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Chapter 5:
The Public Sector and Public Choice
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
2
What a Price System Can and Cannot Do A perfectly competitive price system can
allocate resources efficiently through the interaction of markets.
Market FailureA situation in which an unrestrained market
economy leads to too few or too many resources going to a specific economic activity
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What a Price System Can and Cannot Do Market failure prevents economic
efficiency. Market failure prevents individual freedom. Public policy (government) is often called
upon to address market failure.
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Functions of Government Economic Functions
Correcting for externalities Providing a legal system Providing public goods Ensuring economywide stability
Political Functions Merit and demerit goods Redistributing income
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Correcting for Externalities
ExternalitiesOccur when the consequence of an economic
activity spillover to affect third parties Third Parties
Parties who are not directly involved in a given activity or transaction
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Correcting for Externalities
Externalities are examples of market failures.
Pollution is an example of a negative externality.
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External Costs and Benefits
Figure 5-1, Panel (a)
S2
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P1
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Quantity of Steel per Year
Panel (a)
D
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External Costs and Benefits
Figure 5-1, Panel (b)
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Q2Q1
P1
P2
Pri
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Quantity of Inoculations per Year
D1
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Panel (b)
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The Other Economic Functions of Government Providing a legal system
Enforcing contractsDefining and protecting property rightsEstablishing legal rules of behavior
Property RightsThe rights of an owner to use and to
exchange property
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The Other Economic Functions of Government Promoting competition
Market failure may occur if markets are not competitive.
Monopoly power A firm that has great control over the price
Antitrust legislation Laws that restrict the formation of monopolies and
regulate certain anticompetitive business practices
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The Other Economic Functions of Government Providing Public Goods
Goods to which the principle of rival consumption does not apply
In contrast, private goods can be consumed by one individual at a time.
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The Other Economic Functions of Government Characteristics of public goods
Indivisible Additional people can use public goods at no
additional cost Additional users of public goods do not deprive
other users Difficult to charge for a public good based on
consumption—the exclusion principle
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The Other Economic Functions of Government Free-Rider Problem
Arises when some individuals take advantage of the fact that others will take on the burden of paying for public goods
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The Political Functions of Government Merit Goods
Goods deemed socially desirable through the political process Museums Ballet Concerts
Provided through subsidization Demerit Goods
Tobacco Alcohol Gambling
Discouraged through taxation
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Total Government Outlays Over Time
Figure 5-2Source: Facts and Figures on Government Finance
and Economic Indicators, various issues
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Federal Government Spending Compared to State and Local Spending
Budget of the United States Government; Government Finances
Figure 5.4
5-17
Public Spending and Transfer Programs (cont'd) Publicly subsidized healthcare
Medicare Began in 1965 Pays hospital and physicians’ bills for U.S. residents
over 65 with public monies 2.9% of earnings taxed Second biggest domestic program in existence
Medicaid Subsidizes people with lower incomes
5-18
Figure 5-4 The Economic Effects of Medicare Subsidies
5-19
The Economic Effects of Medicare Subsidies To increase the quantity of medical care,
the government pays a subsidy.
The price per unit paid to medical service providers increases.
The price per unit paid by consumers falls.
More medical services are consumed.
5-20
Policy Example: Is the Medicare Program on the Fast Track to Bankruptcy?
Medicare spending is growing much faster than employer and employee contributions.
If both Medicare and federal tax collections continue to grow at present rates until 2050, Medicare will account for half of all federal tax collections.
5-21
Policy Example: Is the Medicare Program on the Fast Track to Bankruptcy? (cont'd)
Because of the growth in program spending, Medicare will lack financial resources to cover promised benefits by 2019 or sooner.
Congress will have to increase taxes or cut benefits or both.
5-22
Policy Example: Is the Medicare Program on the Fast Track to Bankruptcy? (cont'd)
How do increasing life expectancies contribute to Medicare’s funding difficulties?
5-23
Economic Issues of Public Education State and local governments provide
primary, secondary, and post-secondary education at prices well below those that would otherwise prevail in the marketplace.
5-24
Economic Issues of Public Education (cont'd) Economics of public education
Publicly subsidized, similar to government subsidized healthcare
Education priced below market
5-25
Economic Issues of Public Education (cont'd) Incentive problems of public education
Various measures of performance show no increase or decline in performance.
Many economists argue failure to improve relies on incentive effects.
Higher subsidies may translate to services unrelated to learning.
5-26
Policy Example: What Have Public Schools Done with Subsidies?
Public school enrollments have increased 40% since 1960.
Inflation-adjusted spending per student has increased 200%.
Teachers have increased by 60%.
5-27
Policy Example: What Have Public Schools Done with Subsidies? (cont'd)
Overall, number of non-teaching staff increased 500%.
As predicted by the basic economics of subsidies, schools have allocated funds to activities contributing little to student learning.
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Collective Decision Making: The Theory of Public Choice
Collective Decision MakingHow voters, politicians, and other interested
parties act and how these actions influence non-market transactions
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Collective Decision Making: The Theory of Public Choice
Theory of Public ChoiceThe study of collective decision making
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Collective Decision Making: The Theory of Public Choice
Similarities in market and public-sector decision making Individuals motivated by self-interest Scarcity and opportunity cost Competition Similarity of individuals and incentives
Incentive Structure The system of rewards and punishments individuals face with respect
to their actions
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Collective Decision Making: The Theory of Public Choice
Differences between market and collective decision makingGovernment (political) goods at zero price
Goods (and services) provided by the public sector
Use of force
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Collective Decision Making: The Theory of Public Choice
Differences between market and collective decision makingVoting versus spending
Political system versus market system Political System
Run by majority rule Market System
Run by proportional rule
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Collective Decision Making: The Theory of Public Choice
Differences between market and collective decision making Voting versus spending
Spending of dollars can indicate intensity of want Votes cannot; each vote counts with the same
intensity
Chapter 5:
The Public Sector and Public Choice
ECON 152 – PRINCIPLES OF MICROECONOMICS
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.
