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CHAPTER 16 Public Goods and Tax Policy. Goods Classifications: Excludable –can prevent people from consuming without paying Rival in consumption –can.

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Presentation on theme: "CHAPTER 16 Public Goods and Tax Policy. Goods Classifications: Excludable –can prevent people from consuming without paying Rival in consumption –can."— Presentation transcript:

1 CHAPTER 16 Public Goods and Tax Policy

2 Goods Classifications: Excludable –can prevent people from consuming without paying Rival in consumption –can not be consumed by more than one person at the same time

3 Four types of goods Private goods: –excludable and rival in consumption Collective goods (Artificially scarce goods): –excludable and non-rival in consumption Commons goods (common resources): –non-excludable and rival in consumption Public goods: –non-excludable and non-rival in consumption

4 Four types of goods

5 Private good (wheat) Collective good (pay-per-view TV) Commons good (fish in the ocean) Public good (national defense) Rival Non-rival Non-excludable Excludable From Table 16.1, P.365 Goods Classification

6 HW5 Explain the characteristics of the 4 types of goods 4 types: private; collective; common; public List 5 goods that belong to each of the 4 types and explain

7 Private Goods: Excludable and rival in consumption Non-payers can be easily excluded Each unit consumed by one person means one less unit available for others the only goods that can be efficiently produced and consumed by market

8 Collective Good: (Artificially Scarce Goods) Excludable but non-rival in consumption –It is not really scarce: use by one person does not reduce its availability to others –But it can be excludable: people who do not pay can be prevented from using it

9 Artificially Scarce Goods An artificially scarce good is excludable and non-rival in consumption. It is made artificially scarce because producers charge a positive price but the marginal cost of allowing one more person to consume the good is zero.

10 Common Goods: (Common Resources) Non-excludable and rival in consumption –Non-payers cannot be easily excluded –Each unit consumed by one person means one less unit available for others The problem of overuse - a user depletes the amount of the common resource available to others but does not take this cost into account when deciding how much to use the common resource

11 A Common Resource Fishing in a public river: Each fishermans individual marginal cost does not include the cost that his or her actions impose on others: the depletion of the common resource the marginal social cost curve, MSC, lies above the supply curve; in an unregulated market, the quantity of the common resource used, QMKT, exceeds the efficient quantity of use, QOPT.

12 The Efficient Use and Maintenance of a Common Resource Use taxes Make it excludable and assign property rights Create of a system of tradable licenses for the right to use the common resource

13 Public Good: A good or service that, at least to some degree, is both non-rival and non- excludable –Non-rival Good A good whose consumption by one person does not diminish its availability to others –Non-excludable Good A good that is difficult, or costly, to exclude non-payers from consuming

14 If non-excludable: Rational consumers won t be willing to pay for the good People who do not pay can not be prevented from consuming Free-rider problem: individuals have no incentive to pay for their own consumption Inefficiently low production

15 If non-rival in consumption Marginal cost = 0 Price should be 0 Inefficiently low consumption

16 What goods and services should government provide? Pure Public Good –A good or service that, to a high degree, is both non-rival and non-excludable Pure public goods should be provided by government because: –For-profit private firms would find it difficult to recover their costs of production. –Since the MC of serving additional users is zero once the good has been produced, then charging for the good would be inefficient.

17 Cost-Benefit Analysis Social costs and social benefits People have no incentive to pay for efficient quantity of public goods People tend to overstate the value of public goods (people tend to prefer too much of the goods when they don t have to pay for it: marginal cost is 0)

18 Advantages of Using Government to Provide Public Goods Cost of adding a tax is relatively low Minimizes the difficulty in determining who will bear what share of the tax burden May be the only feasible provider

19 Government Provision A pure public good should be provided by the government only when the benefit exceeds the cost. The cost of the public good is the sum of the explicit and implicit costs incurred to produce it. The benefit of the public good is the sum of the reservation prices of all people who want the good.

20 Government taxes: the way to finance public goods Paying for Public Goods –Not everyone benefits equally from a public good or service. –Therefore, the most equitable way to pay for the public good or service is to tax people in proportion to their willingness to pay.

21 Tax System Head Tax –A tax that collects the same amount from every taxpayer –A head tax rule will rule out the provision of many worthwhile public goods. Proportional Income Tax –A tax under which all taxpayers pay the same proportion of their incomes in taxes

22 Tax System Regressive Tax –A tax under which the proportion of income paid in taxes declines as income rises Progressive Tax –One in which the proportion of income paid in taxes rises as income rises.

23 Alternatives to using taxes to fund public goods: Funding by donation Development of new means to exclude non-payers Private contracting Sale of by-products

24 Tax System Trade-off between equality and efficiency –Equity: fairness, the right people actually bears the tax burden –Efficiency: minimizes the direct and indirect tax collection costs to the economy

25 Tax Efficiency Minimizing administration costs (direct costs) Reducing deadweight loss (indirect costs)

26 Recall: excise tax

27 To Reduce Deadweight Loss Taxes decreases the price the producers receive and increases the price the consumers pay The incidence of tax is determined by the elasticities of demand and supply To reduce the deadweight loss caused by tax, impose taxes on the ones who have the most inelastic responses

28 To Lower Administration Costs Administration costs: the resources actually spent on collecting and paying the taxes The difficulties of calculating, collecting and paying the taxes

29 Tax Fairness The benefits principle –The ones who benefit from the spending should pay for it The ability to pay principle –The ones who are more able to pay should pay for it

30 The Tax System Tax bases: the income or property value that determines how much tax an individual pays Tax Structure: how the tax depends on the tax base –Proportional –Progressive –Regressive

31 Tax Bases

32 Income Redistribution through Taxes and Government Spending Progressive taxes: taking more money away from the rich to provide supports for the poor Government Spending: transfer payments –Welfare –In-kind transfers –Negative income tax

33 Income Redistribution: Social Security Progressivity (vertical equity) Individual equity Horizontal equity Economic efficiency

34 Progressivity: Redistribution from the better-off to the less well-off Redistribute resources to the elderly from the rest of the population (intergenerational redistribution Higher rate of return on the contributions of workers with lower wages than for those with higher wages

35 Individual Equity Ensuring a fair return on contribution Individuals should be paid retirement benefits that, on average, equal their contributions plus a fair interest rate The allocative and distributive functions of government are combined into a single program Benefits are paid out before adequate contributions have been built up

36 Horizontal Equity Equal treatment for equals Equal assessment of payroll taxes on those with equal earnings Equal benefits to those born in the same year, with equal earnings histories, and of the same family type

37 Economic Efficiency Achieving maximum benefit to society from available resources Minimize any losses of efficiency that might arise unintentionally


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