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What is the proper role of government?o Public Financing of Private Provision Governments may want to influence the level of consumption but may not want to directly involve themselves in the provision of a good (example is privately provided health insurance paid for by government in Medicare-Medicaid or Medicare prescription drug cards, where private companies administer the drug insurance

2 .of resources.3 .1.1.

What is the proper role of
government?
Expenditure side: What services should
the government provide?
Taxation side: How
should the government raise its money?
INCOME
EXPENDITURE slam

FOur Questions
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THE FOUR QUESTIONS O F PUBLIC FINANCE
1 When should the government intervene ni the economy?
How might the government intervene? What is the effect o f those interventions on
economic outcomes?
Why do governments choose to intervene in the way that they do?

1 -W h e nShouldt h eGovernment Intervenei nt h eEconomy?
Generally hard to justify government intervention in markets. But two main justifications are:
Market failures Redistribution

market failure.- Causes of Development
• The reason for developing public funding is the state intention to soften the drawbacks
resulting from economic decisions made by individual entities (households and
companies).

Market failure
Comparison Government failure
it occurs when government
It is a socially inefficient
intervention results in a more allocation of resources in
inefficient a n d wasteful allocation a free market.
of resources.
Market failure can occur
Governmentfailurecanoccur forvariousreasons dueto:

1. Externalities


2. Imperfect competition
   | 3) Imperfect Information 4) Individual failures

Poor incentives in public sector
2 . 3 .
Lack of information
Bureaucracy and administration costs higher in public sector
4.
Decisions taken for political reasons

Market Failure Causes

1. Externalities for example greenhouse emissions which
   requires government interventions through taxes, subsidies, and public good provision)


2. Imperfect competition for example monopoly it requires regulation typically in Industrial Organization). Some failures can be eliminated without public finance intervention through (taxes and governmental purchases or transfers)


3. Imperfect Information: for example, adverse selection in health insurance may require mandatory insurance)


4. Individual failures: People are not always saving enough for retirement

Example of government intervention
1- in transport
2- Subsidy for loss-making firm 3- Monopoly

Example ofgovernment intervention 1- Transport
Transport is prone to market failure. (two negative externalities)
A sa resulto fbuildingt h enew highway.i tmay
1.
encourage more people to buy a car and
2.
To live further out of the city. After5 o r1 0years.

1. the levels of congestion are high


2. the levels of pollution are high

More raising taxes to build a new highway

2- Subsidy for loss-making firm
I The government may
be worried that if a large
steel plant closes down, it will result in
unemployment. A sa
result, the government uses public funds to
give a subsidy to the steel plant and keep the firm in business
• This leads to government failure.
If firms become reliant on subsidies and the
government ends up
wasting public funds on
supporting inefficient firms.

•
increase
Monopoly leads to market failure because
firms are in a position to increase prices at the expense of the consumer and be more
inefficient.
To prevent an
in Monopoly power, the government intervenes
through blocking mergers.
• If the government blocked all mergers
this may be harmful
tothe economy. however, some mergers could have benefits
e.g.
more research and development.
3- Monopoly

When Should the Government Intervene? 2- Redistribution
Second: Redistribution is the shifting of resources from some groups in society to others.
Government intervention may help reduce inequality
inequality by redistributing resources through
taxes and
transfers.
• Redistribution often involves efficiency losses.
Redistribution through taxes and transfers might reduce incentives to work hard = create inefficiencies
Taxingt h ericht odistributemoneyt othe p o o rc o u l dc a u s eb o t hg r o u p st ow o r kl e s s
d.rha

2 -HowMighttheGovernmentIntervene?
1.
Using the price mechanism: Taxes or subsidies 2 . Restrict or Mandate
3.
Public Provision or Private Provision through Public Financing

Taxes& Subsidies
Maximum & MinimumPrices
Regulating the Market
State eatSt
pihOswren /
Funding & Provision
Government intervention

TAXES AND
SIRSINIES
ANALYSIS DIAGRAMS
EVALUATION
о

Through taxes,
• which raise the price
for private sales or
purchases of goods that are
overproduced to reduce carbon
emissions through
carbon
tax, or

Through subsidies,
• which lower the
price for private sales or purchases of goods that are underproduced for example government
subsidizes flu shots).
F l uS h o t $35

• f o rc a s h - p a y potientsa t
  t h i sl o c a t i o n

2- Restrict or Mandate
or mandate the private
purchase of goods that are underproduced and force
individuals to buy that good
for example is auto insurance.
• Minimum wages

Restrict or Mandate Restrict
The government can directly restrict the private sale or purchase of goods that are overproduced,
for example: speed limit
SPEED
20 LIMIT

3-Public Provision vs. Private Provision
Public Provision
The government can provide the good directly, in order to potentially attain the level of consumption that maximizessocial
welfare for example defense, and Medicare program for U.S. senior citizens.
• Public Financing of Private Provision
Governments may want to influence the level of consumption but may not want to directly involve themselves in the provision of a good (example is privately provided health insurance paid for by government in Medicare-Medicaid or Medicare prescription drug cards, where private companies administer the drug insurance

2 .
•
3 -WhatAretheEffects
o fAlternativeInterventions?
Direct effects "no behavioral responses"
can be defined as effects of government interventions that would be predicted fi individuals didnotchangetheirbehavior in response to the actions.
These effects are relatively e a s yt ocompute.
Indirecteffects "behavioral responses" arise because some people
change their behavior in response to an intervention. This is sometimes called the "law of unintended consequences." ("free" government health
insurance

4 -WhyDoGovernmentsD oWhat T h e yDo?
Governments do not intervene only because of
market failure and
redistribution.
• Tools of political economy helps us understand how governments make public policy decisions.
• The study of how political decisions affect people and economy.

Continued
Politicians have considerations other than getting to the socially efficient level or conducting cost-benefit analyses in order to approve a project. Instead, such economic decisions are made in the context of a political system.
• For example, a 2004 spending bill contained many projects of dubious value. $200 million was allocated to build one bridge in Alaska that would connect a small town with an island that housed 50 residents
and the area's
airport
(offering 6 flights a day). The crossing is now made by a ferry and takes 5 minutes.

Government: Whatdoesit
Sets
laws
-Create courts
Preventa FrIME
•Protech
foreier
vi - Libra
ries,
whack,
• Manage econorty
• Manage fo