Public Finance: The Role of Public Finance in The Economy

01/01/2021
PUBLIC FINANCE
Public Finance and Public Policy Jonathan

Copyright
Gruber
© 2010
Third
Worth
Edition Copyright © 2010 Worth Publishers 1 of 24
Publishers
The role of public finance in the economy
1. The role of public finance in the economy

2. Tools used by government to intervene in
the economy
3. The impact of government interventions
4. Choice of policy
5. Public sector problems
6. Issues related to social infrastructure,
health insurance and education
Public Finance and Public Policy Jonathan Gruber Third Edition Copyright © 2010 Worth Publishers 2 of 24
1
01/01/2021
CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

1.1
The Four Questions of Public Finance
public finance The study of the role of

the government in the economy.
four questions of public finance

When should the government intervene in the
economy?
How might the government intervene?
What is the effect of those interventions on
economic outcomes?
Why do governments choose to intervene in the
way that they do?

1.1
When Should the Government Intervene in the Economy?
Market Failures
Redistribution
market failure Problem that

causes the market economy to
deliver an outcome that does
not maximize efficiency.
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Why Free Markets usually Work Well for Consumers
Free markets are efficient
• Is it necessary to have a government?
$14 S = (MC)
$12
$10
$8
$6
D = (MB)
90 100 110 Q
Market failure
• Here we briefly explore a failure in the health insurance

market that may cause its equilibrium outcome to be
inefficient.
• In 2019, there were 84 million people with health
insurance in Vietnam
• Is this equilibrium outcome, which leaves 12 million
people without health insurance, the most efficient
outcome for society?
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Problems for the Free Market

Externalities: Chapter 3
Figure 1.8
P MSC
Negative
B
externality $14 – S (MC)
D
$12 – $4
MSC = (MC + marginal $10 –
A
environmental damage)
$8 –
Solution? $6 – D (MB)
A corrective tax.
90 100 110 Q

Externalities: Chapter 3
Figure 1.9
Positive P
externality $14 –
B
S (MC)
D
$12 – $4
MSB = (MC + marginal $10 –
A MSB
benefit to other people)
$8 –
Solution? $6 – D (MB)
A corrective subsidy.
90 100 110 Q
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Taxes, Subsidies, Regulations, and Inefficiency
Deadweight loss • An inefficiency which causes a

reduction in society’s welfare
Figure 1.4
$14 – S
$12 – B
$10 – T=$4 D
$8 –
A Deadweight loss is
$6 – D represented by area
= BAD
90 100 110 Q
$14 – S
$12 – B
D
$10 – S=$4
$8 –
Deadweight loss is
A
represented by area
$6 – D
= BAD
90 100 110 Q
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Public Goods: Chapter 4

• A public good has 2 properties:
1. Non-rivalry
2. Non-excludability
• Free-rider problem
Income distribution, taxation and efficiency: Chapter 6
• Income redistribution
• Taxation – progressive, regressive,
and proportional
• Efficiency trade-offs

 APPLICATION
The Measles Epidemic of 1989–1991
 After the measles vaccine was introduced in 1963, measles cases had
become relatively rare in the U.S. by the 1980s. Over the period from 1989
to 1991, however, there was a huge resurgence in measles.
 It is clear that this outbreak resulted from very low immunization rates
among disadvantaged inner-city youths:
 These unimmunized children were imposing a negative externality on
other children who had received their immunizations but for whom
immunization may have worn off.
 The federal government responded to this health crisis in the early 1990s:
 The government publicly encouraged parents to get their children
immunized.
 The government also paid for the vaccines for low-income families.
The result was impressive. Immunization rates, which had never been above
70% before the epidemic, rose to 90% by 1995. Government intervention
clearly reduced this negative externality.
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Redistribution
redistribution The shifting

of resources from some
groups in society to others.

Figure 1
GDP per capita (USD)

2500 2343.125
2170.648
2012.046 2065.169
2000 1871.325
1722.684
1515.48
1500 1310.37
1000
500
0
2010 2011 2012 2013 2014 2015 2016 2017
GDP per capita
(Source: World Bank)

Think of the economy as a pie, the size of
which is determined by the social efficiency of
the economy
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Table 1
GDP per capita in some Southeast Asian countries

(USD)
1997 2017 Growth
Vietnam 347 2.343 6,8
Indonesia 1.064 3.847 3,6
Thailand 2.468 6.594 2,7
Singapore 26.387 57.714 2,2
(Source: WB)
Redistribution
• More
Vertical resources,
higher taxes
Equity
• Similar
Horizontal individuals,
same tax
16
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Tools used by government to intervene in the economy
How Might the Government Intervene?
Tax or Subsidize Private Sale or Purchase
One way that the government can try to address failures in the private
market is to use the price mechanism, whereby government policy is
used to change the price of a good in one of two ways:
1. Through taxes, which raise the price for private sales or
purchases of goods that are overproduced,
or
2. Through subsidies, which lower the price for private sales or
purchases of goods that are underproduced.
A tax levied on producers or a tax levied on consumer
P P
S`
$14 $14
S S
$12 T=$4 $12
$10 T=$4 $10 T=$4
$8 $8
T=$4
$6 D $6 D
D`
90 100 110 Q 90 100 110 Q
…produces the same effect.

A decrease in quantity.
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A subsidy given to producers or a subsidy given to consumers
P P
$14 S $14
S
$12 $12
S=$4
S=$4 S`
$10 $10 S=$4 D`
$8 $8
S=$4
$6 D $6 D
90 100 110 Q 90 100 110 Q
…produces the same effect:

an increase in quantity
Exercise
• Suppose there is a demand and supply function of

agricultural product A as follows: QD = - 3P + 570, QS =
P –30
• Problems:
• 1. Determine the equilibrium quantity, price and total
revenue of the farmer
• 2. Suppose the government subsidizes 48 per unit of
product, what are the equilibrium quantity, price that the
seller receives and the price consumers pay?
• 3. How much does the government subsidize?
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Tools used by government to intervene in the economy
How Might the Government Intervene?
Restrict or Mandate Private Sale or Purchase

The government can directly restrict private sale or purchase of goods
that are overproduced, or mandate private purchase of goods that are
underproduced and force individuals to buy that good.
Public Provision
The government can provide the good directly, in order to potentially

attain the level of consumption that maximizes social welfare.
Public Financing of Private Provision

Governments may want to influence the level of consumption but may
not want to directly involve themselves in the provision of a good.
The impact of government interventions
What Are the Effects of Alternative Interventions?
Direct Effects
direct effects The effects of

government interventions that
would be predicted if individuals
did not change their behavior in
response to the interventions.
Indirect Effects
indirect effects The effects of

government interventions that
arise only because individuals
change their behavior in
response to the interventions.
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Choice of policy
Why Do Governments Do What They Do?
political economy The theory

of how the political process
produces decisions that affect
individuals and the economy.
Why Study Public Finance? Facts on Governments
The Size and Growth of Government
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Why Study Public Finance? Facts on Government
The Size and Growth of Government
Decentralization
A key feature of governments is the degree of centralization across local

and national government units—that is, the extent to which spending is
concentrated at higher (federal) levels or lower (state and local) levels.
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Spending, Taxes, Deficits, and Debts
Biểu đồ nợ công và nợ công/GDP Việt Nam giai đoạn 2003-2014

( Nguồn: EIU)
Việt Nam
Public Finance and Public Policy Jonathan Gruber Third Edition Copyright © 201028Worth Publishers
3/9/2021 28 of 24
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Spending, Taxes,
Deficits, and Debts
Federal Revenues and
Expenditures, Surplus or
Deficit, and Debt, 1930–2008 •
For most of the twentieth century,
except for the World War II
period, federal government tax
receipts have kept pace with
expenditures. But expenditures
have exceeded receipts by
several percentage points of
GDP on average since the
1970s. The resulting federal
government debt is now at about
40% of GDP.
Source: Office of Management and Budget

(2008), Tables 1.2 and 7.1. (Debt figures for
1930–1939 come from the U.S. Department of
the Treasury’s Bureau of the Public Debt.)
Spending, Taxes, Deficits, and Debts
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Distribution of Spending
public goods Goods for

which the investment of any
one individual benefits
everyone in a larger group.
social insurance programs

Government provision of
insurance against adverse
events to address failures in
the private insurance market.
Review
• The goal of public finance is to (understand or

strengthen) the role of government in the economy
• What government intervention can be used to reduce
prices of underproduced goods?
• The government has adopted many accountability
measures to reward schools if their students’ scores are
high on standardized tests. Suppose the school
responds by manipulating the test participants to
increase the average score. This result is an example of
a(n):
16

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01/01/2021

Public Finance and Public Policy Jonathan

The role of public finance in the economy

1. The role of public finance in the economy

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

public finance The study of the role of

four questions of public finance

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

When Should the Government Intervene in the Economy?

market failure Problem that

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

When Should the Government Intervene in the Economy?

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

• Here we briefly explore a failure in the health insurance

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

Problems for the Free Market

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

Problems for the Free Market

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

Taxes, Subsidies, Regulations, and Inefficiency

Deadweight loss • An inefficiency which causes a

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

Taxes, Subsidies, Regulations, and Inefficiency

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

Problems for the Free Market

Public Goods: Chapter 4

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

The role of public finance in the economy

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

The role of public finance in the economy

When Should the Government Intervene in the Economy?

redistribution The shifting

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

GDP per capita (USD)

(Source: World Bank)

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

GDP per capita in some Southeast Asian countries

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

Tools used by government to intervene in the economy

How Might the Government Intervene?

Tax or Subsidize Private Sale or Purchase

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

Taxes, Subsidies, Regulations, and Inefficiency

A tax levied on producers or a tax levied on consumer

$10 T=$4 $10 T=$4

…produces the same effect.

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

Taxes, Subsidies, Regulations, and Inefficiency

A subsidy given to producers or a subsidy given to consumers

90 100 110 Q 90 100 110 Q

…produces the same effect:

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

• Suppose there is a demand and supply function of

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

Tools used by government to intervene in the economy

How Might the Government Intervene?

Restrict or Mandate Private Sale or Purchase

The government can provide the good directly, in order to potentially

Public Financing of Private Provision

CHAPTER 1 ■ WHY STUDY PUBLIC ECONOMICS?

The impact of government interventions

What Are the Effects of Alternative Interventions?