1. Frank Cowell: EC426 Public Economics EC426 MSc Public Economics 2007/8 http://darp.lse.ac.uk/EC426.htm The Scope of Public Economics 8 October 2007

2. EC4r26: Public Economics Public economics Purpose of this lecture Purpose of this lecture  What is the purpose of public economics?  What does it attempt to do?  Introduce the rest of the course. Is PE some special case? Is PE some special case?  A minor subset of microeconomic analysis?  Particular variants of standard models? Is PE some kind of intruder? Is PE some kind of intruder?  An aberration from “conventional” economics?  An unnecessary complication? Begin with something simple… Begin with something simple…

3. EC4r26: Public Economics Overview... The private economy “Market Failure” Redistribution Looking forward The Scope of Public Economics The standard story of the microeconomic system. A place for public economics?

4. EC4r26: Public Economics Positive economics How does the economy work? How does the economy work? Standard story based on a well-known set of models Standard story based on a well-known set of models Challenge on functionality? Challenge on functionality?  Do the models work?  Do they provide useful predictive power? Challenge on completeness? Challenge on completeness?  Do the models appropriately cover the world as we know it?  Do they address the appropriate questions? Let’s look at the standard story… Let’s look at the standard story…

5. EC4r26: Public Economics A standard approach: outline We use a model of the private economy We use a model of the private economy Two main features: Two main features:  private internal economic mechanism – the market  private external frame of reference – rules of the game Competitive markets Competitive markets  Perfect [?] information  No restraint on trade  Minimal market power  Effective coverage Rules of the game Rules of the game  Incomes determined by property  Guaranteed private property rights

6. EC4r26: Public Economics A standard approach: result Use the private-economy model Use the private-economy model Additional assumptions: Additional assumptions:  Small agents  Large numbers  Convexity? Equilibrium Equilibrium  The existence of competitive equilibria  If well-behaved – stability etc Interpretation: Interpretation:  An “Adam Smith” result  Decentralisation  Each agent max/min with just price guidance

7. EC4r26: Public Economics Implementation through the market q 2 q 1`  p1—p2p1—p2 q *f x 2 x 1`  p1—p2p1—p2 x *h f f ` h h `  f (q f ) = 0 U h (x h ) = U h (x *h )

8. EC4r26: Public Economics A standard approach: implication Is the private-economy model a good one? Is the private-economy model a good one? What do you mean by “good?” What do you mean by “good?”  Predictive power?  Empirical relevance?  Welfare significance? Can consider the model in terms of efficiency: Can consider the model in terms of efficiency:  Will the equilibrium be efficient?  Can we use the market to implement any efficient outcome? Focus on two important theorems Focus on two important theorems  One on implication  One on implementation

9. EC4r26: Public Economics Welfare theorem 1 Assume a competitive equilibrium. Assume a competitive equilibrium. What is its efficiency property? What is its efficiency property? THEOREM: if all consumers are greedy and there are no externalities then a competitive equilibrium is efficient. THEOREM: if all consumers are greedy and there are no externalities then a competitive equilibrium is efficient. Explanation: Explanation:  If they are not greedy, there may be no incentive to trade.  If there are externalities the market takes no account of spillovers.

10. EC4r26: Public Economics Welfare theorem 2 Pick any Pareto-efficient allocation Pick any Pareto-efficient allocation Can we find a property distribution d so that this allocation is a CE for d? Can we find a property distribution d so that this allocation is a CE for d? THEOREM: if, in addition to conditions for theorem 1, there are no nonconvexities then an arbitrary PE allocation be supported by a competitive equilibrium. THEOREM: if, in addition to conditions for theorem 1, there are no nonconvexities then an arbitrary PE allocation be supported by a competitive equilibrium. Explanation: Explanation:  If “lump sum” transfers are possible then we can arbitrarily change the initial property distribution.  If there are nonconvexities the equilibrium price signals could take us away from the efficient allocation...

11. EC4r26: Public Economics ObOb OaOa x1x1 b x1x1 a x2x2 a x2x2 b Supporting a PE allocation   The contract curve   Support the allocation by a CE.   This needs an adjustment of the initial endowment.   Beware: lump- sum transfers may be tricky to implement Allocations where MRS 12 a = MRS 12 b ll ll   An efficient allocation   Supporting price ratio = MRS l l [x] ^ [R]   The property distribution   A lump-sum transfer p1p2p1p2 p1p2p1p2

12. EC4r26: Public Economics Supporting a PE allocation (production)   Firm f’s technology set 0   Supporting price ratio = MRT   f’s net output in the efficient allocation p1p2p1p2 p1p2p1p2   f’s net output in the allocation is profit- maximising for f. q2fq2f q1fq1f ll ll qfqf ^ what if preferences and production possibilities were different?

13. EC4r26: Public Economics Private model: limitations The Adam Smith result is fairly demanding The Adam Smith result is fairly demanding Not hard to think of practical instances where these don’t hold. Not hard to think of practical instances where these don’t hold. Should we speak of “market failure”? Should we speak of “market failure”?  A convenient shorthand  But is it appropriate? Or limits of private economics? Or limits of private economics? Labelling is not so important.. Labelling is not so important.. Provides one important route into Public Economics Provides one important route into Public Economics

14. EC4r26: Public Economics Where the private model doesn’t “work” Useful to look at the separate reasons why… Useful to look at the separate reasons why… A typology of difficulties A typology of difficulties  Market deficiency  Nonconvexities  Externalities  Public consumption Perhaps only the first two are really “failure” Perhaps only the first two are really “failure” But all provide a normative role for public economics But all provide a normative role for public economics Look at these briefly Look at these briefly First an important methodological point First an important methodological point

15. EC4r26: Public Economics Competitive Failure and Efficiency The market “failures” raise two classes of problem that lead to two distinct types of analysis: The market “failures” raise two classes of problem that lead to two distinct types of analysis: 1. The characterisation problem  Description of modified efficiency conditions…  …when conditions for the welfare theorems are not met. 2. The implementation problem  Design of a mechanism to achieve the allocation. These two types of problem pervade nearly all of modern micro economics These two types of problem pervade nearly all of modern micro economics It’s important to keep them distinct in one’s mind It’s important to keep them distinct in one’s mind

16. EC4r26: Public Economics Overview... The private economy “Market Failure” Redistribution Looking forward The Scope of Public Economics Where markets do not quite do the business… Market deficiencies Nonconvexities Externalities Public consumption

17. EC4r26: Public Economics Market deficiencies – 1 A further typology: A further typology: Distorted markets Distorted markets  Monopoly  Restrictive practices Missing markets Missing markets  Futures? Risk?  Highly specialised commodities Thin markets Thin markets  Not enough traders  Highly specialised commodities Problems of information Problems of information  Imperfect / incomplete  Asymmetric The role for intervention…? The role for intervention…?

18. EC4r26: Public Economics Market deficiencies – 2 Role for public sector in each of these cases. Role for public sector in each of these cases. Distorted markets Distorted markets  Monopoly / Anti trust legislation Missing markets Missing markets  Pension / social security provisions  Internal markets in health Thin markets Thin markets  Franchising  Private finance initiatives Problems of information Problems of information  Regulation

19. EC4r26: Public Economics Overview... The private economy “Market Failure” Redistribution Looking forward The Scope of Public Economics Large firms, large projects and infrastructure Market deficiencies Nonconvexities Externalities Public consumption

20. EC4r26: Public Economics Nonconvexities Nonconvexities: ugly name for a crucial issue Nonconvexities: ugly name for a crucial issue Covers many well-known things Covers many well-known things  Increasing returns  Fixed costs  Weird tastes But includes other stuff too But includes other stuff too  Interactions amongst agents…  …positive externalities The market may not actually fail completely The market may not actually fail completely  Could still get decentralisation  But under what circumstances? Let’s see why the second W-theorem does not work Let’s see why the second W-theorem does not work

21. EC4r26: Public Economics Household h makes “wrong” choice x2hx2h 0 x1hx1h xhxh ^ ll ll xhxh ~ ll ll   Household h ’s utility function violates second theorem   Suppose we want to allocate this consumption bundle to h.   Introduce prices   h's choice given this budget p1p2p1p2 p1p2p1p2   Nonconvexity leads to “market failure”

22. EC4r26: Public Economics Firm f makes “wrong” choice q2fq2f 0 q1fq1f ll ll qfqf ^ ll ll qfqf ~   Firm f ’s production function violates second theorem   Suppose we want to allocate this net output to f.   Introduce prices.   f's choice at those prices p1p2p1p2 p1p2p1p2   Another example of “market failure”

23. EC4r26: Public Economics Nonconvexities: a case for public intervention? The conditions for the second W-theorem are violated The conditions for the second W-theorem are violated But this does not automatically mean to say that the market won’t “work” But this does not automatically mean to say that the market won’t “work” Do nonconvexities require intervention in the market? Do nonconvexities require intervention in the market?  there’s a large-numbers argument  “induced” convexity  argument for effective competition laws…  …for example in the EU But what if large-numbers argument doesn’t apply? But what if large-numbers argument doesn’t apply?

24. EC4r26: Public Economics Nonconvexities that won’t go away Sometimes the large-numbers argument is implausible. Sometimes the large-numbers argument is implausible. Big firms Big firms  Boeing  Microsoft Strategic suppliers Strategic suppliers  Network rail  Electricity / gas distribution There may be other cases for a “natural monopoly” There may be other cases for a “natural monopoly” Can see what happens in the case of a large fixed-cost firms Can see what happens in the case of a large fixed-cost firms

25. EC4r26: Public Economics The “infrastructure problem” Represent the analysis in terms of a two-good model. Represent the analysis in terms of a two-good model. Take something like electricity, highways – good 1 Take something like electricity, highways – good 1 To be paid for by sacrifice of all other goods – good 2 To be paid for by sacrifice of all other goods – good 2 Basic questions: Basic questions:  Should good 1 be produced at all?  If so, how much should be produced?  The answer depends on people's preferences A simple diagram A simple diagram

26. EC4r26: Public Economics x1x1 x2x2 ll ll Efficiency and non-convexities in production: case 1 0 l l x′   Endowment of good 2   Fixed set-up cost to produce good 1   Possibilities once fixed-cost has been incurred   Reservation indifference curve   Indifference map   Point where MRS=MRT   Efficient point l l x°   Attainable set is shaded area + “spike”   In this case MRS=MRT is not sufficient   Utility is higher if x 1 = 0

27. EC4r26: Public Economics Efficiency and non-convexities in production: case 2 0 l l x° ll ll x1x1 x2x2   Attainable set as before   Indifference map l l x′   Consumption if none of good 1 is produced   The efficient point

28. EC4r26: Public Economics Nonconvexity: effect of the competitive market   Efficient to produce where MRS=MRT 0 l l x° ll ll l l x′ x1x1 x2x2 p1—p2p1—p2 p1—p2p1—p2   Iso-profit-line   Profit-maximisation over the attainable set

29. EC4r26: Public Economics Nonconvexity: efficient fee schedule   Efficient to produce at x' 0 l l x° ll ll l l x′ x1x1 x2x2 p1—p2p1—p2 p1—p2p1—p2   MRS=MRT   Fixed charge   Variable charge

30. EC4r26: Public Economics Nonconvexities: the role for public economics Focus on issues raised by the infrastructure problem Focus on issues raised by the infrastructure problem  Generalise to more complex cases  Foundation of large sub-branch of public economics Determination of willingness to pay Determination of willingness to pay  Often assumed away in private model – consumer sovereignty  But emerges in many applied public problems  Used as the basis of CB analysis…  …see below The science of regulation The science of regulation  Fairly clear for a world of certainty  But tricky if there is uncertainty about costs  Typically the case where there are few producers

31. EC4r26: Public Economics Overview... The private economy “Market Failure” Redistribution Looking forward The Scope of Public Economics Beneficial and harmful spillovers. A special type of transaction? Market deficiencies Nonconvexities Externalities Public consumption

32. EC4r26: Public Economics The nature of externality An externality is a kind of “involuntary” transaction An externality is a kind of “involuntary” transaction A case where market allocation methods don’t work A case where market allocation methods don’t work  Agents cannot be excluded from the transaction using conventional price mechanism  An example of “market failure”? Externalities can be detrimental or beneficial Externalities can be detrimental or beneficial Normally concerned with two broad types: Normally concerned with two broad types:  Production externalities  Consumption externalities

33. EC4r26: Public Economics Production externality One firm influences another’s production conditions One firm influences another’s production conditions  Affects other firms’ cost curves.  Not effect of wage or input price changes…  …externality is outside the market mechanism. Model this as a parameter shift Model this as a parameter shift  If firm f’s output produces an externality…  …production function of firm k has f’s output as a parameter…  … or MC curve of firm k has f’s output as a parameter. Example: networking Example: networking  One firm’s activity creates pool of skilled workers from which neighbouring firms may benefit. Example: pollution Example: pollution  One firm’s activity (glue production) causes emissions to the detriment of its neighbours (restaurants)

34. EC4r26: Public Economics Externality: Production possibilities low emissions by firm f low emissions by firm f q 1` k q 2 k high emissions by firm f high emissions by firm f   Production possibilities, firm k   Production possibilities, if firm f’s emissions increase

35. EC4r26: Public Economics Consumption externality One agent’s consumption of a good directly affects another One agent’s consumption of a good directly affects another  A’s consumption of good 1 is an argument of agent B’s utility function Related to the analysis of public goods (below) Related to the analysis of public goods (below) Consumption externalities can be seen as qualitatively different Consumption externalities can be seen as qualitatively different  Formal analysis may look similar  But informational problems differ

36. EC4r26: Public Economics Externalities and the welfare theorems What is the role in the fundamental results? What is the role in the fundamental results? Equilibrium may be inefficient. Equilibrium may be inefficient.  If agents are guided just by prices  Then they get misleading signals A clear case for public concern? A clear case for public concern? In the case of production, perhaps not In the case of production, perhaps not  See the externality as special transaction – missing market  Perhaps you just need to extend the coverage of markets  Then let trading happen in the extended markets But it’s difficult to do this for some types of externality – particularly consumption But it’s difficult to do this for some types of externality – particularly consumption An essential role for “public” solutions. An essential role for “public” solutions.

37. EC4r26: Public Economics Overview... The private economy “Market Failure” Redistribution Looking forward The Scope of Public Economics Characteristics of public goods Market deficiencies Nonconvexities Externalities Public consumption

38. EC4r26: Public Economics Public consumption and public goods An important instance. An important instance.  not so much of market failure…  …but of limitations of private model A different characteristic of goods and services in the economy A different characteristic of goods and services in the economy Variety of types of institution to provide Variety of types of institution to provide What are the public goods? What are the public goods? Defined by their economic characteristics Defined by their economic characteristics

39. EC4r26: Public Economics Characteristics of public goods Two key properties that we need to distinguish: Two key properties that we need to distinguish: Excludability Excludability  You are producing a good.  A consumer wants some.  Can you prevent him from getting it if he does not pay? Rivalness Rivalness  Consider a population of 999 999 people all consuming 1 unit of commodity i.  Another person comes along, also consuming 1 unit of i.  Will more resources be needed for the 1 000 000? These properties are mutually independent These properties are mutually independent They interact in an interesting way They interact in an interesting way

40. EC4r26: Public Economics Typology of goods: classic definitions Rival? [ Yes ][ No ] pure private [??] pure public [ Yes ] [ No ] Excludable?

41. EC4r26: Public Economics How the characteristics interact Private goods are both rival and excludable Private goods are both rival and excludable Public goods are nonrival and nonexcludable Public goods are nonrival and nonexcludable Consumption externalities are non- excludable but rival Consumption externalities are non- excludable but rival Non-rival but excludable goods often characterise large-scale projects. Non-rival but excludable goods often characterise large-scale projects. Example: defence Example: defence Example: National defence (E) you can't charge for units of 'defence‘ (R) more population doesn't always require more missiles Example: National defence (E) you can't charge for units of 'defence‘ (R) more population doesn't always require more missiles Example: bread Example: bread Example: Bread (E) you can charge a price for bread (R) an extra loaf costs more labour and flour Example: Bread (E) you can charge a price for bread (R) an extra loaf costs more labour and flour Example: bridge Example: bridge Example: Wide Bridge (E) you can charge a toll for the bridge (R) an extra journey has zero cost Example: Wide Bridge (E) you can charge a toll for the bridge (R) an extra journey has zero cost Example: flowers Example: flowers Example: Scent from Fresh Flowers (E) you can't charge for the scent (R) more scent requires more flowers Example: Scent from Fresh Flowers (E) you can't charge for the scent (R) more scent requires more flowers

42. EC4r26: Public Economics Public goods and the welfare theorems Why is implementation likely to be difficult in the case of pure public goods? Why is implementation likely to be difficult in the case of pure public goods? Private provision will be inefficient Private provision will be inefficient We have an extreme form of the externality issue. We have an extreme form of the externality issue. But there is a fundamental difference from private model But there is a fundamental difference from private model Rationality and self interest: Rationality and self interest:  Unambiguous for the pure private world  Ambiguous here Therefore we may need different solution method Therefore we may need different solution method

43. EC4r26: Public Economics Example Good 1 - a pure public good Good 1 - a pure public good Good 2 - a pure private good Good 2 - a pure private good Two persons: A and B Two persons: A and B  Each person has an endowment of good 2  Each contributes to production of good 1 Production organised in a single firm Production organised in a single firm

44. EC4r26: Public Economics [–][–][–][–] 1,13,0 0,32,2[+]Alf Bill [+] [–][–][–][–] Public goods: strategic view (1)   If Alf reneges [–] then Bill’s best response is [–]   If Bill reneges [–] then Alf’s best response is [–]   Nash equilibrium

45. EC4r26: Public Economics [–][–][–][–] 0,03,1 1,32,2[+]Alf Bill [+] [–][–][–][–] Public goods: strategic view (2)   If Alf plays [–] then Bill’s best response is [+].   If Bill plays [+] then Alf’s best response is [–].   A Nash equilibrium   By symmetry, another Nash equilibrium

46. EC4r26: Public Economics Which paradigm? Clearly the two simplified +/– models lead to rather different outcomes. Clearly the two simplified +/– models lead to rather different outcomes. Which is appropriate? Will we inevitably end up at an inefficient outcome? Which is appropriate? Will we inevitably end up at an inefficient outcome? The answer depends on the technology of production. The answer depends on the technology of production. Also on the number of individuals involved in the community. Also on the number of individuals involved in the community.

47. EC4r26: Public Economics Overview... The private economy “Market Failure” Redistribution Looking forward The Scope of Public Economics Public economics and the rules of the game

48. EC4r26: Public Economics Redistribution Move away from private-only model Move away from private-only model  Slightly odd preoccupation  Define public economics as a “complement” Move away also from simple efficiency Move away also from simple efficiency  Pareto criterion  Potential Pareto An area where private economy approach is (almost) silent An area where private economy approach is (almost) silent Two broad areas for consideration Two broad areas for consideration  Motivation  Implementation

49. EC4r26: Public Economics Overview... The private economy “Market Failure” Redistribution Looking forward The Scope of Public Economics A framework for analysis? Motivation Implementation

50. EC4r26: Public Economics Normative economics How should the economy be organised? How should the economy be organised? On what basis make the recommendation? On what basis make the recommendation? Could argue that we’ve already strayed into this territory Could argue that we’ve already strayed into this territory Efficiency is a normative criterion? Efficiency is a normative criterion? Distinguish three approaches: Distinguish three approaches:  Constitution  Principles  SWF Have use for all three in Public Economics Have use for all three in Public Economics

51. EC4r26: Public Economics Constitution approach Relies on a representation of orderings of social states Relies on a representation of orderings of social states “Social will” is some aggregation of individual orderings “Social will” is some aggregation of individual orderings Runs into Arrow “Impossibility Theorem” Runs into Arrow “Impossibility Theorem”  Given a general specification  And a rich set of alternatives  There is no constitution that is not dictatorial Lesson for us Lesson for us  Not just a curiosity  Fundamental to key aspects of Public Economics  Can’t just assume away issue of social consensus

52. EC4r26: Public Economics Basic principles: approach Judge outcomes on the basis of (sets of) agreed principles Judge outcomes on the basis of (sets of) agreed principles Efficiency Efficiency  Universally endorsed?  Simply defined  Rests on principle of Pareto improvements Potential Pareto improvements? Potential Pareto improvements?  Potential efficiency  Potential efficiency (Harberger 1971)Harberger 1971  Basis for CB analysis  Basis for CB analysis (Adler and Posner 1999)Adler and Posner 1999 Direct distributional concern? Direct distributional concern?  Fairness  Equity Key question: Where are these additional principles to come from? Key question: Where are these additional principles to come from?

53. EC4r26: Public Economics SWF approach Social Welfare Function (SWF) is a convenient device Social Welfare Function (SWF) is a convenient device Commonly invoked in a variety of applied policy problems Commonly invoked in a variety of applied policy problems Restricts normative economics to a more limited field Restricts normative economics to a more limited field  imposes much more structure on welfare comparisons  usually provides clear-cut answers Key questions: Key questions:  What properties for the SWF?  Where does it come from?  How to determine its parameters? This will receive special attention in our core lectures This will receive special attention in our core lectures

54. EC4r26: Public Economics Overview... The private economy “Market Failure” Redistribution Looking forward The Scope of Public Economics Public economics and the rules of the game Motivation Implementation

55. EC4r26: Public Economics Redistribution: implementation An aspect of private-economy model that is deceptively simple An aspect of private-economy model that is deceptively simple Application of second welfare theorem Application of second welfare theorem “Support” requires an adjustment of endowments “Support” requires an adjustment of endowments Commonly use the device of “Lump-sum transfers” Commonly use the device of “Lump-sum transfers”  Exogenous reassignment of property rights  Takes place before trading in the private economy  A basis for public policy? Why don’t we see more of these in practice? Why don’t we see more of these in practice?  Practical difficulties – land expropriation?  Political difficulties – poll tax? But there are deep issues associated with implementation But there are deep issues associated with implementation  Design issues  Informational problems

56. EC4r26: Public Economics The implementation problem At the core of public economics At the core of public economics  Politics is the art of the possible  Policy is the art of implementation If not lump sum redistribution, then…? If not lump sum redistribution, then…? Design issues cover… Design issues cover…  Economic incentives  Administrative difficulties  Informational restrictions Informational difficulties include… Informational difficulties include…  Role of uncertainty  Asymmetric information  Central to interesting questions in public economics

57. EC4r26: Public Economics Implementation: asymmetric information Why is asymmetric information so central? Why is asymmetric information so central? Consider the two broad economic categories Consider the two broad economic categories Private information Private information  Defines the public/ private boundary  What is the State allowed to know about you?  Adverse selection problem Hidden actions Hidden actions  Defines a boundary of responsibility  How much can/should the State do for you?  Moral hazard

58. EC4r26: Public Economics Implementation: design  Private information induces incentive problems  May be an incentive to “manipulate” the economic mechanism  Mechanism had better be designed to avoid unfortunate effects of manipulation  Limitation on private action  Limitation on public policy options Closely related to “constitution” problem Closely related to “constitution” problem  Arrow theorem is linked to the incentive problem  Same issues arise in trying to resolve it Affects whole range of tools available to public sector Affects whole range of tools available to public sector  Social insurance  Taxation  Income support  Provision of public goods

59. EC4r26: Public Economics Overview... The private economy “Market Failure” Redistribution Looking forward The Scope of Public Economics Connections between parts of the course

60. EC4r26: Public Economics Looking forward This brief summary of public economics… This brief summary of public economics… …provides an agenda …provides an agenda …an introduction to the course …an introduction to the course All of the elements presented here play a role All of the elements presented here play a role  The main economic issues analysed in detail  And practical examples are examined  Essential components are done in this term Let’s briefly look at how they fit together Let’s briefly look at how they fit together

61. EC4r26: Public Economics Preview: 1 Begin with motivation Begin with motivation Welfare analysis of redistribution Welfare analysis of redistribution  How do we justify intervention?  What’s the philosophical basis?  How do people feel about redistribution? Equity, social welfare and taxation Equity, social welfare and taxation  What do we know about SWFs?  How are these linked to notions of equity?  What implications for taxation?

62. EC4r26: Public Economics Preview: 2 We make repeated visits to the problem of design We make repeated visits to the problem of design Policy design: social insurance Policy design: social insurance  An analysis of the basic principles of design  Examination of hidden-action problem  Application to health and pensions Optimal taxation Optimal taxation  The problem of private information  Income tax – the structure of the problem  Commodity taxation – how to use information about transactions

63. EC4r26: Public Economics Preview: 3 Two key areas of applied public economics Two key areas of applied public economics Needed to make sense of the theory Needed to make sense of the theory  Taxation and individuals  Taxation and companies Difficult issue of rationality Difficult issue of rationality Behavioural public economics Behavioural public economics  Bounded rationality and self-interest Providing public goods Providing public goods  Reconciling the ambiguity in rationality

64. EC4r26: Public Economics Summary: 1 Public economics is not an “intruder” into microeconomics Public economics is not an “intruder” into microeconomics A role for it follows from fundamental welfare theorems A role for it follows from fundamental welfare theorems First: where the theorems “break down’’ First: where the theorems “break down’’  Whether or not we speak of “market failure”  Or consider it as limits of the private model Second: in implementing the support theorem Second: in implementing the support theorem  Mechanisms to guide the private action?  Mechanisms to replace the private action?

65. EC4r26: Public Economics Summary: 2 Public economics is not just a minor subset of microeconomics Public economics is not just a minor subset of microeconomics Deals with questions that we would not otherwise touch Deals with questions that we would not otherwise touch Addresses fundamental questions of economic organisation Addresses fundamental questions of economic organisation  How to balance conflicting interests – move beyond the Pareto criterion  Lump-sum transfer – harder in practice than might be supposed A basis for foundation of economic policy A basis for foundation of economic policy

66. EC4r26: Public Economics References Adler, M. D. and Posner, E. A. (1999) “Rethinking cost- benefit analysis,” The Yale Law Journal, 109, 165-247 Adler, M. D. and Posner, E. A. (1999) “Rethinking cost- benefit analysis,” The Yale Law Journal, 109, 165-247 Adler, M. D. and Posner, E. A. (1999) Adler, M. D. and Posner, E. A. (1999) Cowell, F. A. (2006) Microeconomics: Principles and Analysis, Chapter 13 Cowell, F. A. (2006) Microeconomics: Principles and Analysis, Chapter 13 Cowell, F. A. (2006) Cowell, F. A. (2006) Harberger, A. C. (1971) “Three basic postulates for applied welfare economics” Journal of Economic Literature 9, 785.797. Harberger, A. C. (1971) Salanié, B. (2000) Microeconomics of Market Failures Cambridge Massachusetts: MIT Press, Chapter 1.