    need a decoder. A view becomes rival if too many
    people crowd.
  • -An IMPURE PUBLIC GOOD is to some extent rival or
    to some extent excludable
  • -most public goods are impure, but analysis of
    pure public goods still gives valuable results
    for impure public goods

11
3) NONRIVAL ? NONEXCLUDABLE
  • -National parks are excludable if they have
    gates, but practically nonrival as they are so
    big
  • -My office hours are nonexcludable, as everyone
    is welcome, but rival if too many people are
    waiting in line

12
4) VARIOUS THINGS HAVE SIMILARITIES WITH PUBLIC
GOODS
  • -Inspiration can be nonrival and nonexcludable
    (such as coming from a sunset)
  • -Fear is nonrival, as one person being afraid
    doesnt prevent others. Fear is also
    nonexcludable, as its hard to prevent.
  • -Income distribution or honesty are public goods
    as everyone benefits

13
5) THE PUBLIC SECTOR CAN PROVIDE PRIVATE GOODS
  • -Medical services, housing, licenses, and
    utilities can all be provided by the government
    and/or private sector
  • -The label public or private doesnt indicate
    what sector provides the item

14
6) PUBLIC PROVISION ?gt PUBLIC PRODUCTION
  • -Some public services are contracted out to
    private contractors
  • -For example, the City of Edmonton contracts out
    much of its snow removal business
  • -it provides the public service through private
    contractors

15
Efficient Provision of Private Goods
  • -To cover efficient provision of public goods, we
    first look at efficient provision of private
    goods
  • -Consider Maka and Susans individual demands for
    video games
  • -At a market price, we add up Maka and Susans
    quantity demanded for video games to find market
    demand
  • -This results in a HORIZONTAL SUMMATION

16
Efficient Provision of Private Goods

Maka
Susan
Market demand
P
P
P
100
40
Q
Q
Q
2
5
7
_at_ P40, QMQSQD 257
17
Efficient Provision of Private Goods

When market supply intersects market demand, we
find equilibrium price and individual demand.
Maka
Susan
Market
P
P
P
S
100
65
40
Q
Q
Q
2
5
7
Q5
3.5
1.5
_at_ P65, QMQSQ 1.53.55
18
Efficient Provision of Private Goods
  • -From microeconomic theory, we know that a
    consumer maximizes utility where MRSxyPx/Py
  • -If we normalize Py to 1, this simplifies to
    MRSxyPx
  • -Since price is found on the demand curve, Makas
    (Susans) demand expresses Makas (Susans) MRS
    at each level of consumption

19
Efficient Provision of Private Goods
  • -From microeconomic theory, the supply curve
    comes from MC
  • -MRTxyMCx/MCy, but since PyMCy and Py1,
    MRTxyMCx
  • -therefore the supply curve represents MRTxy
  • Then, at equilibrium, SupplyDemand, and

Pareto Efficiency Condition
20
Efficient Provision of PUBLIC GOODS
  • -Consider Maka and Susans individual demands for
    a public good radio shows
  • -Radio shows are nonrival and nonexcludable one
    persons consumption doesnt affect the other
  • -The key difference in a public good is that BOTH
    can consume a purchased good it is not used up
  • -This results in a VERTICAL SUMMATION to
    calculate willingness to pay

21
Efficient Provision of Public Goods

Market demand
Maka
Susan
P
P
P
11
10
7
4
Q
Q
Q
2
2
2
Maka is willing to pay 4 each for 2 radio shows,
and Susan is willing to pay 7 each, therefore
the market is willing to pay 11 each
22
Efficient Provision of Public Goods
Market demand
Maka
Susan
P
P
P
S
11
10
7
6
4
4
2
Q
Q
Q
2
3
2
3
3
The market Supply gives an equilibrium quantity
of 3. Here price paid in the market (6) is the
sum of Makas payment (2) and Susans payment
(4).
23
Efficient Provision of Public Goods
  • -Once again, if we normalize our other good to
    1, demand (willingness to pay) represents MRS
    for each person.
  • -The sum of both peoples willingness to pay
    (market demand), is therefore the sum of
    individual MRS.
  • -The supply curve still represents MC and
    therefore MRT, so we have

24
Efficient Provision of Public Goods
  • -Furthermore, again since Py1,

-Intuitively, public goods should therefore be
provided until the point where the marginal cost
of the good is equal to the sum of marginal
benefits -The private good equation can also be
rewritten as
25
THEORY - Distortionary Taxes and Public Goods
  • If Public Goods are funded by distortionary
    taxation, we have two additional effects
  • 1) We have to consider the cost of raising an
    additional dollar through a distortionary tax, or
    marginal cost of public funds (MCF). Gross cost
    then becomes

26
Distortionary Taxes and Public Goods
  • 2) The public good may encourage economic
    activity, which translates into new taxes,
    captured by

-Therefore, optimal provision of a public good
then occurs when
27
Distortionary Taxes and Public Goods
  • Note that if MR is positive (the public good
    benefits the economy), benefit becomes

Alternately, if MR is negative (the public good,
though it may benefit people, hurts the economy
(such as a free themepark hurting private
themeparks),cost becomes
28
Public Goods Conclusion
  • In short, public goods are always best provided
    where
  • Total Marginal Benefit Marginal Cost
  • Providing a public good through distortionary
    taxes may increase or decrease its provision when
    compared to lump-sum taxation funding

29
Theory - Private Provision of Public Goods
  • If a public good is provided privately, its
    efficiency depend on how people represent their
    willingness to pay
  • -For private goods, people have no incentive to
    misrepresent their willingness to pay
  • -if the price is 10, and that lies in their
    willingness to pay, they will pay the 10,
    consume the good and be happy

30
Private Provision of Public Goods
  • -For public goods, people have an incentive to
    misrepresent their willingness to pay
  • -if the price is 10, a person could hope
    someone else pays the price, then they get to
    enjoy it (they are a FREE RIDER)
  • -for example, at an alligator reserve, people
    can pay money to throw meat into the water and
    watch the alligators go, and often wait for
    someone else to buy and throw the meat

31
Private Provision of Public Goods
  • -If the public good can be made excludable (ie
    entrance fee), it is still provided
    inefficiently, as the MC of an additional
    consumer is zero, therefore PgtMC
  • -The one way to avoid the free rider problem is
    through PERFECT PRICE DISCRIMINATION everyone
    pays their willingness to pay
  • -this requires full information, therefore
    private provision is often doomed to be
    inefficient

32
The Free Rider Problem
  • THE FREE RIDER PROBLEM comes from the incentive
    to let others pay while you enjoy the benefits
  • -Yet empirically, people do band together to
    raise funds for public goods such as libraries
  • -Studies have shown that although people may be
    willing to contribute some towards public goods,
    this contribution generally falls short

33
The Free Rider Problem Example
  • Many people are willing to help construct homes
    for low income families.
  • People go to great lengths to help construct
    these homes, and one low income family is very
    happy.
  • -But the project never continues until a city
    reaches zero homelessness
  • -Similarly, private provision of public goods
    only goes so far

34
Privatization of Government Functions
  • Government functions (both public and private
    commodities) can be provided privately IF THEY
    ARE EXCLUDABLE
  • Privatization has 2 LEVELS
  • Private Provision private firms provide the
    good or service
  • Private Production private firms produce the
    good or service, which can then be provided by
    the government

35
Private Provision Debate
  • Many government functions can be and are provided
    privately IF THEY ARE EXCLUDABLE
  • Home/private schooling vs. public schooling
  • Police force vs. Private security
  • Private swimming pool vs. Public lake
  • -To debate the merits of private provision of
    government functions, a variety of issues need be
    examined

36
Private Provision Debate
  • Input costs
  • -Do private firms or the government pay lower
    input costs (wages, materials, etc) for the good
    or service?
  • -Are there unions or unique suppliers involved?
  • 2) Administrative Costs
  • -Typically, government can reduce administration
    costs through size and economies of scale
  • -This is not always the case

37
Provision Debate
  • 3) Diversity of Tastes
  • -If people have a variety of tastes (quality,
    quantity, environmental footprint, etc), private
    provision allows for variety
  • 4) Quality of Information
  • -If individuals are poorly informed about the
    quality of the good, government provision may be
    best
  • -sofa selection is a lot easier than healthcare
    selection

38
Provision Debate
  • 5) Distributional Issues
  • -Does fairness imply that some goods and services
    should be available to EVERYONE, (COMMODITY
    EGALITARIANISM (Tobin, 1970))
  • -This argument is often made for healthcare

39
Public Production Debate
  • The argument about who should PRODUCE public
    goods often hinges on two concepts
  • Cost vs. Quality

-private companies often produce inferior
products (as in US health insurance refusing
coverage or charging high premiums)
-private companies often have lower costs due to
a focus on profit and lack of unions
40
Production Debate
  • Some argue that quality can be maintained through
    good contracts
  • -Some contracts are straightforward cut the
    park lawn once a week
  • -Some contracts are near impossible treat this
    yet-to-be-discovered disease with the following
    yet-to-be-discovered drugs

41
Production Debate
  • Market structure also needs to be considered
  • -If the government has a monopoly, is lack of
    competition causing inefficiency?
  • -If privatization creates a monopoly or
    oligopoly, will market power cause inefficiency?

42
Case Study Alberta Liquor Privatization
  • West (1997) studied the 1993 privatization of
    Alberta liquor stores and learned the following
  • -the number of liquor stores rose from 258 to
    604, and although selection and individual stores
    fell, overall selection increased
  • -liquor prices rose between 8.5 and 10
    (compared to 5 inflation)

43
Case Study Alberta Liquor Privatization
  • -Liquor store employment tripled as wages fell by
    up to 50 (the union was replaced)
  • -There was no evidence of increased alcohol
    consumption or alcohol-related crimes

44
Case Study Alberta Liquor Privatization
  • Was privatization good?
  • More stores vs. poorer selection
  • Liquor Price Increases
  • More employment vs. Lower wages
  • If this privatization is so complex, what does
    that say about privatizing healthcare, utilities
    or schools?

45
Chapter 4 Summary
  • Public goods are nonrival and nonexcludable
  • With lump-sum taxation
  • Public Goods are efficiently provided where
    ?MRSMRT or ?MBMC
  • (Private goods are efficiently provided where
    MRSA MRSB MRT)
  • With distortionary taxes, the marginal cost of
    public funds (MCF) and the tax revenue effect of
    the public good must be taken into account
  • Efficient provision still occurs where Total
    Benefit Total cost

46
Chapter 4 Summary
  • It is unlikely that markets would provide public
    goods efficiently, even if they are excludable
  • Free-riding limits private provision of public
    goods
  • Privatization entails private provision or
    production of a government function
  • 5 issues were raised in the debate between public
    or private provision
  • Two issues with public production are efficiency
    and quality
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