Bases of the Public Sector

Economic analysis of public decisionsEconomics of the Public SectorCourse outlineIntroduction to Public Sector EconomicsThe system of public economyThe state, actor of public economyThe Public Sector structure, reformThe market failureLabour marketCompetitionMonetary market

Remember!ReferencesMatei A. (2003) Economie public. Analiza economic a deciziilor publice, Editura Economic, Bucureti.Andrei L. C. (2007) Economie, Editura Economic, Bucureti, pp. 366-393.Dinu I.T. (2012) The Economics of Public Affairs, Bucureti, http://store.ectap.ro/externe/The_Economics_of_Public_Affairs_2012l.pdfStiglitz J. E. (1999) Economics of the Public Sector, Ediia a treia, W.W. Norton & Company, New York.Lipsey R. G. i Chrystal K. A. (1999) Economia pozitiv, Editura Economic, Bucureti. Lipsey R. G. i Chrystal K. A. (2002) Principiile economiei, Editura Economic, Bucureti, pp. 371-434.Stiglitz J. E. i Walsh C. E. (2005) Economie, Editura Economic, Bucureti, pp. 302-326, 722-739.

Additional references:Friedman M. (1995) Capitalism i libertate, Editura Enciclopedica.McConnell C. R. i Brue S. L. (1996) Economics. Principles, Problems, and Policies, ediia a 13-a, McGraw-Hill, SUA.Friedman M. i Friedman R. (1998) Liber s alegi. Un punct de vedere personal, Editura Bic All.Smith A. (2011) Avuia naiunilor, Editura Publica, Bucureti.Keynes J. M. (2009) Teoria general a ocuprii forei de munc, a dobnzii i a banilor, Editura Publica, Bucureti.Schumpeter J. A. (2010) Zece mari economiti. De la Marx la Keynes, Editura Publica.Stiglitz J. E. (2010) n cdere liber. Editura Publica, Bucureti.

Why does PS economics interest us? (1)Public economics is a branch of economics that aims at analysing public decisions in economic terms (Matei 2003)Reason: the need for organising the public activitiesRegulationPrice settingSupply of public goods and servicesTaxes and tariffs/dutiesIncome from capital Income from states private goodsBorrowingTransfersExpenditures with public policiesCapital expensesInterestWhy does PS economics interest us? (2)Mixed economy the role of the two sectorsDefining the public-private frontier Privatisation Vs. Nationalisation Mercantilism invisible hand Laissez-faire MarxismPositive economics versus normative economicsPositive economics (What is) An analysis limited to facts that can be verified, be them true or false: Should the unemployment rate on a national level increase by 8 per cent, the youth unemployment rate decreases by 80 per cent.Normative economics (What should be) an analysis based on value judgments, which does not include verifiable facts: is necessary, should be, would be wrong, better, more importantWhat is our aim? (1)Introduce aspects of public economics, economic tools and so on - concepts, notions

Substantiate these elements through theories in the field of public economics

Strengthen your knowledge of public economics with special reference to the European states economy, American or Asian economy if relevant to the subject upon debate public intervention, market failure and so on.

What is our aim? (2)State your expectationsCourse (?)Seminar (?)*Understanding the public economics features Mixed economyPrivatisation Nationalisation Laissez-faire Deregulation RecessionResourcesTaxDeficit8Seminar*Texts from famous authors (e.g. Thomas Piketty)Case studies (e.g. HBR)Group research on a topic (e.g. DG Competition )

Public Economy economic sub-systemCybernetic system the capacity to self-regulate Reacts to disturbances (internal or external factors)Maintains self-control on different periods (cyclical nature of economic activity)Mixed system public sector + private sectorEconomic activities - undertaken both by the state and by companies (their behaviour can be influenced by the state through regulation, taxes/duties, subsidies)State involvement Strong (former USSR, North Korea, Cuba)Medium (Europe before the privatisation wave)Low (USA has evolved over time: from privately held highways and railways to public roads and state transport companies)

The cyclical nature of economic activitiesThe economic activity does not have a linear path economic growth vs. recession How do we establish this alternation? Answer: macroeconomic indicators (GDP, Inflation rate, Unemployment rate, etc.)The time between recession (crisis depression) and growth (recovery boom)Old Testament: 7 good years vs. 7 bad years Short cycles Kitchin 3-5 years Joseph Kitchin (1861 1932)Medium cycles Juglar 10-12 years Clement Juglar (1819 1905) Long cycles Kondratief 40-50 years Nikolai Kondratieff (1892 1938)State involvement - outlook17th century mercantils promoting trade and industries by the state Classics Smith (1776) limiting the states role; the individuals, by aiming at satisfying their own interests (competition, profit) will thus serve the public interest - invisible hand19th century laissez faire lack of state involvement in the private sectors activities (through regulation or control) best responds to the societys interests 19th century increased role of the state in controlling the means of production (collective farming) 20th century transition to market economy, though the private-public frontier still remains an open subjectTriple view of public economyThe object of public actionsConsequencesThe public economics principleHuman needs are always greater than the available resources.Resources = factors of production (land La, labour L and capital K).La (Land) = natural resources. L (Labour) = physical and mental capacity of workers to produce goods and services. K (Capital) = goods that do not directly satisfy human needs: factories, machineries, equipment used to produce other goods. Is money considered capital in economics ?The concerns of the public decision-maker:What is to be produced?How is to be produced?For whom is it to be produced?How are these decisions made?

What is to be produced?Production possibility frontierResource allocation in between the two industries (public goods, private goods)Efficient allocation: A, BA B public goods private goodsInefficient allocation: CInfeasible allocation: D

Public goodsPrivate goodsABCDHow is to be produced?ProductionPublicPrivate Factors of productionMore k, less L?Less k, more L?Public policy makingEnvironmental (can have an impact upon technology)Fiscal (can influence labour factor)QLkFor who is to be produced? How are these decision made?The distribution problem is influenced by:Fiscal policy;Social policy;Provided public goods (satisfy the needs of certain groups).Free rider issue (linking the payment with the benefits the tendency to lie about the benefits)

Wagner Law (law of public activity increase in the developed countries through corelation with the national income) an economic development pushes for more public spending laissez faire

Redistribution (matching the needs for social aid to the financing obtained through taxes)

CollectivelyDavid Hume - tragedy of the commonsStages of collective (public) decision:Knowing the public sector activities and organization:Financing method;Expenditures and taxes (on a central and local level);Anticipating the consequences:The effects of a tax on return (price increase, wage cut);Increasing the retirement age;Assessing the alternatives;The influence of the political factor. Utility and preferenceLet us rememberUtility real/assumed capacity of a good to satisfy a need.Economic utility = satisfaction felt by an individual after consuming a good. Marginal utility = the value of the last consumed quantity of a good; the gain in satisfaction after consuming an additional quantity from an economic good. Indifference curve (isoutility) = combinations of goods from which the consumer hopes to receive the same level of satisfaction.Why does it interest us?In the analysis of public economy the four pillars:Optimum;Public goods;Collective choices;Justice.OptimumA balanced situation preferred by everyone (equilibrium);Is reached by the presence of other individuals producing spillovers (externalities) positive or negative (beneficial or harmful);The value of an old house in a new neighborhood;Pollution;E.g. (Stiglitz, 2010) situations in which a trade involves certain costs and benefits for third parties (non-participants).Pareto Optimum no individual can be made better off without someone being made worse off efficient resource allocationPublic goodsSome goods will either not be supplied by the market or, if supplied, will be supplied in insufficient quantity. Pure public goods:It costs nothing for an additional individual to enjoy their benefits;It is difficult or impossible to exclude individuals from the enjoyment of a pure public good.As more individuals join the group consuming the public good its quality could decrease. The optimum size of a groups consuming a certain good is analyzed by the theory of clubs Buchanan, 1965.Collective choicesExample of collective decision-making the voting paradox (Marquis de Condorcet)Voting preferencesAs preferencesBs preferencesCs preferencesFirst choiceShrekTwittyTomSecond choiceTwitty TomShrekThird choiceTomShrekTwitty

2:12:1tranzitivity

?NO !

2:1The majority vote can only compare two preferences and cannot decide the order of all preferences!JusticeSocially acceptable objective of the Government:Protecting life and property;Economic efficiency (obtaining the best result with limited resources);Reaching a standard of justice (equity) (income distribution equal vs. differentiated);Economic growth;Economic stability.Tradeoff between equity and efficiencyleaky bucketEconomic policy fulfilling the criteria of economic efficiency;Social policy aims at fair income distribution.The return of rationingThe difficult decisions needed in an age of austerity

POLICYMAKERS must juggle three priorities when offering a public service: coverage, cost and choice. They almost always have to sacrifice at least one of the three. As austerity bites, this equation is going to lead to very tricky decisions.The American health system historically gave a high priority to patient choice at the price of ballooning costs and the exclusion of the uninsured from the system. Having increased coverage, the Obama reforms will have to restrict choice if they are to control costs.Health is an area where the trilemma clearly applies. Britains National Health Service offers universal coverage but as a result has to limit patient choice in order to control the costs.

THE STATE, ACTOR OF PUBLIC ECONOMYImproving the utility of one individual must not diminish the utility of another individual. The individuals incapacity to cooperate market failurePublic economy actors:Man organized in communities (or any other organizations)State through:Power of coercion monopoly on:Law making;National defense;Management of military reserves during war. Accountability limited power through nations will (Constitution, laws);Motivation public interest.How much does the state matter? Public expenditures (% GDP)

States functions Allocative function Government intervention in the allocative function of the market to correct its negative effects;

Distribution function ensuring equity, social justice on the distribution of income and wealth;

Stability function mitigate market failures in the national economy as inflation, unemployment, stagnating economic growth, balance of payments imbalances;

Regulatory function maintenance of individual behavior within limits imposed by society and contract discipline (through a functioning legal system).

Allocative functionProperty rightBelongs to an individual (private property) the right to exclude other individuals from the benefits provided by a certain good;Belongs to more individuals (common property) the right of a group of individuals to benefit without boundaries from the object of that property (see tragedy of the commons and free rider);The use of common property right: Umg PriceIt does not involve scarce resourcesOtherwise:Excessive use (like in the case of excess hunting and fishing); Premature exhaustion of natural resources;Congestion (in the case of positional goods goods having an insufficient supply and their production cannot be easily increase).

Distribution function (1)Income distribution between the members of society social cohesionIncome distribution Existent (can be in accordance with societys standards on equity)Preferable (desirable) established through state intervention in order to correct the existent income distribution Why the State and not another actor? Free rider behavior Competition can leave out certain interest groupsThe State redistributes its revenues and wealth through:Progressive taxes to finance monetary benefits; Subsidies for the provision of public goods and services.Distribution function (2)Public goods and services:Fully financed through taxes;Provided at subsidized prices.Alternatives for the provision of goods: Direct provision;By providing additional income for those acquiring the goods on the market.! Individuals may not choose the most appropriate level of public good, such as education and health;! State would prefer to have direct control over quality and price of these goods and services because of their importance for the general welfare merit goods.Regulatory function (1)Regulating the producers and consumers decisions so to reduce:Tendencies towards monopoly;Negative externalities.Why the State and not another actor? There are large costs (for the individual consumers) of obtaining and interpreting information about product safety;The individuals may not be able to protect themselves because they do not have the resources at their disposal to establish minimum standards and quality control.Regularization limits the discretionary behavior and freedom of individuals by imposing rules.

Regulatory function (2)Regulations are based on legal norms aimed at: Protecting the consumer against fraud,Preventing damage to consumer health,Control the design of goods so as to ensure their safe operation,Ensure harmless conditions of employment,Control the commercial systems, biological research etc.The State also regulates:Money supply;Prices of utilities and nationalized industries;Many of the allocative decisions in the economy (through price and income policies).

Regulatory function (3)Criticisms:Restriction of personal freedoms, namely of choice on the efficient marketImplementing regulations entails costs (e.g. operational costs of the regulatory bodies)Tendency to increase uncertainty in business Delays in carrying out investments. Stigler (1971) The theory of economic regulation the demand and supply of regulationPeltzman - reaction to regulation can prove to be contrary to the wanted effect (Peltzam effect) a strict regulation of safety belt use can encourage the driver to be less carefulRegulatory function (4)Deregulation A stage which logically follows a state of excessive regulationWhen the regulation cost exceeds its social benefitsRegulation for countries in transition to market economyis absolutely necessary to first introduce coherent economic regulationSelf-regulation Automatic regulation of systems (cybernetic system)Principle anticipated by Smith "invisible hand"Stability function (1)When does it intervene?In case of macroeconomic imbalances (inflation, unemployment, economic downturn, deficits of the trade balance and balance of payments etc.) To reach the macroeconomic targets:Economic growthJob security reducing unemployment;Price stability inflation control;External balance balance of payments.How?Through monetary and fiscal policy instruments used to restore balanceBy coordinating the economic decisions of different groups of economic actors from the private sectorStability function (2)Economic growthglobal process referring to an upward evolution of certain aggregate economic measures, over a period of time, on a national or international level, and producing favorable effects both economically and socially.an element of continuity beyond the particular macroeconomic policies implemented by one government or another.takes place on long term, governments are often faced with cyclicity, requiring reformulation of the objectives of economic growth:Establishing a social, economic and institutional environment favorable to economic growth Ensuring balance for an economic growth path (Keynes)Targeting economic recovery (growth of real national income vs. Growth of potential national income) limit economic cycle oscillation for ensuring sustainable and balanced economic growthStability function (3)Jobs securityUtopia heavily promoted during the communist command economic systemAssociated with the right to workOpen access to the labor marketInstitutional and economic environment to stimulate the development of economic initiativeConfusion!States responsibility to ensuring the general conditions for every individual to work (with the appropriate exceptions)States duty to secure jobs for all those who want to work oversizing the public sector developing the PS in accordance with different criteria, not economic efficiencyStability function (4)Reformulating the objective:Much more productiveFull use of production factors (L included) means:Their efficient use (optimum use) by every economic agent NOT using all factors of production available at a time unemployment rate 0(an unemployment rate lower than the natural rate can cause short circuits on the labor market)A difference must be made in terms of types of unemploymentStability function (5)Types of unemployment:Cyclical unemployment seasonal unemployment Is formed during economic cycle recession (crisis depression) Or directly flows from economic activity downsizing in certain seasons of the year measures for employment growth are those supporting economic recovery

Structural unemployment determined by the restructuring of economic activities, property forms etc., which is influenced by the technical and economic progress, or important social and political phenomena.Frictional unemployment determined by L switching jobs (in transition from one job to another). macroeconomic policies (! OLF)Stability function (6)Price stabilityAssociated with the anti-inflationary policiesThe dilemma of macroeconomic policies reducing unemployment or reducing inflationThe achievement of a high degree of price stability; this will be apparent from a rate of inflation which is close to that of, at most, the three best performing Member States in terms of price stability (one of the convergence criteria)Where is Romania standing? Inflation/deflation/disinflation?What is the supervising body?Through what tools?Also contributes to regulating competition tendency to artificially increase prices for monopoly and oligopolyStability function (7)External balanceEnsuring balance for:Trade balanceBalance of payments

Monetary policy

Policies for economic recoveryLead to solving many other macroeconomic imbalancesPreferred due to social pressures pertaining to recession

THE PUBLIC SECTOR - STRUCTURE AND REFORMHow do we define the public sector in economic terms?1. Types of activityDefining government intervention == public expenditures Defining public interventionMarket vs. Non-marketPublic vs. Private How do we define the public sector in economic terms?2. Results of activitiesProductiveThe activity of state-owned companiesThe existence of a commodityMarketable goods and services Non-productivePublic administration activityNon-existence of a commodityThe existence of expenditures item financed from taxesNon-marketable goods and services

How do we define the public sector in economic terms?3. TimeShort termState budgetPublic revenues and expenditures = Correlating the budget with the public sector sizeShows the balance/ imbalanceBudget surplus (can show a false profitability, inflationary situations)Budget deficit (common situation)Long termThe public sector itselfMarginal social benefit (MSB) = marginal revenue of the public sectorMarginal social costul (MSC) = cost of administering the public sectorMSB = MSC optimum size of the public sectorMSB > MSC public sector is efficient, in terms of profitabilityMSB < MSC oversizing the public sector, low public service efficiency

How do we define the public sector in economic terms?4. In practice market economy modelsLaissez-faire model Low involvement of the state (both socially and economically)Consumer has the main roleEconomic problems are solved through individual decisions (not decisions of the collective authorities)Welfare state Social aidLower incomeSocial-democrat modelProviding collective servicesActive policy aiming at employmentHigh tax ratesHybrid model (Japanese)Based on private enterprisesPromotes cohesion and solidaritySoviet model rigid and authoritative planningHow do we define the public sector in economic terms?5. In terms of other criteriaNegative versus positive economic policy Negative promotes competition, anti-monopoly, neutrality in the national economic spacePositive direct state involvement, supporting imports and exports, measures favoring the economic Nationalization versus privatizationCommon objectives :Improving resource allocation;Improving pricing and investment policies;Distinct objectives:Nationalization strengthening the public sector and national strategies, control of natural resources;Privatization improve efficiency and reduce costs, reduce the needs of budget financing/ public borrowing.Reforming the public sector (1)What is it? Politic activityWhy do we need it?Improving efficiency in public resource allocation;Greater justice in income distribution.What does it depend upon?Technology;Economic and political circumstances.What are the reform reasons?Institutional reform;Reducing expenditures, costs savingsWho influences the reform?Decentralization institutional change (political and administrative);Privatization institutional change (economic);Private sector deregulation (to intensify competition). Reforming the public sector (2)Results in the public sectorExemples DecentralizationExpansion of public servicesReducing expenditures through a better allocation PrivatizationExpansion after changing the state-owned company into a joint stock company (still state-owned)Reducing PS by transferring social assistance to the private sectorDeregulation Expansion due to cost coverage (American financial system) Reducing PS through careful deregulation Reforming the public sector (3)Micro-focusedFocused on single programs;Technical and administrative nature.Macro-focusedFocused on the general dimension of PS;Political nature.

Both strategies aim at:

Either improving results through:Introducing new programs;Technologies;Institutions.Or cost savings.

Reforming the public sector (4)Privatization can cover:Sales of public property;Long-term lease of public infrastructure, private enterprises;Use of decision-making processes like contracting and bidding (procurement);Replacement authority as a mechanism of coordination with market mechanisms;Insertion of market incentives in the reward system for the public officials.Decentralization strategy replaced:Do these contribute to productivity and efficiency increase?

AnswerEfficiencyCan be stimulated by a local administrative (decentralized) system, but moving resources (down) does not necessarily improve efficiency (e.g. police and justice) Reduction policies are neutral in relation to efficiency or inefficiency in the PSProductivity Aimed at through privatizationNeed for increased competition on the supply sideExpanding opportunities for selection on the demand side

Will these released resources be used for public sector development?!The current trend (1)Focus on return, marketingManagerial state = a new concept of public service provision, part of the initiatives reported as key reforms

Australia and New Zeeland

New model takes into account the market values, so the PS:Becomes a set of internal markets;Intensive use of tender process (procurement) for providing public goods and services;Allocation of vast resources to implement such a management model.52The current trend (2)Return suggests profit and efficiencyApplying specific private sector mechanisms:Decisions models;Value chain analysis;Activity Based Costing (ABC);Corporate Social Responsibility (CSR);Operations management;HR management;Public policy management;Performance management;ITC management;Structural analysis of sectors of activity

53Structural analysis of sectors of activity54Porters Five Forces ModelCompetitive rivalry within the industry

Idea The five forces are the grounds for STRATEGY developmentreflect the complexity of competition in a sectorA greater intensity of competition is registered under perfect competition (free market entrance, existing players have no bargaining power with suppliers and customers, and the rivalry is unlimited due to the presence of a large number of identical products)Influence the profitability of a sectorLower return if there is a better and cheaper substituteOr if there is market rivalryDo not consider factors that may influence short-term return - have TACTICAL significanceFluctuations in the economic situation;Shortages of raw materials;Strikes;Demand fluctuations, etc.

1. Threat of new entrantsBarriers to entry in a particular industryEconomies of scaleProduct differentiationFinancial needsCosts of changing partnerAccess to distribution channelsCost disadvantages independent of scale economies (know-how)Existing reactions from the existing playersPrice to prevent entryCharacteristics of the barriers to entry (e.g. exclusive rights to technology)2. Intensity of rivalry between existent actorsDepends on structural factors:The presence of a large number of actors or actors of equal sizeSlow sector development pace High storage or fixed costsLack of differentiation or partner switching costsHigh strategic stakesHigh barriers to exitEntrance barriersHigh LowExit barriersLow High3. Pressure from the substitute productsPerform a function identical to that of the product in question

Presents a dangerous cost-performance rate for the products in a particular sector

Attitude towards substitute products takes the form of collective action (Buy American)4. Bargaining power of buyersIt is a focused group or buy a large quantity of the concerned products

Products are standard or undifferentiated

The switching cost is reduced

The buyer has complete information

In case of upstream integration

5. Bargaining power of suppliersA more focused and smaller group than the one is selling their products to

There are no substitute products

Sector is not an important client for the group of suppliers

The providers product is an important input for the work done by the buyer

There are switching costs

The current trend (3)Marketing focuses more on value The value chain analysisORGANIZATIONHUMAN RESOURCE MANAGEMENTTECHNOLOGYPURCHASINGMarginPrimary activitiesSupport activitiesMARKET FAILUREPublic policy objectives impose:The need for a market mix;Technically possible (PPF); What and how is produced?What individuals prefer (utility). Whom for?Public intervention. How are these decisions taken?The aims is to ensure a Pareto efficient economy (the ideal situation)Namely a competitive economyWith an efficient resource allocation

What if the market fails?63Failure dissatisfactionYou always want what you do not have!The idea of an alternative way to organize the economy (more advantageous for one who thinks of it)Maybe you are right!Markets (almost always) produce too much of something (pollution) and too little something (research); a change that improves the situation of the rich without affecting the poor is also Pareto efficient

The market intervention can happen both when markets fail, and when the markets are efficientIntervention the beginning Property righttragedy of the commonsProperty guarantee leads to: Improvement (rent vs. property);Increased saving and investment capacity.Contracts guaranteeThe problem of the overdue loans

Government intervenes to protect the citizens and their rights

The intervention generated by market failureSix situations in which the markets are not Pareto efficient:

Failure of competitionPublic goodsExternalitiesIncomplete marketsFailure of informationUnemployment, inflation and imbalance

! Failure = the best possible result was NOT reached = inability of individuals to cooperate

1. Failure of competitionPareto efficiency means perfect competition (ideal situation)Number of companies is large enough to keep the market price unchangedOtherwise:MonopolyOligopoly

Reasons to limit competitionCompetitive advantage of large companiesWhen the production cost decreases with the production growth (economies of scale)

Natural monopolyA company produces cheaper together with other companies (utilities water, electricity etc.)

Large transport costs

Granting patents / licenses - they stimulate innovation, but restrict competition2. Public goodsThey are either not provided or are insufficiently provided;

For a private company that good would be inefficient and non-marketable;

Pure public goods (defense, police protection, energy plants etc.):They do not involve additional costs when they are consumed by another individual (non-rival);Is difficult or impossible to restrict the individuals access to the benefits brought by that good (non-excludable).

3. ExternalitiesThe actions of an individual / a firm raises costs for another individual / company negative externalities Examples: PollutionUse of cars traffic jam more time spent while driving higher risk (accidents)

Individuals do not cover the total cost of negative externalities they generate they will get involved in more and more activities of this kind

People do not enjoy the full benefit of the positive externalities tempted to get involved less and less in such activities

4. Incomplete marketsNot only pure public goods and services are those that private markets fail to provideA complete market - providing all goods and services for which the delivery cost is lower than the cost that individuals are willing to payAn incomplete market - which fails to provide these goods and services

Examples:Failure of the insurance market covering all types of riskFailure of real estate market first house loan Failure of car market first car loanFailure of students loans market Why do markets become incomplete?They concentrate on product innovation and not market innovation Market innovation Involves large transaction costs (information, decision, negotiation, cost of closing a deal)There is no protection through patents and licensesFace asymmetric information and enforcement costsThe two sides have different levels of information about risk (e.g. covering the risk of a dropping demand)unguaranteed student loans== adverse selection (a participant in a transaction has more information about the game than the other party) role in health insurance market study5. Failure of informationInformation = public good (supplying information to an individual does not reduce the information quantity of the others

Example: weather information

Regulating information disclosure Supported as is considered vital - for example, labelling productsCombated, being unnecessary, irrelevant and costly

6. Unemployment, inflation and imbalanceThe most common symptoms of market failure

Indicators of market failure but also of macroeconomic imbalances

Influence the structure of fiscal policy

Heavily regulated on a regional level

Intervention on efficient marketsIncome distributionCompetitive markets Equal distributionGovernment intervenes for income redistribution (social services)

Merit goodsPerfect information does not always lead to good decisions Smoking, seat belt

this type of intervention = paternalism (example: drug prohibition, compulsory social security) libertarianismPaternalism (smoking ban) externality (example: the cost of smoking may be covered by a fee)The consequences of failureChanges made by state intervention are often unpredictablePublic policies aimed at ambiguous concepts such as serving the public interestEven the implementation of policies may be a failure (due to complexity)Government intervention is not free, is made through a bureaucracy that is expensive to administerRent-seeking - lobbying to influence regulatory policies (price distortion) which lowers social welfare (social costs) (monopoly - transfer of wealth from buyer to producer)LABOUR MARKETMarket failsMarkets (almost always) produce too much of something (pollution) and too little of something (research);Market is efficientMarginal benefit = Marginal cost = Price QPSDEQEPE077Equilibrium (balance) on the labor marketWhat do we take into account?Supply of laborDemand of laborQuantity of the good (labor)Price of labor

Significance of the imbalancesI over-wageII over-quantityIII under-wageIV under-quantity

LwSLDLIIIIIIIVLEwE0EUnderuse of laborLabor main factor of productionUnderuse of labor unemployment:Supplied labor quantity is higher than demanded labor quantity (II)It must be considered for both the over-wage and the under-wage areasThere will be losses due to the production that the unused workers could coverOkuns Law unemployment assumes sacrificing a part of the potential national income Based on the statistical data for the American economy, Okun draws the conclusion that for an increase of 1 per cent over NAIRU (Non Accelerating Inflation Rate of Unemployment) in the unemployment rate there will be a reduction in the GNP growth rate of 2 per cent in terms of the potential national income Overuse of laborCan lead to overproduction of goodsAssociated to an economic boom USA 2006-2007 unemployment rate < 5%

Oversizing the wagesThe costs of labor (L) increaseInflationary pressures occur

Solution = perfect competition (equality of wages) ?!Change in wagesType of job

Education (undergrad studies, high school etc.)

Age

Experience at work (employee loyalty, encourage employment stability and enterprise attachment) does not substitute the workers competence

Gender and race (discriminations)

Market type (the case of the unionized labor markets)

Imperfections of the labor market Competition on the labor marketMonopsony on the labor marketA single dominant buyer The small companies will follow the wage policy of the large companies Particular case : coordinated oligopsony (agreement between the companies on wage levels) Effects:Lower wage levels Lower employment levels (in comparison to the perfect competition)Monopsony Monopsony with low wageThere is no negotiation on wages, or differentiations in these negotiationsThe hiring conditions are pre-established (wage included)Labor:Accepts the monopsonys terms, Leaves the area to search for work (uncommon, due to rigidity)

Monopsony with differentiated wagesHiring is done in groupsWage negotiations take place in groups or even individuallyWages are set differently, so that the wage costs do not exceed the planned level Monopoly on the labor marketThe union sets a wage salary (Wi)The employment level will be QC, pertaining to the labor demand Real supply is larger QrThe area WiEcQcO represents supplementary income of the employees (Union members)The area ABQrQc (limited by WE) represents losses for the workers who could still be hired if the labor market would be competitive Pareto inefficiency

BAWiQcQrEcErQWSDEQEWE0The monopoly monopsony confrontationDescribed by the negotiation power of the two sides

Creates powerful actors UnionsEmployers associations

Trigger Large transaction costs on the labor market Free rider behaviorIllegal hiringHiring immigrantsState interventions on the labor marketSetting a minimum wageDiscourages the use of illegal labor since taxes and contributions are calculated as percentages relative to the entrance wageDiminishes the unduly monopsony profits received through wage differentiation Avoids a low employment level (artificially)

Establishing the minimum wage on the level of the wage of that market balance, otherwise imbalances occur

The meaning of the minimum wage a policy tool to correct the income distribution and to combat poverty

Alternative raise taxes on high wage earners (also affects companies through the contributions quota)

Regulating the labor marketLimiting the excesses of the two main poles of the labor market:union - monopolyemployers monopsony

Involves two categories of actions:Trade unions and employers regulation in order to prevent excesses and discrimination;Direct involvement in the negotiations between unions and employers as a mediator to ensure convergence to the labor markets optimum.

Regulations on employers Consider void the employment contracts subject to not belonging to the union (yellow-dog contracts);Declare as core labor rights: the right to self-organization of labor and the right to collective bargaining;Prohibit employers to interfere in trade union activities and create obstacles to trade union organization;Prohibit employers discrimination against union membership pertaining to hiring, firing and promotions;Consider illegal to discriminate against any worker who has claims against employers, or testify against him;Require employers to properly negotiate with the unions, without resorting to pressure or threats;Prohibit or limits wage discrimination based on gender, race, religious beliefs etc.Regulations on unionsAddress three main areas:

Union organization

Unfair union practices

Right to strike

Union organizationAims at exclusive objectives specific to the labor market:higher wages,better working conditions,shorter working hours,paid annual leave etc.Political neutralityHave the autonomy to negotiate (organized as Unions)May have degrees of recognition:Closed shop,Union shop,Open shop.

Unfair union practicesPressure on employees to become union members

Judicial jams

Secondary boycotts (confrontation between unions)

Sympathy strikes

Discriminatory or excessive contributions

Refusal to negotiate with employersThe right to strikeFree way of expressing the attitude of workers about the working conditionsThe aim should refer to the labor marketOtherwise, are prohibited:Political strikesReligious strikesSolidarity or social groups strikes.Are also prohibited :Strikes that can block the entire national economy andMay endanger public health,Or national security.COMPETITIONEconomy system organized on markets:Labor marketMarket of goods and servicesMonetary market An efficient market = a competitive marketPerfect competitionImperfect competitionNon-optimal income distributionState intervention

The Pareto inefficiency of monopolyMonopolyBest known case of imperfect competitionLack of competition on one goods market

The supplier has discretionary powers on setting the operating conditions of a goods market

Monopolistic competitionWho is competing against monopoly?

Who is competing against monopoly?With the companies that produce substitutable goods in relation to the good self-produced.

With any other company the limited nature of short-term income.Considering short-term consumer income constant, it results that any increase in consumption of a good will lead to a reduction in consumption of another good, regardless of the relationship of substitutability or complementarity.

Advantages of monopoly will attract other supplier/ manufacturers.Monopolys strategies

Legend (1) Monopoly faces the market demand demand curve around the gates of the company will be identical with those of market demand.The optimal level of monopoly output (Q*) is set in relation to the intersection of marginal revenue with marginal cost curve (Vm < VM)The price corresponding to this level of supply is P*, but market demand is at a higher marginal income PC > P*Monopoly can set the supply at its discretion (the only supplier)Usually the monopolistic firm restricts the supply to get a higher sales price (the more the supply curve will be to the left, the higher the price will get)Legend (2) The monopoly obtains superprofit (S), as the difference between the profit pertaining to the intersection between the demand curve and the supply curve (PC) and optimizing price (P*) Pareto optimum? No.Obtaining superprofit is in the detriment of consumers, meaning that the Q* solution is not Pareto optimumThe prices are higher than the level pertaining to profit maximization (P*)Are there favorable conditions for monopoly? When it does not worsen the welfare of othersThe case of the technological monopoly improving technological performance can be found in welfare improvements (R & D)

The Pareto inefficiency of oligopoly

Kinked (broken) demand curveLegend (1)Initial situation (Q0, P0).

Temptation price control.

The oligopolistic firm has the following alternatives:If it wants to increase the price, the demand will suddenly turn elastic because its product that became more expensive will be substituted by powerful products of other firms from the oligopoly that have kept the price unchanged losses for the supplier.If it intends to reduce the price, the demand will turn inelastic, because at least one other firm from the oligopoly will do the same, and the sales surplus will be split between firms that reduce price losses for the supplier.Legend (2)The marginal income Vm in the case of the imperfect competition is below average income (of the market demand) the marginal revenue curve of the oligopolistic firm will be discontinuous

Point N marginal revenue curve break (slope changes in the firm's demand curve)The second part of the marginal revenue curve is negative (which measures the change in total revenue of the company to lower prices, unlike the first part which describes the change in revenue from an increase in price)Solution negotiation

Cooperation between firms in the oligopoly avoids the kinked curve and the firm gains because the income earned due to price increase is larger than the income lost due to sales quantity dropquantityMethods of coordination in the oligopolyTrust firms are horizontally integrated through joint assets monopoly

Cartel firms keep their autonomy (e.g. OPEC)Coordination may be based on agreements negotiated by the participantsThese agreements provide for:Commodity prices,Local markets,Supply quotas assigned to each participant.How does coordination take place?Sending signals through the lead price promotional strategy

Conditions favorable to tacit coordination :Less fierce competition,Demand expansion,Lower danger of new competitors emergence.

Otherwise - coordination arrangementsCoordination difficulties in the oligopolyNon-transparent pricing strategies pricing information exchanges take place only when cooperation is desired

Wholesale - If a company raises the price of some of its supply contracts for next year is unlikely that a competitor can benefit from an increase in sales since it works with its traditional clients

Real complex and non-fungible goods

Antitrust lawCoordination horizontal/verticalHorizontal structures define the same level of economic activity (producers, sellers).

Vertical structures are considered:Integration on technological flows (upstream-downstream),producer-seller,In line with the supplies of raw materials or parts.How do we establish the influence of the oligopolistic horizontal coordination on free competition?market definition monitoring through specialized bodies (setting the price increase threshold)sales concentration (degree of market concentration) determine the share in total sales H-H indexbarriers to entry (see Porter's Forces)other market characteristicsPredator behavior (price dumping)degree of complexity pertaining to the supplied goods qualitySuppliers history on that market.efficiency and cost savings following a merger.The case of coordination through vertical integrationMerger between two independent firms that had made transactions, on being the others supplierWhere do problems occur?long-term contracts make the entrance of a new seller or buyer impossible franchise, sales, leasing, licensing, sales, exclusive, contractual requirements, territorial restrictionsresale price maintenance price strategy used by the manufacturer to control the final consumer priceinformational limitationsconditional sales contracts conditions the delivery of a good by the purchase of another goodThe difficulty establishing the boundaries of the intervention Regulation of competitionInvolves complex mechanismsIt is costlyIt is unnecessary when the barriers created by state regulations produce Pareto efficiency losses (beyond the benefits of regulation)?Not necessarily the case of merit goodsBut yes, looking for the solution of self-regulation:professional associationsagreements on compliance with quality goods and servicesfair rules of doing business.Competition in RomaniaCompetition Council (Consiliul concurentei)http://www.consiliulconcurentei.ro/ro/despre-noi.html

Competition in EUDG CompetitionTest your knowledge on competition policy http://ec.europa.eu/competition/consumers/quiz/index_en.html

MONETARY MARKETPremises Money creationMoney Supply and DemandMonetary Policy

What is money?Money can be:Payment for goodsMedium of exchangeValue keeper savingCommodities (stones, cigarettes), Silver, Gold, Coins, Bills vs. BarterPrice of money = exchange value of money = purchasing power of the monetary unit (PPM)Price of money inversely proportional with the price of goods PPM = 1/P

Measuring moneyMonetary aggregates = statistical indicator used for certain groups of currency:CashCurrent accounts without interestTravel checksM1 = 1+2+3 (narrow money)Savings accountsTerm deposits M2 = M1+4+5Deposit certificatesLong term savings account M3 = M2+6+7 (broad money)

Money creationMoney suppliers: Central Bank, Treasury, commercial banks

How?Commercial banks reservesMoney in circulationDepositsLoans/ creditsCentral Banks supplies liquidity+1000Loaning the money-10+100+10Depositing the money-8+8Loaning the money+0,8+7,2+7,2Depositing the money-5,8+5,8Loaning the money+0,6+5,2+5,2Back to step 2TOTAL+1,4+8,6+13,8+22,4Monetary policyThe way in which the state uses the instrument of money emissionCorrelates the fiduciary money with the other assets to regulate the monetary supplyMasters of the monetary policy Mugur Isarescu (NBR), Mario Draghi (ECB), Janet Yellen (Fed), Haruhiko Kuroda (Nippon Ginko)Objectives: Maintaining price stabilityExchange rate stabilityBalanced economic growthFull employment

Exam questionsWhat is the general principle of public economics? What are the main issues it focuses upon?The public decision-maker has four main dilemmas. What are those and how is he/she tackling them?The utility interests us due to its role in the analysis of public economy focusing on four pillars. Please comment.What are the states economic functions and how do they operate?How can you define the public sector in economic terms (depending on the types of activities, results of activities, or time)?The state can intervene in case of a market failure. Choose three such situations and explain them.Labour (L) can be underused or overused. What can the two situations determine?How can the state intervene in the labour market?What are the results that reforming the public sector can have? Please provide examples. Porter describes a model helping the decision-makers to establish the grounds for strategy development. Explain.