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ECON 200
Peter Coughlin

Lecture Notes 11/7/13 Econ 200 Chapter 11: Public Goods and Common Resources Markets are USUALLY a good way to organize economic ex. Lighthouses  mark specific locations so that passing activity, and in some cases they are inefficient ships avoid wrecks  When inefficient, government intervention may  all benefits go to shippers (NOT rival in achieve efficiency and improve outcomes consumption- seeing lighthouse doesn’t interfere Important Characteristics of Goods w/ anyone else seeing/benefitting from it) 1. A good is a rival in consumption if one person’s use of  NOT excludable- b/c no one is prevented from it diminishes others’ use seeing it a. Tacos- when buy and consume, no one else can If a group of shippers wanted to put a lighthouse in a certain harbor, how would it get all of the shippers to consume them b. National Defense NOT rival in consumption: participate in its maintenance? What could they do about i. Is consumed equally by “hawks- people someone who refuses to pay? Is there any way they could using military” and “doves- libertarians-prevent that person from benefitting from the lighthouse? those willing to have national defense  There is an incentive for shippers to try to be able but object to scale of its importance/ to use lighthouse w/o paying funding”  Once a PURE PUBLIC good has been produced, 2. A good is excludable if a person can be prevented from any individual can get benefits from the good using it o Can also provide benefits to individuals a. Tacos- require payment before receiving tacos who didn’t pay anything for the good (controls who gets access) o b/c firms can’t prevent non- payers from b. National Defense NOT excludable consuming the good i. A newborn child in the US enjoys  free rider- person who receives benefit of a good but national defense w/o any additional cost avoids paying for it to gov (it would be virtually impossible  b/c of free rider problem: little or none of a public to exclude the newborn from benefits of good might be produced – even if the cost of defense) providing it is less than the value of the good to the Rival in consumption buyers (collectively) Excl Yes No o keeps businesses from being willing to uda Ye Private Goods Club Goods ble s provide the goods No Common Public Goods  private markets undersupply public goods, b/c the benefits aren’t completely valued by market (if at Resources all) Free Rider Problem occurs when:  the number of beneficiaries is large  exclusion of any one of them is impossible Private Goods- excludable + rival in consumption (ex. Tacos) Pure Public Goods- not rival and not excludable (public goods provided by gov  One person’s consumption of good doesn’t reduce amount available for others (not rival)  No one can be excluded from consuming a good, even if he/ she hasn’t paid for it (not excludable) o babies haven’t paid gov any fees but get benefits of national defense anyways Deciding whether something is a PUBLIC Good Public Goods  determine the potential beneficiaries  if benefit of a public good exceeds cost of providing  determine whether one potential beneficiary’s use of it there is a good argument for gov providing the good is rival in nature, and reduces ability of others good and paying for it with a tax on people who to use it benefit How can gov determine efficient level of a public good?  determine whether the beneficiaries can be Method used by Federal agencies excluded from using the good Pure Public Goods may be viewed as extreme cases of  Cost- Benefit Analysis- study that compares costs and benefits of providing a public good positive externalities o Problem: difficult ot measure the benefit  government has a role in supply these kinds of o Since cost benefit analyses are imprecise, goods achieving an efficient level is more difficult  governments can address free rider problem by for a public good than it is for a private good providing public goods and paying for them through general taxation o the government provides lighthouses, Sometimes Lighthouses are closer to PRIVATE goods highways, state parks, police, and similar  Coast of England, 19 C: not run by English gov, goods, largely funded through general but owned/ operated by private businessmen taxation  The owner of the lighthouse charged the owner of Other public goods: a nearby port - knowledge produced by basic research- but not specific Highways- rival in consumption only if it gets congested technological knowledge that can be patented (since a (with each additional car patent makes specific technological knowledge excludable) - fighting poverty- if many people prefer living in a society  Provided/ maintained by gov but has different w/ little or no poverty degrees of rivalry  most don’t like that homelessness exists, by alleviating poverty everyone will feel better, but using own money to help, everyone will benefit even if they didn’t help alleviate it (NOT rival, and once alleviate poverty everybody receives benefits and NOT excludable) o welfare system, food stamps Lecture Notes 11/12/13 CHAPTER 11 Useful to think about the degree to which a good is not excludable (cost of exclusion) and the degree to which it is rival in consumption (cost of an additional person using the good) High Pure Public (lighthouse) Fish (fewer fish available for other fishermen Degree of if catch a lot) non- Fire Departments Private (fruits and vegetables) exclusivene ss 0 Degree of Rivalness High The efficient amount of a public good  For a public good- the total benefit for a person (of a given level of provision) is the dollar value that the person places on that level of provision  For a public good- the marginal benefit to an individual is the increase in his total benefit that results from a one- unit increase in the quantity provided o Marginal benefit of public good diminishes w/ level of good provided Willingness to pay (for each fireworks display) Fireworks Displays Lisa Marginal Benefits Max Marginal Benefits Economy’s Marginal st Benefits 1 10 7 17 2nd 8 6 14 3rd 6 5 11 4th 4 4 8 5th 0 2 2 **Graph in back of ECON201 notebook Public good is non rival so everyone can consume each unit of public good Economy’s marginal benefit is sum of individuals’ marginal benefits  Suppose cost of each fireworks display is 9  Total surplus= total benefits- total costs The level of a public good should increase until, with any further increase, the economy’s marginal benefit would no longer exceed economy’s marginal cost  1,2,3 Fireworks Displays above marginal cost of display (9), and marginal benefits for economy is below marginal cost line Lecture Notes 11/12/13 Common Resources- goods that are rival in consumption Property but not excludable  Having property gives rights to:  Cannot prevent free riders from using o Use the item (use land to live on it, grow  More problems b/c also rival in consumption crops, rent it out) o Sell the item Parable about common resource (by William Forster Lloyd-  Property also carries responsibilities (cannot use car 1833) to drive over people)  A medieval town where sheep graze on Town Common  When property rights fail, inefficient outcomes are possible  As population grows, number of sheep grows  In order to be efficient:  The amount of land is fixed and grass begins to o Property rights need to be well defined, disappear from overgrazing access must be excludable, rivalrous and  Eventually people could no longer raise sheep transferable Garett Hardin- suggested calling the problem that parable illustrates: the Tragedy of the Commons [overuse of a Government can sometimes improve outcomes common resource when individual users fail to take into  When property rights are absent or limited, account their actions on that resource] inefficient outcomes are possible  “Tragedy”- essense of dramatic tragedy resides in solemnity of remorseless working of things  There are some situations where well defined property rights will assure efficiency  Bad result is due to a negative externality o Allowing one’s flock to graze on the Policy options to prevent Overconsumption of a Common common land reduces its quality for other Resource families  Establish private ownership of the resource o People neglect external cost, resulting in  Regulate use of resource (restricted hunting overuse of the land seasons) Other common resources:  Corrective tax to internalize the externality (entrance  Clean air and water fees for congested national parks)  Fish, whales, other wildlife The presence of externalities, public goods or common  Permits allowing limited use of a resource resources can cause markets to fail to achieve efficiency  In all of these cases, the basic reason is that property rights are not well established o Ex. No firm could charge everyone who benefits from national defense (or else too little defense) o Ex. Nobody owns the air, so no individual can charge polluters (or else too much pollution) Lecture Notes 11/14/13 Design of the Tax System Governments can sometimes improve outcomes and Health achieve efficiency - Medicaid (Federal health program for the poor)  Provide public goods - Spending on medical research (NIH)  Regulate use of common resources Some of the things in the category labeled as “other”  Remedy the effects of externalities spending - Federal court system  BUT to perform its many functions, the gov must raise revenue through taxation - Space program TODAY taxes account for up to a third of the average - Farm support programs American’s income - Salaries of members of Congress and the - The US federal gov collects about 2/3 of the taxes in President our economy Budget Deficit- excess of government spending over government receipts The Importance of Various Taxes Budget Surplus- excess of government receipts over - At federal level the largest share of taxes come fromgovernment spending individual income tax Government finances the deficit by borrowing - Other major federal taxes are payroll taxes and the National debt- total amount owed by Federal Government corporate income tax Individual Income Taxes Long term projections - As percentage of gross domestic product - Based on (total income)- (amount based on • Taxes- constant number of dependents)- (deductible expenses) o Called “taxable income” • Government spending- will rise gradually - The “marginal tax rate” is tax applied to each but not substantially additional dollar of taxable income - Government will spend vastly more than it will o 25000- 7825 finds the additional dollars receive in tax revenue o Ex. Consider a single tax payer w/ a taxable income of $25,000 What’s causing rise in government spending?  The amount he owed in taxes was 1. one cause of rise in government spending is related to social security and medicare (7825)x 10% + (25000-7825) x 15% • b/c elderly are growing percentage of overall  = $3358.75 population - Families w/ higher taxable incomes pay a larger o “baby boom” generation percentage of their taxable income in taxes Social Security o Medical advances and lifestyle improvements leading to increased life - Program of redistribution fo income from young to expectancy elderly 2. Rise in gov spending related to medicare and Medicaid - Medicare- health care for the elderly 3. Rising in cost of healthcare - Income Security- transfer payments to poor families • Medical advances (new, better and expensive - 5 major benefit programs for low income ways to extend and improve our lives) households • Welfare- provides cash assistance to poor families • Medicaid- provides health care for those on welfare and other poor children • Food Stamps- provides vouchers for purchase of food • Supplemental Security Income (SSI)- provides cash to low income elderly and disabled • Public housing and rental vouchers- provide housing assistance Lecture Notes 11/19/13 Chapter 12 Long term projections- As percentage of gross domestic Evaluating a Tax System product - Saying that one tax system is more efficient than another will mean it raises the same amount of revenue at a smaller - Taxes- constant cost to taxpayers - Government spending- will rise gradually but substantially - The costs to taxpayers include: - Result: gov will spend vastly more than it will • The tax payment itself receive in tax revenue • Deadweight losses Paul Ryan- want a country prevents debt crisis and gets • Administrative burdens:  costs taxpayers bear as they back to prosperity (an opportunity society/ wsafety net) comply with the tax laws - Or continue on path we are on  debt crisis where children will have an inferior standard of living than  costs to government from the one we have administering and enforcing the tax laws Ways to Possibly Handle Spending Increase  administrative burden could be 1. Raise taxes as a percentage of GDP reduced if tax code was simplified a. Imposes a greater cost on younger workers Should income or consumption be taxed? 2. Reduce the promises now being made to elderly of the future - Some economists advocate taxing consumption instead 3. Encourage people to take a greater role in caring forof income themselves as they age - Argument for using Consumption Taxes  would restore incentive to save, a. Raise the normal retirement age  better for individuals’ retirement income security b. Give people more incentive to save during and for long run economic growth their working years - European countries rely more on consumption taxes than State and Local Government Spending does the US - Many of the services that people look for from - Along with the types of consumption taxes used in the US, they also use a value added tax (VAT) government (police protection, schools, roads, fire,  A tax collected in stages as a good is being libraries, parks) are largely provided by state and produced local governments There are some provisions in the US tax code that are like - State and local tax revenue is much more a Consumption Tax fragmented than at the federal level Education- public schools (kindergarten to high school) and - For instance, Individual Retirement Accounts & public universities 401(k) plans Public Welfare- transfer payments to the poor • People can put a limited amount of saving Highways- building and maintenance of roads into such accounts Other Spending- libraries, police, garbage removal, fire protection, park maintenance, snow removal • The funds are not taxed until withdrawn at retirement Marginal and Average Federal Income Tax Rates Sales tax, property tax, as well as revenue from other Marginal tax rates increase by jumps levels of government and income taxes are the major sources of state and local revenue  the marginal tax rate for a taxpayer is the extra tax paid on an additional dollar of income - Other receipts  affects how much tax system distorts incentives • Fees for fishing and hunting licenses  determines the deadweight loss • Tolls from roads and bridges Average tax rates- increase gradually • Fares for public buses  Useful for measuring the sacrifice made by a taxpayer Evaluating a Tax System Flat Tax- a tax system under which the marginal tax rate is the same for all taxpayers Another goal of tax policy: - equity- distributing the burden of taxes “fairly”  Typically, income above a certain threshold is taxed • agreeing on what is fair is much harder at a constant rate than agreeing on what is efficient  Radically reduces administrative burden - but there are several principles that people apply to  Used in some central/ eastern European countries evaluate the equity of a tax system  BUT not popular in US with 1. The Benefits Principle- people should pay taxes based o people who benefit from the complexity of on the benefits they receive from a gov g/s the current system (accountants, lobbyists) - tries to make publicly provided goods similar to private goods  the more you use the more you pay o people who can’t imagine life w/o their favorite deduction/ loophole - ex. Gasoline taxes (amount of tax paid is related to Lump- Sum Taxes  could have the amount paid in taxes how much a person uses public roads) be the same for every person 2. The Ability to Pay Principe- taxes should be levied on - is the most efficient tax b/c: a person according to how well that person can shoulder  no deadweight loss b/c does not distort incentives the burden • suggests that all taxpayers should make an “equal  has a minimal administrative burden b/c no need to hire accountants or keep track of receipts sacrifice” - BUT perceived as unfair • recognizes that the magnitude of the sacrifice  In dollar terms, the poor pay as much as the rich depends not just on the tax payment, but on the person’s income and other circumstances  Relative to income, the poor pay much more than o a $10,000 tax bill is a bigger sacrifice for a the rich - Efficiency is not sensible to be only criterion poor person than a rich person - ex. Lump- sum tax= $4000/ person Income Average tax rate Marginal tax rate $20,000 20% 0% $40,000 Tax paid/ 0% income= 4000/40000= 10% Lecture Notes 11/21/13 Types of Taxes: Tax Incidence and Tax Equity Horizontal equity- taxpayers with roughly the same income - The person who bears the burden is not always the pay roughly the same taxes person who gets the tax bill (sellers pass part of burden to Vertical equity- taxpayers who are better off pay more taxtheir buyers) 1. Proportional Taxes- taxpayers pay the same  Ex. A tax on fur coats  vertically equitable (mostly fraction of income, regardless of income level rich buying-- But furs are a luxury (income inc 2. Progressive Income Taxes- individuals with higher then people buy more) w/ very elastic demand (as incomes pay a higher % of their income in taxes price inc even rich people stop buying it) 3. Regressive Taxes- individuals with higher incomes  Tax shifts demand away from furs, hurting the pay a lower % of their income in taxes people who produce furs (who are NOT rich) - When evaluating tax equity, one must take tax incidence Examples of the Three Tax systems: into account Regressive Proportional Progressive Incom Tax % of Tax % of Tax % of How Tax Burden is Distributed e incom incom incom  Considers families – ranked according to their e e e income 50,00 1500 30% 1250 25% 1000 20% 0 0 0 0 Five groups of equal size- # of families: “quintiles” (lowest, second, middle, fourth, highest) 10000 2500 25% 2500 25% 2500 25%  Poorest quintile: average income= $17,200 (Earns 0 0 0 0 3.9% of all income) 20000 4000 20% 5000 25% 6000 30% o and Taxes= 4.3% of income (pays .8% of 0 0 0 0 all taxes) State and Local taxes are Regressive  Highest/ Richest quintile: average income= - these governments get a lot of their revenue from $248,400 (earns 55.7% of all income) o And Taxes= 25.8% of income (pays sale taxes - b/c low and middle income individuals spend a larger 69.3% of all taxes) fraction of their income on items subject to sales tax  Richest 1%: average income= approximately *The US tax system is progressive overall $1.75 million (earns 18.8% of all income) o And Taxes= 31.2% of income (pays Tax Incidence The study of who bears the burden of taxes 28.3% of all tatxes) is central to evaluating tax equity Do the wealthy pay their fair share of taxes?  depends on Flypaper Theory- the burden of a tax (like a fly on a what consider “fair” flypaper) sticks where it first lands - ex. legislature passes law saying tax will be borneTax Burden Distribution: the sellers, is where tax initially goes and stays - Account for taxes and transfer payments: even greater (but in reality, market forces come into play and sprogressivity burden)  Richest families pays about 25% of income to the - BUT, has not been held up well in empirical studies government, after transfers Who pays the Corporate Income Tax  Poor Families- receive more in transfers than they - When the government levies a tax on a corporation, the pay in taxes corporation is more like a tax collector than a taxpayer  The burden of the tax ultimately falls on people • Average tax rate= negative 30% - Corporation becomes a tax collector not tax payer  Suppose government levies a tax on automakers  owners receive less profit, may respond over time by shifting their wealth out of the auto industry  The supply of car falls, car prices rise, car buyers are worse off  Demand for auto workers falls, wages fall, workers are also worse off Lecture Notes 11/26/13 Chapter 22: Frontiers of Microeconomics Political Economy- uses economics models to study a Arrow’s Desirable Properties of a Voting System for X type of choice that is common in the public sector 1. Unanimity- if everyone prefers A to B, then A beats B - How much of a public good to provide 2. Social Preferences rank the alternatives- actually used - Sometimes called “public choice” in Arrow’s analysis - For each pair of alternatives A or B - Process by which individual preferences combined into collective decisions ( ademocratic society o either A beats or ties B or B beats or ties A stresses importance of individual values/ tastes in - for each triple of alternatives A, B or C such an aggregation) • if A beats/ ties B, and B beats/ ties C, then • One person, one vote  expresses this A beats/ ties C individualist underpinning of our political 3. Arrow’s Indepenence of Irrelevant Alternatives system (Arrow’s IIA)- actually used in Arrow’s analysis Ex. w/ 2 Alternatives: When a city is choosing between two - IF set of alternatives held constant and individuals’ possible locations for a new park, the decision could be preference schange but their preferences between made by letting the majority have its way A and B don’t change, THEN the social preference - Let A, B, C be three possible locations for a new between A and B doesn’t change park w/ 3 types of voter, each w/ its own ranking of 4. No Dictator- there is no person that always gets his way, the locations regardless of everyone else’s preferences Voter Type Voter Type Voter Type 1 2 3 Borda Count- each voter ranks the alternatives according % of all 35% 45% 20% to his preferences Voters - For each voter, a number is assigned to each 1 choice A B C alternative that indicates its rank in his preferences: 2 choice B C A 3 choice C A B • 1 point goes to alternative ranked last Each person’s preferences have the following two • 2 points go to second to last alternative properties: • And so on - for each pair of distinct alternatives A&B, either A is - Then for each alternative, we add up its points preferred to B or B is preferred to A - for each triple alternatives A,B,C: if A is preferredOne alternative beats another alternative if its sum is B and B is preferred to C, then A is preferred to C greater than the sum for the other alternative A possible approach: mayor tries “pairwise voting”  letting - Two alternatives are tied if their sums are equal majority have its way in each pairwise vote The social preferences from the Borda count can be used to 1. A runs against B  A beats B select a winner 2. B runs against C  Type 1 and Type 2 vote B over - An alternative is a winner if/ only if it has at least as C, 35%+45%=80% prefer B  B beats C many points as any other alternative Social preferences- for each pair of alternatives A&B, Voter Type Voter Type Voter Type 1 2 3 “social preferences” specify one of the following: Number of 35 45 20 1. A beats B 2. B beats A Vostrs 1 ndoice A- 3 points B C 3. A ties B 2 choice B- 2 points C A Transitivity- Normally, we would expect preferences to 3 choice C A B exhibit following property:  Transitive preference- outcome is same preference convert Voter Type Voter Type Voter Type no matter in change of order of voting percentages 1
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