Public Goods and Market Failures: Understanding the Role of the Public Sector in Economics, Apuntes de Administración de Empresas

¡Descarga Public Goods and Market Failures: Understanding the Role of the Public Sector in Economics y más Apuntes en PDF de Administración de Empresas solo en Docsity! Topic I: Economics and the Public Sector Business Administration and Management Fall 2015-2016 Departament d’Economia Pública, Economia Política i Economia Espanyola Bibliography 2 Rosen and Gayer: • Chapter 1 • Chapter 4 • Chapter 5 • The Soviet Union contains some of the most fertile agricultural land in the world. • Prior to the communist revolution of 1917 Russia was the world’s largest exporter of grain. Collectivization of agriculture during the 1920s and 1930s was quickly followed by dramatic declines in agricultural output. Between five and ten million Russians died of starvation during these years with twelve to thirteen million more saved by food donated from the Western capitalist countries.  Incentives matter! Introduction: What if the State bans private property What is Public Economics or Public Finance? Part of economics that studies the intervention of the public sector in a market economy, mainly through financial activity (i.e. public revenues and expenses). • Public Economics: Economic decisions of the public sector and/or the reaction of private agents to the public sector • Public Finance: Decisions directly related to public revenues and expenditures. Public Economics Economics Introduction: The Public Sector (Public) Economics € Policy Which Protessions Capture the Attention of Congress? The Congressional Record provides a verbatim account of the debates, proceedings and activities of the United States Congress. Economists get cited most often. Total number of mentions in the Congressional Record, 1989-present. Economist Historian Psychologist Sociologist Anthropologist 3 Demographer O ¡a l=t=1 0 Universitat de Barcelona Tnomas searen engine, 10 Twofold approach: 1. What are the measureable effects of government programs and interventions? (positive analysis) 2. What should the government do if we can choose optimal policy? (normative analysis) Closely related: Political Economy • Why do governments behave the as they do? (e.g. climate change) Introduction: The Public Sector When we do NOT need a public sector… First Welfare Theorem Private markets provide a Pareto efficient outcome under the following conditions: • Private good • No externalities • Perfect competition 1) All firms sell an identical product 2) All firms are price takers 3) All firms have a relatively small market share 4) Buyers have complete information about the product being sold and the prices charged by each firm 5) The industry is characterized by freedom of entry and exit. Functions of the Public Sector • If Q<Q*, the marginal revenue exceeds the marginal cost (under-provision) • If Q>Q*, the marginal cost exceed the marginal revenue (over-provision) p* Aggregate Supply (Marginal Cost) P Q* Aggregate demand (Marginal Revenue) Q Functions of the Public Sector How it should be The market maximizes the consumer’s and producer’s surpluses Functions of the Public Sector How it should be – Private goods A simple example: Fig Leaves (f) Source: Rosen and Gayer (Chapter 4) Functions of the Public Sector How it should be – Private goods: e.g. Fig Leaves  price=marginal cost: efficient provision Source: Rosen and Gayer (Chapter 4) Characteristics of public goods (e.g. national defense): 1. Non-rival consumption: The consumption of a good by an individual doesn’t ↓ the available q for the rest of individuals. The mg cost of a new individual that starts consuming is equal to 0. • a good cannot be taken “off the shelf” because individuals enjoy the same. 2. Non-excludable consumption: It is not possible to prevent the consumption of a good by someone who is not paying for it. • everybody can enjoy the public good. The aggregate demand for public goods is derived by summing individual demand vertical: We sum public goods vertically, because consumers can consume the same units. Functions of the Public Sector Market Failures: Public Goods Why are public goods a market failure? • Inefficient market provision - unlike price, quantity is not an effective market mechanism: For a given quantity, individuals will not automatically self-select their optimal price, but will instead wish to pay the lowest price possible when they cannot be excluded from consuming the good.  If the consumption of a good is non-excludable, the market will not provide it.  the free rider problem occurs when those who benefit from resources, goods, or services do not pay for them, which results in an under-provision of those goods or services. Functions of the Public Sector Market Failures: Public Goods Public Sector Interventions: public provision Functions of the Public Sector Market Failures rival excludable yes no yes private good natural monopoly (e.g. cable tv) no common resource (Fishing grounds) public good (national defense) Public goods ≠ goods provided by the public sector • Public sector might or might not provide public goods Goods Classification: If the consumption of a good is non-rival but excludable, there may be private provision, but it will be sub-optimum Functions of the Public Sector Market Failures: Non-rival and Excludable Goods Public Sector Interventions: public provision? Example: Natural Monopoly Monopoly 26 MR D Pr Q AC MC Qm Pm Monopoly profits: Not efficient! In perfect competition: Pr=MC In Monopoly: Pr>MC Monopoly 27 MR D Pr Q AC MC Qm Pm Q* P* Monopoly 28 MR D Pr Q AC MC Qm Pm Q* P* Loss for the monopolist: he is in deficit Qm=Sub-optimal demand for the good MC (S) Ext MR social=D+ext Qm Q* € e.g. Vaccines (positive) Functions of the Public Sector Market Failures: Externalities PS Intervention : Increase the consumption of the good (subsidize vaccine) Marginal Benefit (MB) e.g. contamination of a river (negative) Qm=Over-provision of the good MC private (S) Ext MC social=S+ext Qm Q* € Functions of the Public Sector Market Failures: Externalities PS Intervention: Decrease the production of the good (tax on the dumping of waste, regulation,…) Marginal Benefit (MB) • Lisa fishes in the river • Bart owns a firm polluting a river: Bart creates a negative externality  Externalities are due to inability to establish property rights: why? • If Lisa owned the river, she could tax Bart for polluting, in turn Bart will reduce his level of pollution to save money • If Bart owned the river, he could tax Lisa for fishing, in turn Bart will reduce his level of pollution otherwise Lisa would stop fishing Functions of the Public Sector Market Failures: Externalities Functions of the Public Sector Market Failures: Externalities • Empirical issues: • Which pollutions do harm? • What activities produce pollution? • What is the value of the damage done? • E.g. effect on houses’ prices • IF the costs of bargaining are low • And IF the owners can identify the source of damages and legally prevent them  An efficient solution will be achieved simply by assigning property rights without any State intervention (known as Coase Theorem) • e.g. Animal hunting Functions of the Public Sector Market Failures: Externalities Animal hunting: Elephant populations in Africa • Kenya’s approach in 1977: ban hunting  Drop in elephants from 167.000 to 16.000 by 1989 • Zimbabwe in 1982: individuals owning lands get property rights to wild animals  Increase in elephants from 40.000 to 68.000 by 1995 In Kenya the cost of an elephant killed was 0 for the landowner; In Zimbabwe the landowner had an incentive (tourists’ safari) to protect the animals. Marginal Damage (MD) Marginal Benefit (MB) private MC + MD = Marginal Social Cost Qm Q* € Functions of the Public Sector Market Failures: Externalities private MC • Pigouvian Tax: a tax on each unit of output in an amount equals to the marginal damage at the efficient output c d private MC + cd E.g. medical insurance • Lisa is a very healthy girl, she is willing to pay up to 1000euro per year for a medical insurance • Marge is a ordinary middle age woman, she is willing to pay up to 5000euro per year for a medical insurance • Homer is troublesome guy, he is willing to pay up to 7000euro per year • Mr Burns is a very old sicky guy, he is willing to pay up to 10000euro per year for a medical insurance The insurance know the average health costs, he cannot perfectly distinguish among sick and healthy people: (1000+5000+7000+10000)/4=5750  Only Homer and Mr Burns will buy the insurance for an average cost of (10000+7000)/2=8500  The insurance company will lose: (2*8500)-(2*5750)=-5500 Functions of the Public Sector Market Failures: Incomplete markets and information asymmetries 2. Moral Hazard: the insurance modifies the behavior of individuals, reducing the effort on preventing the risk from realizing. If individuals can affect the probability of the risk (losing a job), no one will provide insurance for it (unemployment insurance) Functions of the Public Sector Market Failures: Incomplete markets and information asymmetries Public Sector Intervention: Public provision: e.g., public unemployment insurance Objective: Stabilizing the economics fluctuations by fiscal policy:  Expansive during recessions: Increase the disposable income (increase expenditure and/or decrease taxes)  Restrictive during expansions: Decrease the disposable income (decrease expenditure and/or increase taxes) Automatic stabilizers: government budget policies, particularly income taxes and welfare spending, automatically act to dampen fluctuations in real GDP  during recessions: unemployment benefits automatically increase  during expansions: income and corporate tax revenues increase Functions of the Public Sector Stabilization Economic Inequality DEFINITION: Inequality studies focus on the unequal distribution of resources among agents (e.g. individuals, countries) Source: World Bank (various 1994-2011) 26-11-214 46 • A curve showing the proportion of national income earned by a given percentage of the population. • E.g. what proportion of national income is earned by the top 10% of the population? Lorenz Curve 26-11-2014 47 Lorenz Curve % of National Income Percentage of Population This line represents the situation if income was distributed equally. The poorest 10% would earn 10% of national income, the poorest 30% would earn 30% of national income. 10% 10% 30% 30% 26-11-2014 48 The Great Gatsby Curve • The Great Gatsby Curve illustrates the connection between concentration of wealth in one generation and the ability of those in the next generation to move up the economic ladder compared to their parents (economic mobility) • Social Mobility important source of economic growth, innovation and political stability 26-11-2014 51 Left axis: intergenerational elasticity of income - how much a 1 percent rise in your father’s income affects your expected income -. 26-11-2014 52 Kuznets Curve • Before Industrialization: low inequality • First stages of Industrialization: inequality goes up • Only some social classes benefit (productivity gap, e.g. industry Vs agriculture) • Later Stages of Industrialization: wealth spreads to other social classes (e.g. rural areas) 26-11-2014 53 Inequality: Perceived Vs Real Source: Norton, M. I., & Ariely, D. (2011). Building a better America—One wealth quintile at a time. Perspectives on Psychological Science, 6(1), 9-12. 26-11-2014 56 Inequality: Perceived Vs Real Source: Norton, M. I., & Ariely, D. (2011). Building a better America—One wealth quintile at a time. Perspectives on Psychological Science, 6(1), 9-12. 26-11-2014 57 Inequality Over time English-speakIng countries (share of top 1 percent In Income distribution, percent) 30 United States Australla 25 — nited Kingdom > reland == Canada — Now Zealand 20 15 10 5 o MAA AE 1900 10 20 30 40 50 60 70 80 90 2000 Source: IMF 6 Universitat de Barcelona  Worldwide gaps Global inequality—between world citizens—is higher than inequality within even the most unequal individual countries. (Gini coefficient) 1970 1980 1990 2000 2010 Sources: For United States and Sweden, Luxembourg Income Survey database; for Brazil, Socio-Economic Database for Latin America and the Caribbean (SEDLAC); for the world, Milanovic (forthcoming). The 2008 world Gini is a preliminary estimate. Note: Gini based on disposable income. Source: IMF 6 Universitat de Barcelona A Global Perspective: Inequality Figure 4. Change in real income between 1988 and 2008 at various percentiles of global income distribution (calculated in 2005 international dollars) 90 80 70 60 40 30 Real increase 20 10 0 -10 50 + Percentile of global income distribution Main Points • Inequality mostly increased in the last decades at the country level • Inequality slightly decreased in the last decades at the global level • Global Inequality is higher than inequality across countries • Income increased mostly in some developing countries (e.g. China) and at the very top of the income distribution (i.e. top 1%) • Perceived inequality is lower than real and “ideal” inequality 26-11-2014 63 Causes of Inequality • Unions’ power declined: union membership declined and globalization reduced unions’ bargaining power • Change in social norms: we accept more inequality (e.g. compared to the past, we tolerate huge pay gaps) 26-11-2014 66 Capital in the 21st century • Piketty’s point: • In an economy where the rate of return to wealth (or capital) is higher than the rate of economic growth, inherited wealth will always grow faster than earned wealth 26-11-2014 67 Capital in the 21st century • 2 individuals, A and B • A does not work but he owns and he gets rents out of it = r • B does not own anything but he works and B’s wage depends upon economy growth rate = g • In economic terms, r = net-of-tax rate of return on capital; g = growth rate • If r>g A will become richer and richer compared to B… 26-11-2014 68 Economic Inequality • Definitions: Gini coefficient, Kuznets Curve, Great Gatsby Curve • Inequality Trends • Causes of Inequality • Effects of Inequality 26-11-2014 71 Consequences of Inequality • Inequality might decrease social mobility (Great Gatsby Curve) • Efficiency Vs Equity  good or bad for growth? • Effects on social outcomes • Political Rent Seeking 26-11-2014 72 Consequences of Inequality GOOD: • Providing incentives for innovation and entrepreneurship (Lazear and Rosen, 1981) • Raising saving and investment if rich people save a higher fraction of their income (Kaldor, 1957) 26-11-2014 73 Recent studies mostly argue that too high inequality can be disruptive for growth (e.g. IMF’s studies and Alesina and Rodrik, 1994) 26-11-2014 76 Consequences of Inequality Political Rent Seeking: The Price of Inequality (Stiglitz, 2012) • Those with power use it to insulate themselves from competitive forces by winning favourable tax treatment and government-protected market share • E.g. decreasing taxes on top income & corporations; electoral campaign contributions; think tanks • This might lead to the growth of populist movements… 26-11-2014 77 Consequences of Inequality Solution: more redistributive policies? They might have the reverse effect (decrease growth and additionally foster inequality)! E.g. of win-win policies • Taxes on activities with negative externalities paid mostly by the better-off (such as, perhaps, excessive risk-taking in the financial sector) • Cash transfers aimed at encouraging better attendance at primary schools in developing countries • Fight tax-avoidance 26-11-2014 78