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Summary Public Economics, ISBN: 9780190723187 Economics 381
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PUBLIC ECONOMICSDEFINITIONS
• Public Economics (This definition is NB) (asked a lot)
“Study of the nature, principles and economic consequences of expenditure, taxation and financing, and the
regulatory actions undertaken in the non-profit-making government sector of the economy.”
• Instruments of fiscal policy (who will they tax, how will they be taxed)
1. Taxation
Who do we tax? Individuals? Corporates? Indirect tax such as VAT?
2. Government Expenditure
(Where it spends, how it will they allocate expenditure and who will benefit from those
expenditure)
3. Financing
(Will only come into play if there is a difference between taxation and expenditure)
• Regulation (means of intervention) (extremely strong instrument of government)
• entails enacting a law or administratively proclaiming an enforceable instruction that leads to
different allocation of private resources
• Legislations
• Rules
Two broad views on role of government
• Mechanistic/Individualistic role of government
• Opinion that individuals matter most (i.e., Maximisation of individual welfare), rules must be
implemented so that the individual’s welfare is considered first and foremost
• Public interest/Collectivist (sometimes known as the organic view)
• Opinion that government must be promote social or national interest must be maximised. The benefit
to the individual, consequently, is derived from the benefits accord to or achieved by the group
ADD IN COMPOSITON OF PUBLIC CENTER
Government affects the private sector in several ways:
1. Supplies public goods and services using factors of production and intermediate inputs
2. Households and businesses pay for such goods and services by means of taxes and user charges
3. Government purchasing activities
4. Government financing strategies (taxes and/or borrowing)
5. Budget surpluses and deficits affect the saving-investment balance and the balance of payments
6. But developments in the private sector also influence the government (eg cyclical patterns in tax
revenues)
ADD IN THE DEVELOPMENT STATE
IMPORTANT PREMISE
• The state has a crucial role:
- State-dominated development has failed, but so will state-less development. Development
without an effective state is impossible (p 25)
• Countries differ:
- No one-size fits all recipe for an effective state is suggested here. The range of
differences among states is too enormous, as are their starting points (p 3)
• The real issue is not state size, but state effectiveness
- Effectiveness depends on the capability of states (the ability to undertake and promote
collective action efficiently)
, PUBLIC ECONOMICS
THE BENCHMARK MODEL
Based on host of unrealistic assumptions (neoclassical theory of general equilibrium)
• It assumes the individual consumes or producer is fully informed about the economy, unaffected by the
actions of others. And always striving to maximise his or her own utility or profit within perfectly
competitive markets.
• The model shows us what the economy should look like to function efficiently without government
intervention
Key assumptions of the model
Parento optimality
o Should not be possible to increase output/utility without decreasing output/utility of
another commodity/consumer
Individual consumers and producers are:
o Fully informed about the economy
o Unaffected by the actions of other consumers/producers
o Fully mobile (occupationally and spatially)
o Always striving to maximise utility or profits
o All markets are perfectly competitive
Exogenous disturbances trigger instantaneous adjustments that automatically restore equilibrium
There are no external effects associated with consumption and both individuals have fixed tastes,
as reflected in the existence of smooth and ‘well-behaved’ individual indifference curves. These
curves (which show combinations of goods that yield the same levels of utility) are convex with
respect to the origin, cannot intersect and exhibit diminishing marginal rates of substitution.
The two production processes are both characterised by unlimited factor substitutability,
diminishing marginal productivities and constant returns to scale. The latter assumption rules out
internal (dis)economies of scale, while there are also no external costs or benefits in production.
These assumptions together ensure the existence of smooth and ‘well-behaved’ isoquants (recall
that an isoquant is a curve that shows combinations of inputs that yield the same level of output).
As consumers, A and B maximise utility, and as producers, they maximise profit. Both are perfectly
informed about their respective environments and are perfectly mobile in the occupational and
spatial sense of the word.
The commodity and factor markets are all perfectly competitive, which implies that each market
behaves ‘as if’ there were many individual demanders and suppliers involved, none of whom can
influence price.
These assumptions together ensure the existence, uniqueness, and stability of a general
equilibrium.
Just a reminder…
Allocative efficiency
- when the limited resources of an economy are allocated
in accordance with the wishes of its consumers
Technical efficiency (aka X-efficiency)
- when the maximum possible improvement in outcome is
obtained from a set of resource inputs.
Economic efficiency
, PUBLIC ECONOMICS
- defined in terms of both allocative efficiency and
technical efficiency (or X-efficiency), and can also refer
to a country’s ability to achieve economic growth
The benchmark model in a nutshell
The model explores the possibility of allocative efficiency in a competitive economy: a
situation when the limited resources of an economy are allocated in accordance with the
wishes of its consumers
• Such an economy produces an optimal mix of commodities
• Requirements for allocative efficiency in the absence of any government intervention:
All producers should be in equilibrium
w
MRTSxik = =MRTSyik
r
All consumers should be in equilibrium
P
MRSAXY = Px =MRTSBXY
y
All producers and consumers should be in equilibrium simultaneously
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