PUBLIC ECONOMICS

PUBLIC ECONOMICS



Manuela Samek Lodovici – LIUC (msamek@irsonline.it)



James Wickham – Trinity College Dublin

Aim of the course



 To examine the role of the public sector in modern

economies



 To provide an understanding of the economic

rationale for government intervention,



 To discuss the effects of government’s actions in

terms of efficiency and equity

Course outline

The course is organised into the following units:

1 - An introduction to public economics: the economic roles of government, the rationale and

limits of public intervention according to economic theory, its effects in relation to efficiency and

equity trade offs;

2 - Public expenditures: basic theory and application to some expenditure programmes, i.e.

welfare policies, education policies, employment policies, health care policies;

3 - Taxation: microeconomic and redistributive effects of fiscal policy and of the structure of

taxation.

4 – Welfare states and inequalities (Prof. Wickham)

References:

 Lecture Slides

 Textbooks on Public Economics :

 E. Stiglitz, Economics of the public sector, W.W. Norton & Company, 3rd edition, 2000,

chapters 3,4,5, 6,7,8,9, 10,14, 15,16,17,19,20,26; or

 J. Gruber, Public Finance and Public Policy, 2007. Chapters 2, 5, 6, 7, 11, 12,13, 14,17,

18,19, 20

 in alternative other textbooks in the library , such as A.L. Hillman, Public Finance and Public

Policy, Cambridge, 2003.

 Optional readings will be mentioned in the course

Examination

2 hours written examination at the end of the course;

optional: short paper (4-5 pages) and eventual oral presentation on one/two articles (+ 0-2

points on the grade of the written exam). The list of articles will be available by early November,

short papers to be handed in by December 21.

1. Introduction to public

economics

 Public intervention is widespread and largely influence

our daily life:

 The government provides goods and services (health,

assistance, education, defence, environment,

infrastructures, etc.),

 it defines the rules for socio economic behaviour

(legal structure and property rights, environmental

regulation and protection of natural resources, safety

regulations, employment regulations, etc.)

 it ensures a stable economic environment;

 it finances its activities with taxation and this affects

the agents’ decisions on labour demand and supply and

on consumption.

The ratio public Deficit/GDP in the EU

= (TOTAL REVENUES – TOTAL EXPENDITURES)/GDP

Source: EC and Eurostat

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Austria -4.2 -4.9 -5.6 -3.9 -1.8 -2.3 -2.2 -1.5 0.3 -0.2 -1.1 -1.3

Belgium -7.3 -5.0 -4.3 -3.8 -2.0 -0.7 -0.4 0.2 0.6 0.1 0.4 0.1

Germany -3.1 -2.4 -3.3 -3.4 -2.7 -2.2 -1.5 1.3 -2.8 -3.7 -3.8 -3.7

Greece -13.4 -9.4 -10.2 -7.4 -4.0 -2.5 -1.8 -4.1 -3.6 -4.1 -5.2 -6.1

Finland -7.3 -5.7 -3.7 -3.2 -1.5 1.5 2.2 7.1 5.2 4.3 2.5 2.1

France -6.0 -5.5 -5.5 -4.1 -3.0 -2.7 -1.8 -1.4 -1.5 -3.2 -4.2 -3.7

Ireland -2.7 -2.0 -2.1 -0.1 1.1 2.4 2.4 4.4 0.9 -0.4 0.2 1.3

-

Italy* -9.3 -7.6 -7.1 -2.7 -2.8 -1.7 -0.8 -3.1 -2.9 -3.4 -3.4

10.3

Luxembourg 1.5 2.7 2.1 1.9 3.2 3.2 3.7 6.0 6.2 2.3 0.5 -1.1

Netherlands -2.8 -3.5 -4.2 -1.8 -1.1 -0.8 0.7 2.2 -0.1 -1.9 -3.2 -2.5

Portugal -8.9 -6.6 -4.5 -4.0 -3.0 -2.6 -2.8 -2.8 -4.4 -2.7 -2.9 -2.9

Spain : : : -4.9 -3.2 -3.0 -1.2 -0.9 -0.5 -0.3 0.3 -0.3

Euro-zone

(12 : : : -4.3 -2.6 -2.2 -1.3 0.1 -1.7 -2.4 -2.8 -2.7

countries)

United

-4.9 -3.6 -3.1 -2.2 -0.8 0.4 0.9 1.6 -0.4 -3.8 -4.6 -4.4

States

2) Ratio Public Debt/GDP

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Austria 60.5 63.4 67.9 67.6 63.8 64.2 66.5 67.0 67.1 66.7 65.4 65.2

137. 135.

Belgium 134 130.2 124.8 119.6 114.8 109.1 108 105.4 100 95.6

9 9

Finland 55.9 58 57.1 57.1 54.1 48.6 47 44.6 43.8 42.5 45.3 45.1

France 45.3 48.4 54.6 57.1 59.3 59.5 58.5 56.8 57 59 63.9 65.6

Germany 46.9 49.3 57 59.8 61 60.9 61.2 60.2 59.4 60.9 64.2 66

107.

Greece 110.1 108.7 111.3 108.2 105.8 105.2 114.0 114.8 112.2 109.3 110.5

9

Ireland 95.1 89.6 81.8 73.3 64.5 53.8 48.6 38.3 35.8 32.6 32 29.9

118. 124. 124. 123. 120. 116. 115. 111. 110. 106. 106.

Italy 108

7 8 3 1 5 7 5 2 7 8 6

Luxembou

6.8 6.3 6.7 7.2 6.8 6.3 5.9 5.5 7.2 7.5 7.1 7.5

rg

Netherlan

79.3 76.4 77.2 75.2 69.9 66.8 63.1 55.9 52.9 52.6 54.3 55.7

ds

Portugal 59.1 62.1 64.3 62.9 59.1 55 54.3 53.3 55.9 58.5 60.1 61.9

Spain 58.4 61.1 63.9 68.1 66.6 64.6 63.1 61.1 57.8 55 51.4 48.9

Euro-zone

(12 66.2 68.9 73.6 75.2 74.9 74.2 72.7 70.4 69.6 69.5 70.8 71.3

countries)

United

75.4 74.6 74.2 73.4 70.9 67.7 64.1 58.2 57.9 60.2 62.5 63.4

States

Japan 74.9 79.7 87.1 93.9 100.3 112.2 125.7 134.1 142.3 149.5 157.6 164

Fundamentals of public economics



 Public economics studies: the role of the government in market

economies, the rationale of its intervention and the economic and

social effects in terms of the efficiency and equity trade offs.



 MAIN QUESTIONS:



 When should the government intervene in the economy

(should the government intervene more or less than it

does?)

 How might the government intervene (should it intervene

differently?)

 What are the effects of public intervention?

 How social choices are made?

When should the government intervene

in the economy?

Roles and instruments of Government

intervention



 The public sector has different roles in market

economies:

 Allocation of resources (efficiency goal)

 Income (re)Distribution (equity goal)

 Stabilisation fo the economic cycle

 these roles interact with each other

When and how to intervene/1

Allocation role (efficiency)

 The ALLOCATION ROLE is to provide efficiently

(increasing the size of the pie) goods and services

when the market is not able to produce them efficiently

(market failures) through:

 The production of public goods or the public

financing of private provision: i.e. all those goods and

services which are not produced (or would be produced

inefficiently) by the market, due to market failures;

 The regulation of market activities to support market

competition (property rights, legal system, restrictions )

 Taxes and subsidies which change the market price of

goods/services

When and how to intervene/2

Redistributive role

 The aim is to foster equity correcting the distribution

of resources resulting from market mechanisms by

shifting resources from some groups in society to

others and/or by changing initial endowments

through:

 Monetary transfers (such as welfare benefits to

support the income of the poor or the unemployed)

 Transfers in kind (provisions of public services

such as education, health services, social services)

 Taxes/subsidies (for example with progressive

taxation or exemptions)

When and how to intervene/3

Stabilisation role



 Smoothing over the business cycle and

external shocks, supporting full employment

and controlling inflation through:

 Fiscal policy (transfers and taxation,

automatic stabilizers, public expenditures)

 Support to productive activities

What are the effects of government

intervention: The analysis of government

failures

 Behind public intervention in modern market economies

is the need to correct actual or perceived market

failures (efficiency goal) and to ensure and

equitable distribution of resources (equity goal)

 However government intervention may also produce

negative direct and/or indirect effects (government

failures) due to:

 Limited information

 Limited control on private markets responses to public

intervention

 Limited control over the public bureaucracy

 Limitations imposed by the political process

What are the effects of public

intervention

 Need to consider direct and indirect effects of public

intervention on individuals and markets:



 Direct effects are those expected assuming that the

behaviour of economic agents do not change as a

consequence of government intervention



 Indirect effects are those that arise because agents

change their behaviour in response of the

intervention (for example increasing taxation may

reduce labour supply)



 Difficult to measure impacts and especially to

establish causation (see Gruber ch.3 if interested)

How decisions are taken?The analysis

of social choices

 Political economy studies how the political

decision making process produces decisions that

affect individuals and the economy

 This part of public economics analyses how socially

desiderable goals are chosen

 Socially desiderable goals relate to:

- the capacity to support socio-economic growth

- the capacity to guarantee adequate living

conditions to citizens

- the capacity to guarantee equality in

opportunities for all

Key economic questions in public

economics

 Efficiency:

 What is produced, how it is produced and how much it is

produced (public vs private goods/services): given available

resources make the pie as large as possible



 Equity

 For whom it should be produced and who should pay for it:

distribute the pie in the most equitable way

 How are decisions taken?



 Trade offs:

 an efficient outcome could be not equitable

 an equitable outcome could be inefficient

Theoretical tools needed for Public

Economics (Stiglitz ch.3,5; Gruber ch.2)

 Consumer theory (constrained utility

maximization)



 Production theory



 Equilibrium and social welfare theory