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1 C H A P T E R 15 1 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Public Goods, Taxes, and Public.

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Presentation on theme: "1 C H A P T E R 15 1 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Public Goods, Taxes, and Public."— Presentation transcript:

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2 1 C H A P T E R 15 1 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Public Goods, Taxes, and Public Choice

3 2 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Overview of Government Providing public goods and services such as streets, education, parks, public safety, national defense, and space exploration Redistributing income to the poor Collecting taxes to support spending programs Trade policy to control international trade, to promote or to restrict some types of trade In most modern societies, governments are involved in the following activities:

4 3 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Rationale for the Existence of Government Certain goods and services would not exist unless we make a collective effort to produce them. The government can help make collective decisions about paying for goods that generate spillover benefits.

5 4 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Local Governments There are more than 80,000 local governments in the United States. Local governments spend most of their money on: Education (kindergarten through high school) Public welfare and health (payments to poor households and support for public hospitals) Highways Police protection Local governments provide goods and services such as water, fire protection, and libraries.

6 5 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Local Expenditures, 1996

7 6 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin State Governments At the state level, the biggest spending programs are: Education (including colleges and universities) Public welfare Highways Health and hospitals Corrections (state courts and prisons)

8 7 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin State Expenditures, 1996

9 8 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Federal Governments At the federal level, the biggest spending programs are: Income security National defense

10 9 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Federal Expenditures, 1996 (1996)

11 10 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Spillover Benefits A market with spillover benefits is inefficient, so there is an opportunity for government to promote efficiency. Spillover PRINCIPLE For some goods, the costs or benefits associated with the good are not confined to the person or organization that decides how much of the good to produce or consume.

12 11 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Spillover Benefits Number of people100,000 Benefit per person$5$5 Total benefit of dam (100,000 x $5) $500,000 Assumed total cost of dam (greater than personal benefit of $5) $200,000 Tax per person$2$2 Tax revenue (100,000 x $2) $200,000 In this example, if each person considers only the personal benefit relative to the cost of the dam, no dam will be built. Since everyone will support a tax per person that is less than the benefit per person, the government can use its taxing power to provide a good that would otherwise not be provided.

13 12 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Public Goods A public good is a good available for everyone to consume, regardless of who pays and who doesnt. A private good is consumed by a single person or household.

14 13 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Public Goods Public goods are nonrival in consumption (available for everyone to consume) and nonexcludable (it is impractical to exclude people who dont pay). Private goods are rival in consumption (only one person can consume the good), and excludable (it is possible to exclude a person who does not pay for the good).

15 14 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Public Goods National defense Law enforcement Space exploration Preservation of endangered species Protecting the earths ozone layer Income transfers to the poor Examples of public goods:

16 15 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Private Goods With Spillover Benefits A good such as education generates workplace and civic spillovers benefits, thus, the government should adopt policies to encourage people to become educated. Local governments provide free primary and secondary education. States subsidize higher education, and the federal government provides financial aid to students in private and public schools.

17 16 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Voluntary Contributions and the Free- rider Problem The problem with using voluntary contributions to support public goods is the free-rider problem. Each person will try to get the benefits of a public good without paying for it.

18 17 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Overcoming the Free-rider Problem Give contributors something in return Arrange matching contributions Appeal to peoples sense of civic or moral responsibility Techniques to encourage people to contribute:

19 18 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Financing Government: Taxes For local governments is the property tax. For state governments are sales taxes and individual income taxes. For the federal government are individual income taxes and social insurance and retirement receipts. The major sources of revenue:

20 19 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Local Revenue, 1996

21 20 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin State Revenue, 1996

22 21 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Federal Revenue, 1996 (1996)

23 22 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin The Effects of a Tax In a competitive market, equilibrium price ($200) is just enough to cover the cost of providing an apartment. A tax of $80 imposed on housing firms increases the average cost of providing 900 apartments by $80, to $280.

24 23 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin The Effects of a Tax At each price, fewer apartments will be supplied. The tax increases equilibrium price and decreases the output of the industry. The tax shifts the supply curve to the left.

25 24 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin The Effects of a Tax Housing firms now offer 750 apartments at $230 per unit. After they pay the $80 tax, only $150 remains to pay input suppliers. Firms collect more money from consumers and pay less money to input suppliers, so consumers and input suppliers indirectly pay the tax.

26 25 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin The Effects of a Tax The $80 tax per apartment is split between consumers and input suppliers. After the tax, consumers pay $30 more and input suppliers receive $50 less per apartment.

27 26 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin The Effects of a Tax Revenue for the government from the 750 apartments equals $750 x $80, or $60,000. Consumers pay $22,500 and producers $37,500.

28 27 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Deadweight Loss From Taxation Both consumer surplus and producer surplus are less after the tax. Some of the losses are transferred to the government. But the triangles C and E are net losses not transferred to anyone.

29 28 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Tax Shifting: Forward and Backward A forward-shifted tax is a tax imposed on producers but passed on to consumers. The amount of a tax shifted forward depends on the price elasticity of demand for the taxed good. A backward-shifted tax is a tax borne by firms and input suppliers. The amount of backward shifting to input suppliers depends on their responsiveness to changes in input prices.

30 29 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Tax Shifting: Forward and Backward When demand is relatively inelastic, the tax burden is forward-shifted. When demand is relatively elastic, the tax burden is backward-shifted.

31 30 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Public Choice Public choice economics is a field of study that explores contrasting views about how governments operate. Four contrasting views of government: Governments take actions to promote efficiency Voters tell governments what to do Government officials pursue their own self- interest Special-interest groups manipulate the government

32 31 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Governments Take Actions to Promote Efficiency The public-interest view of government is based on the idea that governments make the economy more efficient. As we have seen, governments can use their power to collect taxes to provide public goods that would otherwise not exist.

33 32 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Voters Tell Governments What to Do Voters affect government decisions. In a democracy, the government takes actions that are approved by the majority of citizens. If governments respond to voters, the voting public ultimately makes all the important decisions.

34 33 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin The Median-voter Rule The median-voter rule says that the choices made by government will reflect the preferences of the median voter. When two candidates offer divergently opposed views, powerful forces pull them toward the preferences of the median voter.

35 34 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin People Vote With Their Feet According to economist Charles M. Tiebout, people vote with their feet. The choice of which community to live in is based in part on the taxing and spending policies of different communities. Households express their preferences by moving to communities that offer the best package of services and taxes.

36 35 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Government Officials Pursue Their Own Self-Interest The Nobel Laureate James Buchanan, among others, has suggested a model of government that focuses on the selfish behavior of government officials. The self-interest theory of government suggests that voters dont have much information about the costs and benefits of public services, and may not be able to evaluate the actions of politicians. Limitations on taxes and spending are necessary safeguards against politicians and bureaucrats who benefit from large budgets.

37 36 © 2001 Prentice Hall Business PublishingEconomics: Principles and Tools, 2/eOSullivan & Sheffrin Special-interest Groups Manipulate the Government This model of government is based on the idea that small groups of people manipulate government for their own gain. When a few people share the benefit from a project and a large number of people share the cost, government is more likely to approve inefficient projects. Special-interest groups form whenever the benefits are concentrated on a few citizens but costs are spread out over many citizens.


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