Topic 1 Taxation Intro
Transcript of Topic 1 Taxation Intro
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Topic I: Economics and the Public Sector
Business Administration and Management
Fall 2015-2016
Departament dEconomia Pblica, Economia Poltica i Economia Espanyola
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Bibliography
2
Rosen and Gayer: Chapter 1
Chapter 4 Chapter 5
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1. The Public Sector: Introduction2. Functions of the public sector: Why does the
public sector intervene in a market economy?
i.
Efficiency
ii. Redistribution
iii.Stabilization of the economic cycle
Musgrave, (1959)
Outline
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What is Public Economics or Public Finance?
Part of economics that studies the intervention of the public sector in a market economy,
mainly through financial activity (i.e. public revenues and expenses).
Public Economics: Economic decisions of the public sector and/or the reaction of
private agents to the public sector
Public Finance: Decisions directly related to public revenues and expenditures.
Public
EconomicsEconomics
Introduction: The Public Sector
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Twofold approach:
1. What arethe measureable effects of government programs andinterventions? (positive analysis)
2. What should the government do if we can choose optimal policy?
(normative analysis)
Closely related: Political Economy
Why do governments behave the as they do?
Introduction: The Public Sector
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When we do NOT need a public sector!
First Welfare Theorem
Private markets provide a Pareto efficient outcome under thefollowing conditions:
Private good
No externalities
Perfect competition
Complete and symmetric information
Functions of the Public Sector
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If QQ*, the marginal cost exceed the marginal revenue (over-provision)
p*
Aggregate Supply(Marginal Cost)
P
Q*
Aggregate demand(Marginal Revenue)
Q
Functions of the Public SectorHow it should be
The market maximizes the consumers and
producers surpluses
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! The market is not always in this equilibrium due to the existence ofmarket failures.
Public goods (goods that are non-rivaland non-excludable)
Externalities
Natural Monopolies
Information asymmetry (adverse selection and moral hazard)
Functions of the Public SectorMarket Failures
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Functions of the Public SectorHow it should be Private goods
The aggregate demand for private goods is derived by summing individual
demand horizontally:
Rival: a good taken off the shelf it isnt there for other people to consume.
Excludable: once you buy it, you own it and can consume it as you please.
We sum private goods horizontally, because consumers cannot consume the
same units
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Functions of the Public SectorHow it should be Private goods
A simple example: Fig Leaves (f)
Source: Rosen and Gayer (Chapter 4)
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Functions of the Public SectorHow it should be Private goods
A simple example: Fig Leaves (f) EFFICIENT PROVISION
Source: Rosen and Gayer (Chapter 4)
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Characteristics of public goods (e.g. national defense):1. Non-rival consumption: The consumption of a good by an
individual doesnt !the available q for the rest of individuals. The
mg cost of a new individual that starts consuming is equal to 0.
a good cannot be taken off the shelf because individuals
enjoy the same.
2. Non-excludable consumption: It is not possible to prevent the
consumption of a good by someone who is not paying for it.
everybody can enjoy the public good.
The aggregate demand for public goods is derived by summing
individual demand vertical: We sum public goods vertically, becauseconsumers can consume the same units.
Functions of the Public SectorMarket Failures: Public Goods
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Functions of the Public SectorMarket Failures: Public Goods
A simple example: Fireworks
Source: Rosen and Gayer (Chapter 4)
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Functions of the Public SectorMarket Failures: Public Goods
A simple example: Fireworks
EFFICIENT PROVISION
Source: Rosen and Gayer (Chapter 4)
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Functions of the Public SectorMarket Failures: Public Goods
MRSAdam= MRSEve=MCPrivate Good
MRSAdam+ MRSEve= MCPublic Good
SummaryNecessary condition for Pareto efficiency:
MRS= It is the maximum rate at which the consumer would be willing tosubstitute a little more of good x for a little less of good y
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Why are public goods a market failure?
Inefficient market provision - unlike price, quantity is not an
effective market mechanism:
For a given quantity, individuals will not automatically self-select theiroptimal price, but will instead wish to pay the lowest price possible
when they cannot be excluded from consuming the good.
! If the consumption of a good is non-excludable, the market will not
provide it.
Functions of the Public SectorMarket Failures: Public Goods
The Free Rider Problem
Public Sector Interventions:public provision
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Functions of the Public SectorMarket Failures
rival
excludable
yes no
yes private good
naturalmonopoly
(e.g. cable tv)
no
commonresource
(parkingspaces)
public good(national
defense)
Public goods "goods provided by the public sector
Public sector might or might not provide public goods
Goods Classification:
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If the consumption of a good is non-rival but excludable, there may beprivate provision, but it will be sub-optimum
Functions of the Public SectorMarket Failures: Non-rival and Excludable Goods
Public Sector Interventions:public provision?
Example: Natural Monopoly
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In some industries, there are very high fixed costs associated with thestarting of the activity (natural barriers to entry)
Railways
EnergyGas
Telephony
Decreasing average costs (due to the high fixed costs)
Efficient solution:A single producer, public or private?
(Read: Water privatisation: a worldwide failure? (TheGuardian, 30/01/2015))
Functions of the Public SectorMarket Failures: Natural monopolies
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!
Externality: Utility or production of an agent depends directly onthe actions of another agent
! This effect is NOT included in the price
! Defined in 2 dimensions:
! Positives vs. Negatives
!
Production vs. Consumption
Positives / consumption
Vaccine, Education
Negatives / consumption
Tobacco, Alcohol,
Hydrocarbon
Positives / production
R&D, on-the-job training
Negatives / production
Contamination of a river,
Noise pollution
Functions of the Public SectorMarket Failures: Externalities
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Qm=Sub-optimal demand for the good
MC (S)
MR private (D)
Ext
MR social=D+ext
Qm Q*
"
e.g. Vaccines (positive)
Functions of the Public SectorMarket Failures: Externalities
PS Intervention : Increase theconsumption of the good
(subsidize vaccine)
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e.g. contamination of a river (negative)
Qm=Over-provision of the good
MC private (S)
MR private (D)
Ext
MC social=S+ext
QmQ*
"
Functions of the Public SectorMarket Failures: Externalities
PS Intervention:
Decrease the production of the good (tax
on the dumping of waste, regulation,#)
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Taxes (or subventions) are instruments that can bring the level of
provision of a good closer to the social optimum (Pigouviantaxes)
private MC (S)
private MR (D)Ext = t
private MC + t = S+ ext
QmQ*
"
Functions of the Public SectorMarket Failures: Externalities
If the tax matches up with the value of the externality, the taxinternalizes the externality and the level of production isoptimum (Q*)
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1. Adverse selection (example: insurance) In the insurance market, there are high-risk (cost Ph, share $), and
low-risk (cost Pl, share (1-$)) individuals
If the company cant distinguish the 2 types of individuals,
p = !*Ph + (1-!)*Pl
Low-risk individuals wont contract the insurance (too costly for them!) High-risk individuals will contract the insurance (but then profit
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2. Moral Hazard:the insurance modifies the behavior of individuals, reducing
the effort on preventing the risk from realizing.
If individuals can affect the probability of the risk (losing a job), no one will
provide insurance for it (unemployment insurance)
Is this a problem when consider banks bailouts or a bailout to Greece?
Functions of the Public SectorMarket Failures: Incomplete markets and information asymmetries
Public Sector Intervention:Public provision: e.g., public
unemployment insurance
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The market distributes the income of individuals according to theproductivity of their production factors (no production, no payment)
If large inequalities among individuals are not desired from a social point of view:
The Public Sector can improve the income distribution through by
! Public expenditure:
Transfers of income (subsidies, unemployment benefits, social
assistance)
Provision goods and services free of charge or below the market price
(e.g. healthcare) Free or subsidized education improves the redistribution of a very
important factor of production (Human Capital)
! Taxes:
Based on the ability to pay (progressive income tax)
Functions of the Public SectorRedistribution
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GINI coefficient: Index measures the degree of inequality in the distribution of
family income in a country Calculated from the Lorenz curve
Lorenz Curve
A curve showing the proportion of national income earned by
a given percentage of the population.
E.g. what proportion of national income is earned by the top
10% of the population?
Functions of the Public SectorRedistribution
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% of National Income
Percentage of Population
This line represents thesituation if income was
distributed equally
The poorest 10% would earn10% of national income, thepoorest 30% would earn 30%
of national income
10%
10%
30%
30%
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Functions of the Public SectorRedistribution
L C
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% of National Income
Percentage of Population30%
20%
7%
Here, the Lorenz curvelies further below the
line of equality
Now, the poorest 30%only earn 7% of thenational income (brown
line)
Lorenz Curve
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Functions of the Public SectorRedistribution
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%of
NationalIncome
Percentage of Population
Gini Coefficient= A / (A + B)
A
B
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Functions of the Public SectorRedistribution
The Gini index measures the areabetween the Lorenz curve and a
hypothetical line of absolute
equality
A Gini index of 0 represents
perfect equality, while an index of
100 implies perfect inequality.
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Objective:
Stabilizing the economics fluctuations by fiscal policy:
! Expansive during recessions: Increase the disposable income
(increase expenditure and/or decrease taxes)! Restrictive during expansions: Decrease the disposable income
(decrease expenditure and/or increase taxes)
Automatic stabilizers:
government budget policies, particularly income taxes and welfare spending,
automatically act to dampen fluctuations in real GDP
! during recessions: unemployment benefits automatically increase
! during expansions: income and corporate tax revenues increase
Functions of the Public SectorStabilization