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• Public economics is the study of economic rationale for state intervention regarding efficiency and equity.

Last Week's Topics

• Pareto efficiency with its three aspects were covered
• How to prove Pareto efficiency if it occurs was discussed
• Fundamental theorems of welfare economics were examined

This Week's Agenda

• Reasons why governments intervene and methods of intervention
• Discussion of equity
• Analysis of public goods

Government Intervention

• Government intervention addresses market failure for efficiency reasons
• Factors include imperfect competition, public goods, and externalities
• There are increasing returns to scale, imperfect information, and non-rational behavior
• Also incomplete markets

No Need for Government Intervention

• Government intervention is unnecessary when perfect competition, perfect information, rational behavior, and complete markets exist; Efficiency grounds
• Also when there are no concerns about the distribution of resources, or they can be addressed by lump sum taxation; Equity grounds

Perfect Competition

• Price takers exist with a large number of individuals and firms without entry barriers
• Interventions such as price subsidy or regulation may be used (e.g., maximum price)
• Equal power means different incomes are allowed and discrimination is not permitted
• Safety legislation in factories is an example of intervention with regulation

Public Goods and Externalities

• Markets will fail to provide public goods due to non-rivalness, non-excludability, and non-rejectability, therefore, intervention by public provision may be needed.
• Externalities occur when the act of individual A imposes a cost or benefit to individual B
• Market clearing output exceeds efficient output when there is an external cost, and vice versa for external benefit.
• Regulation or a Pigovian tax/subsidy (e.g., factory polluting a river) are types of intervention

Increasing Returns to Scale

• Average cost exceeds marginal cost at all levels of output.
• Long run losses lead to competitive firms leaving the industry, resulting in a monopoly or no industry
• Subsidy, public production, or both can be used to intervene
• Small companies stand no chance of competing with large firms resulting in a monopoly

Imperfect Information

• Agents may have imperfect knowledge of quality of goods, prices, and the future.
• Examples of intervention;
  • Regulation (e.g., hygiene laws for food) sets a minimum standard
  • When information is deficient and/or complex market, solutions may be less efficient through public production/allocation (e.g., health care)
  • Regulation to publish price lists is intervention for price

Intertemporal Utility Maximization

• Intertemporal utility maximization requires perfect information about the future
• Market solution is to offer insurance, but information failures may render private markets inefficient.
• Intervention may include public finance (e.g., insurance against unemployment)

Non-Rational Behavior

• Agents have the capacity to formulate utility maximizing plans and action.
• Bounded rationality means people can form utility maximizing plans but it is too hard to calculate.
• Regulation can be used to simplify choices
• Bounded willpower involves knowing the best interest but not acting on it (e.g., losing weight)
• There is intervention through commitment/auto-enrolment (e.g., organ donation requires opting out)

Incomplete Markets

• Capital markets may fail to provide loans (e.g., student loans from government)
• Incomplete contracts mean neither individuals nor the government can monitor quality effectively (e.g., healthcare).
• Intervention should be public production.

Government Intervention for Equity

• Vertical equity redistributes income or consumption from rich to poor, through cash or in-kind methods like education for consumer preferences who don't want it
• Horizontal equity is equal treatment/minimum standards, equal access, and equality of opportunity

Vertical Equity

• In-kind redistribution means overriding consumer sovereignty/preferences for efficiency reasons
• When information is poor and agent decisions will be better (merit goods)

Horizontal Equity

• Minimum standards are a form of regulation for food hygiene, building codes, and safety at work
• Equal access gives know-how (e.g., legal rights, value of education, social capital)
• Intervention may involve legislation against discrimination, subsidies or public production (free compulsory education)
• The commodity is not easily tradeable or fungible.

Types of Intervention

• Regulation includes quality and quantity of supply as well as price constraints
• Finance includes subsidies and taxes for redistribution
• Examples of public production: education and healthcare

Equity

• Alex has 10 oranges, Bobby has 2 oranges
• Inequity is when 4 oranges are transferred from Alex to Bobby, but one gets lost, now Alex has 6 and Bobby 5
• This trades off equity and efficiency regarding administration costs and distortions

Analysing Social Choices

• The relationship between the number of oranges and Alex's level of utility determines trade off
• Marginal utility is the extra utility Alex gets from an extra orange

As One Consumes More Goods

• The utility that one has decreases, with the more one consumes of it. Point A to Point B.

Marginal Utility

• A small decrease in others' utilities and vice versa. Point A to B will yield a decreasing marginal utility

Evaluating Trade-Offs

• Social welfare function is the level of social welfare corresponding to a particular set of utility levels attained by members of society.
• Social indifference curves combine the utility of members to give = levels of welfare
• The Allocation of resources ranks them through the social welfare function.

Utilitarian Social Welfare Function

• The society's goal is to maximize the sum of individual utilities, everyone is given equal weight, which values redistribution of wealth as the manginal cost decreases

Utilitarian Social Indifference Curve

• Society trades one uit of Alex's utility against 1 Unit of bobby's, regardless if Alax had less income, a larger increase of orance/money will have a larger value to Alex

Rawlsian Social Welfare Function

• A society should maximise the worst-off member, extracting as much as possible to reaslise that
• Better to improve that individual's welfare, gains nothing from improving another individual's welfare

Rawisian Social Indifference Curve

• Any utility increase the lowest welfare individual increases with no limit

Two Caveats to Social Welfare

• Utility has Money + utility variance unlike social welfare which relies on numerical utility
• An individuals preference for wealth isnt always matched by a social welfare allocation

Social Choice in Practice

• Net benefits can measure governments of different segments of society
• Pareo Improvement = project should be undertaken regardless

Measuring benifits

• Willingness to pay - an individuals willingness to pay has nothing to do with how much they have at that moment, and that can change values

Ordinary vs Compensated Outcomes

• Ordinary demand curve to know how many units the individual would buy at each price
• There 2 outcomes as prices fall - subsitution of substitute good and surplus money
• compensated = ordinary - income effect, if level of utility is the same

Consimer Surplus

• Difference between what an individual has to pay and total
• Consumer surplus: difference between what an individual is willing to pay and what they have to pay
• Negligble change between ordinary and compensated curves

Tax Example

• Asking each individual the value they put on a tax eliminated from that
• Lump sum will have to be charged but leaces individuals unaffected

Example of DeadWeight Loss

• Deathweight is the measure of unpayed tax payment from revenue lost, this has a lower affect then the initial tax

Calculation Example

Approaches to Socail choice

• Compensation principle: must be larger then overal costs
• Trade off across measures that target key impacts
• Weight net benfits on groups for social influence overal

Quantifying Distrubutional effects

• Often complex than quantifying efficiency effects.
• Poverty index: measure of share of population whose income is below a critical, 60% of Median
• Poverty gap: how much income would we need to give to the poor to bring them up to this threshold?

Poverty Index

Measuring Welfare

Measuring Poverty In practice

• Measured through monetary means, job satisfaction and job status
• Individuals per family are a factor here

Poverty

• Relative means what the general standard is

Measuring Ineqaulity of Individuals

• Factors include work rates, endowments that they inherent and skills that set opportunity

Measuring Aggregate

• Measured through indivual and family
• The factors are wealth and income
• Estimated by group dispersion

Social Justice and Social theories

• A social justice theory has 3 components

1. Distrubuted resources
2. Theory of society
3. Social structure (Libertarian, liberal and collectivist)

3 social structures

Libertarian

• State interverntion must be reduced and will reduce wealth while prizing freedom

Liberal

• Distribute goods so to maximise the total utility of the members of society and redistribute when able, focused around members

Collectivist

• See's society in a production factor and limited pricate property to aid people in individual needs