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Market failure and public choice

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Slide 1: 

CHAPTER 18Market Failure and Public Choice

Learning Objectives : 

Learning Objectives Explain how the economic role for government arises from market failure and inequality Distinguish between public goods and private goods and explain the free-rider problem Explain how the quantity of public goods is determined

Learning Objectives (cont.) : 

Learning Objectives (cont.) Explain why most of the government's revenue comes from income taxes and why income taxes are progressive Explain why some goods are taxed at a much higher rate than others

Learning Objectives : 

Learning Objectives Explain how the economic role for government arises from market failure and inequality Distinguish between public goods and private goods and explain the free-rider problem Explain how the quantity of public goods is determined

The Economic Theoryof Government : 

The Economic Theoryof Government Four Economic Problems Governments Help People Cope with Public goods Monopoly Externalities Economic inequality

The Economic Theoryof Government : 

The Economic Theoryof Government Public Goods Public goods are goods that are consumed either by everyone or by no one Free-rider problem Monopoly Prevent the allocation of resources from being efficient

The Economic Theoryof Government : 

The Economic Theoryof Government Externalities Externalities are a cost or benefit that arises from an economic transaction and that falls on people who do not participate in that transaction. Pollution Flower beds Market failure results an inefficient use of resources

The Economic Theoryof Government : 

The Economic Theoryof Government Economic Inequality Unfair distribution of income

Public Choice and the Political Marketplace : 

Public Choice and the Political Marketplace Public Choice Theory The Political Marketplace is made up of: Voters The consumers Politicians The Entrepreneurs Bureaucrats The hired officials

The Political Marketplace : 

The Political Marketplace

Political Equilibrium : 

Political Equilibrium Political Equilibrium is the outcome that results from the choices of voters, politicians, and bureaucrats.

Learning Objectives : 

Learning Objectives Explain how the economic role for government arises from market failure and inequality Distinguish between public goods and private goods and explain the free-rider problem Explain how the quantity of public goods is determined

Public Goods and the Free-Rider Problem : 

Public Goods and the Free-Rider Problem Features of Public Goods 1) Nonrivalry The consumption by one person does not decrease the consumption by another 2) Nonexcludable It is impossible, or extremely costly, to prevent someone from benefiting from a good

Public Goods and Private Goods : 

Public Goods and Private Goods Pure private goods Food Car House

Public Goods and the Free-Rider Problem : 

Public Goods and the Free-Rider Problem The Free Rider Problem A free rider is a person who consumes a good without paying for it. Quantity is not influenced by price

Benefits of a Public Good : 

Benefits of a Public Good Quantity (number of satellites) Marginal benefit (dollars per satellite) Quantity (number of satellites) Marginal benefit (dollars per satellite) 0 1 2 3 4 20 40 60 80 Lisa's Marginal Benefit 0 1 2 3 4 20 40 60 80 MBM Max's Marginal Benefit 5 5

Slide 17: 

20 40 60 80 100 120 Quantity (number of satellites) Marginal benefit (dollars per satellite) Benefits of a Public Good 0 1 2 3 4 5 140 Economy's Marginal Benefit

Learning Objectives : 

Learning Objectives Explain how the economic role for government arises from market failure and inequality Distinguish between public goods and private goods and explain the free-rider problem Explain how the quantity of public goods is determined

The Efficient Quantity of a Public Good : 

The Efficient Quantity of a Public Good Consider Cost and Benefit Maximize Net Benefit Total Benefit minus Total Cost Marginal Benefit equals Marginal Cost

The Efficient Quantity of a Public Good : 

The Efficient Quantity of a Public Good Private Provision No one would have an incentive to buy Free-riders Public Provision Politicians must consider the political ramifications of their decisions Maximize the perceived net benefit of the voters

The Efficient Quantity of a Public Good : 

The Efficient Quantity of a Public Good Quantity Total Benefit Marginal Benefit Total Cost Marginal Cost Net Benefit (number of (billions (billions of (billions (billions of dollars (billions satellites) of dollars) per satellite) of dollars) per satellite) of dollars) 0 0 1 20 2 35 3 45 4 50 5 50

The Efficient Quantity of a Public Good : 

The Efficient Quantity of a Public Good Quantity Total Benefit Marginal Benefit Total Cost Marginal Cost Net Benefit (number of (billions (billions of (billions (billions of dollars (billions satellites) of dollars) per satellite) of dollars) per satellite) of dollars) 0 0 1 20 2 35 3 45 4 50 5 50 20 15 10 5 0

The Efficient Quantity of a Public Good : 

The Efficient Quantity of a Public Good Quantity Total Benefit Marginal Benefit Total Cost Marginal Cost Net Benefit (number of (billions (billions of (billions (billions of dollars (billions satellites) of dollars) per satellite) of dollars) per satellite) of dollars) 0 0 0 1 20 5 2 35 15 3 45 30 4 50 50 5 50 75 20 15 10 5 0

The Efficient Quantity of a Public Good : 

The Efficient Quantity of a Public Good Quantity Total Benefit Marginal Benefit Total Cost Marginal Cost Net Benefit (number of (billions (billions of (billions (billions of dollars (billions satellites) of dollars) per satellite) of dollars) per satellite) of dollars) 0 0 0 1 20 5 2 35 15 3 45 30 4 50 50 5 50 75 20 5 15 10 10 15 5 20 0 25

The Efficient Quantity of a Public Good : 

The Efficient Quantity of a Public Good Quantity Total Benefit Marginal Benefit Total Cost Marginal Cost Net Benefit (number of (billions (billions of (billions (billions of dollars (billions satellites) of dollars) per satellite) of dollars) per satellite) of dollars) 0 0 0 0 1 20 5 15 2 35 15 20 3 45 30 15 4 50 50 0 5 50 75 –25 20 5 15 10 10 15 5 20 0 25

The Efficient Quantity of a Public Good : 

Quantity (number of satellites) Total benefit and total cost (billions of dollars) Quantity (number of satellites) Marginal benefit (billions of dollars per satellite) 0 1 2 3 4 15 35 50 75 0 1 2 3 4 10 20 5 5 The Efficient Quantity of a Public Good M Total Benefit & Total Cost Marginal Benefit & Marginal Cost TB

Public Goods and the Free-Rider Problem : 

Public Goods and the Free-Rider Problem The Principle of Minimum Differentiation The tendency for competitors to make themselves identical to appeal to the maximum number of clients or voters

Public Goods and the Free-Rider Problem : 

Public Goods and the Free-Rider Problem The Role of Bureaucrats Bureaucrats translate the choices of the politicians into programs and control the day-to-day activities that deliver public goods.

Slide 29: 

Bureaucratic Overprovision Quantity (number of satellites) Marginal benefit (billions of dollars per satellite) 0 1 2 3 4 15 35 50 75 5 TB

Public Goods and the Free-Rider Problem : 

Public Goods and the Free-Rider Problem Rational Ignorance The decision not to acquire information because the cost of doing so exceeds the expected benefit. Voters usually are ignorant about an issue unless that issue perceptively effects the voter’s income.

Public Goods and the Free-Rider Problem : 

Public Goods and the Free-Rider Problem Two Types of Political Equilibrium 1) Public Interest Theory Predicts governments make choices that achieve efficiency. Fully informed voters 2) Public Choice Theory Predicts that governments make choices that result in inefficiency.

Public Goods and the Free-Rider Problem : 

Public Goods and the Free-Rider Problem Why Government is Large and Grows Voter Preferences Income elastic demand for public goods Inefficient Overprovision

Learning Objectives : 

Learning Objectives Explain why most of the government's revenue comes from income taxes and why income taxes are progressive Explain why some goods are taxed at a much higher rate than others

Public Goods and the Free-Rider Problem : 

Public Goods and the Free-Rider Problem Voters Strike Back Vote for policies they favor Privatize production of public goods

Taxes : 

Taxes Five Types of Taxes Income taxes Social Security taxes Sales taxes Property taxes Excise taxes

Government Tax Revenues : 

Government Tax Revenues Tax revenue (billions of dollars) Income taxes Social Security taxes Sales taxes Excise taxes Property taxes Percent of total taxes 0 10 20 30 40 50

Taxes : 

Taxes Personal Income Tax Tax depends on: Taxable income Equals total income minus personal exemptions and other deductions

Taxes : 

Taxes Tax Rates for a Single Person $0 to $24,000 15 percent $24,000 to $58,150 28 percent $58,150 to $121,300 31 percent $121,300 to $263,750 36 percent Over $263,750 39.6 percent

Taxes : 

Taxes Marginal Tax Rate Percentage of an additional dollar paid in tax Average Tax Rate Percentage of income paid in tax

Taxes : 

Taxes Progressive Tax Average tax rate increases as income increases Regressive Tax Average tax rate decreases as income increases Proportional Tax Average tax rate does not change as income increases

Taxes : 

Taxes The Effect of Income Taxes Raise revenue Influence markets for productive resources

Slide 42: 

0 Labor (hours per week) Wage rate (dollars per hour) 8.50 10.00 The Effects of Income Taxes 30 40 50 36 9.50 LS LD Lowest income tax rate

Slide 43: 

Labor (hours per week) Wage rate (dollars per hour) 121 200 The Effects of Income Taxes 30 40 50 32 175 LS LD Highest income tax rate 0

Taxes : 

Taxes Why Do We Have a Progressive Income Tax? Voter majority Median voter model

Taxes : 

Taxes Corporate Profits Tax Taxing corporations is inefficient median voter Tax is mainly a tax on income from capital Supply of capital is highly elastic Tax is fully borne by firms and quantity of capital decreases Labor productivity and incomes are reduced

Taxes : 

Taxes Social Security Taxes Contributions paid by employers and employees Social security, unemployment compensation, health, and disability benefits. Who pays the tax depends upon elasticities of demand and supply for labor.

Slide 47: 

QL0 LS + tax Labor (hours per week) Wage rate (dollars per hour) Social Security Taxes W* LD WT WC Tax on employees QL* LS

Slide 48: 

Labor (hours per week) Wage rate (dollars per hour) Social Security Taxes W* LS LD Tax on employers QL* QL0 WT WC

Sales and Property Taxes : 

Sales and Property Taxes Sales Taxes Taxes levied by state governments Regressive tax Property Taxes Collected by local governments used to provide local public goods Local public goods are public goods that are consumed by all the people who live in a particular area (ex. parks, museums)

Excise Taxes : 

Excise Taxes Excise Taxes A tax on the sale of a particular commodity Effect can be dramatic Depends upon elasticity of demand

An Excise Tax : 

S + tax An Excise Tax Quantity (millions of gallons per day) Price (cents per gallon) 0 200 300 400 500 100 S D Deadweight loss from tax equals... 50 60 110

Learning Objectives : 

Learning Objectives Explain why most of the government's revenue comes from income taxes and why income taxes are progressive Explain why some goods are taxed at a much higher rate than others

Excise Taxes : 

Excise Taxes Excise Taxes What would happen if the government did away with the gasoline tax and taxed orange juice instead?

Why We Don’t Tax Orange Juice : 

Why We Don’t Tax Orange Juice Quantity (millions of gallons per day) Price (cents per gallon) 60 0 200 300 400 500 100 S D 130 40

The End : 

The End

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