Chapter 1 Introduction

Reading
Essential reading
Hindriks, J and G.D. Myles Intermediate Public Economics. (Cambridge: MIT Press, 2005) Chapter 1.

Further reading
Blaug, M. Economic Theory in Retrospect. (Cambridge: Cambridge University Press, 1996) [ISBN 0521577012 pbk]. Friedman, M. Essays in Positive Economics. (Chicago: University of Chicago Press, 1953) [ISBN 0226264033 pbk]. Koopmans, T.C. Three Essays on the State of Economic Science. (New York: McGraw-Hill, 1957) [ISBN 0678013977 hbk]. Robbins, L. An Essay on the Nature and Significance of Economic Science .(London: Macmillan, 1935) [ISBN 0333370392 pbk].

Public economics
Public economics analyses government economic intervention It studies how decisions are made It analyses what decisions should be made

Normative and positive analysis

Positive analysis is about explaining why there is a public sector, how government policies are chosen and how these policies affect the economy.
Example: analysing effect of the corporate tax on inward investment are examples of positive analysis.

Normative analysis investigates what the best policies are, and aims to provide a guide to good government.
Example: should the level of pensions be indexed to average wages.

Modelling
Public economics uses models
the possibilities for experimentation are limited past experience cannot always be relied upon

The two basic forms

Partial equilibrium
focus only on one or two markets taking behaviour elsewhere in the economy as given.

General equilibrium
provide a complete economic system with prices equilibrating supply and demand on all markets simultaneously.

Institutional setting
the mixed economy
individual decisions are respected but the government intervenes

Methodology
Actions of economic agents
Consumers
maximise private welfare

Firms
maximise profits

Government
chooses policy instruments benevolent or self-serving?

Reactions to a policy change

predicted through the solutions to these optimisations

Methodology
Subject matter of public economics
the comparison of alternative policies
including the policy of laissez faire (or doing nothing)

the choice of the optimal policy

Change in policy
results in a different equilibrium for the economy.

Comparison of policies
equilibria for different policies are contrasted with respect to how well they satisfy the governments objectives.

Optimal policy
yields the highest level for the governments objective.

The minimal state

Why have government?
unregulated economic activity could not take a very sophisticated form.

Property rights
define the ownership of property and prohibit theft

Contract laws
rules governing the conduct of trade ensure participants to a trade receive what they expect

Law enforcement Defence The minimal state

provides contract law, polices it, and defends the economy against outsiders.

Market failure
Market failure arises when efficiency is not achieved. Sources of market failure:
monopoly public goods externalities asymmetric information

Market failure may justify additional government intervention

it must be tested whether intervention is beneficial government cannot always improve upon the unregulated economy

Redistribution
Government intervention also motivated by
inequality of income inequality of opportunity inequality of wealth.

Redistribution of resources
alleviates these inequalities may raise welfare

Two conflicting aims

efficiency equity

Optimal policy
the correct trade-off between equity and efficiency