EC302 Microeconomic Analysis Week 3 Lecture 1 PDF

EC302 Microeconomic Analysis Week 3 - Lecture 1 Overview  Foundations of Public Economics  General Functions of Government  Economic Functions of Government  Public Policy and Principles of Economic Analysis  Positive and Normative Economics 2 Defi...

EC302 Microeconomic Analysis Week 3 - Lecture 1 Overview  Foundations of Public Economics  General Functions of Government  Economic Functions of Government  Public Policy and Principles of Economic Analysis  Positive and Normative Economics 2 Defining the Field of Study  Public Economics: concerned with maximizing public welfare. Benefit of all.  Also called Welfare Economics.  Incorporates the role of the government to maximize public welfare as its objective.  Role of the government is concerned with making decisions to achieve this objective. 3 Introduction to Issues  The defining attribute of government is power  The mixed economy  When and how should government intervene in the economy?  Examples of topical public policy questions  Fundamental questions: what are objectives and roles of government? 4 General Functions of Government  Views on general functions of government depend critically on: 1) How people regard the relationship between the individual and the state and 2) How people view the relative effectiveness of markets and government. General Functions of Government  Historically two main views of the nature of the state/government:  Organic view - whereby the goals of the society are set by the government/state itself. Hence the state has value in itself.  Mechanistic view - whereby goals are set by the society and state is a means of promoting those goals. 6 Alternate views of the role of the government  Mechanistic view is further divided into four views:  Libertarians - strongly support private property and consider markets to be efficient. They advocate limited government control over private exchanges.  Socialists - advocate a command and control economy. They see distribution of rewards in market systems highly unequal therefore government should provide full equity. 7 Alternate views of the role of the government  Conservatives - like Libertarians, question the role of the government and favor market system for distribution. - However they believe that the government can do some things more effectively than the private sector.  Social Democrats - accept that markets are productive but fail to allocate resources efficiently with unequal distribution. The emphasis is on redistribution for which government role is emphasized. 8 Summary of views of the role of government 9 Economic Functions of Government  Generally establish institutions and ground rules that allow markets to work.  Set laws to define and protect property rights.  Overcome three weaknesses of markets. a) Market failure: main forms are public goods; externalities; imperfect competition and information failures. b) Uneven income redistribution. c) Macroeconomic instability  These establish potential roles for government. 10 Three Potential Government functions  Three potential economic roles for the government to overcome market weaknesses. 1. Allocative function 2. Redistributive function 3. Stabilisation function 11 Three Potential Government functions 1. Allocative function - Requires govt to provide public goods, regulate externalities, promote competitive markets and protect individuals from information failures. 2. Redistributive function - Requires govt to alleviate poverty and reduce income inequality. 3. Stabilisation function - management of aggregate demand to achieve price stability and high levels of employment and reduce fluctuations in output. 12 Three Potential Government functions  However, the extend to which govt should carry out any economic role depends not only the weakness of the markets but also on govt’s ability to deliver improved outcomes.  The three economic functions show increasing role of the government in the economy.  On the other hand, globalization appears to reduce the capacity of the governments to control their economies. 13 Public Policy and Principles of Economic Analysis Four public policy questions must nearly always be answered 1. What are the objectives? 2. What are the options? 3. What are the implications of each option? 4. Which is the preferred option? 14 Seven economic principles and the public sector 1. Scarcity, choice and opportunity costs apply to economy and the public sector 2. Trade is the basic means of extracting gains from markets 3. Incentives matter (explain behaviour) in the public sector as in the private 4. Price theory and the core concepts of demand and supply apply even when there are no prices. 15 Seven economic principles (cont.) 5. Principles of efficient production opportunity cost, division of labour apply to public production as to private 6. Markets are powerful forces of demand and supply: Governments should generally work with markets 7. Aim to maximise social welfare subject to constraints. This implies that social marginal benefit should equal social marginal cost  The principles of economics apply equally to actions of government as to the private sector 16 Positive and Normative Economics  One goal of Public Economics is to estimate how government policy affects individuals’ behavior.  The decisions can be based on Positive analysis or Normative analysis. 17 Summary  Key attribute of government is power  Government includes all services financed through the budget. The public sector includes PTEs.  Dominant (Western) view of state is mechanistic and individualistic  Fundamental economic role of government is to establish institutions and rules so markets work  Other key functions are:  Allocating resources when there are markets failures  Provision of an acceptable income distribution,  Macroeconomic management. 18 Summary  Economic analysis includes normative and positive economics.  Governments may act to change the outcomes of market and so raise social welfare.  However, basic principles of economics apply to actions of government as to actions of the private sector.  Principles of demand and supply and role of markets are essential to understanding and assessing consequences of public policies. 19