Chapter 1: Introduction to Public Economics Flashcards
This is concerned with understanding the economic rationale for government
involvement in the market and how public sector decisions affect overall economic performance and equity.
The field of public economics
Public economics developed out of the original _______ of Mill
and Ricardo, through the public finance tradition of tax analysis into public economics and has now returned
to its roots with the development of the new political economy.
political economy
studies the government and how its policies affect the
economy. I
public economics
It considers how the choices of the government are made and how they can improve or hinder
economic efficiency.
public economics
Public economics builds on the theory of _______and is ultimately used as a tool to improve social
welfare.
welfare economics
This provides a framework for thinking about whether or not the government should
participate in economic markets and if so to what extent it should do so.
Public economics
Public economics involves the study of government policy through the lens of ____ and ____
economic efficiency and equity.
The two fundamental principles guide government interventions in markets, influencing tax policies, public
spending, and regulations.
Economic Efficiency and Equity
focuses on maximizing economic output with available
resources
efficiency
concerns the fair distribution of wealth and opportunities.
equity
The purpose of ________is achieving the optimal allocation of resources where no individual can be made better off without
making someone else worse off (Pareto Efficiency)
economic
efficiency
seeks fairness or justice in the
distribution of economic resources and wealth.
economic equity
When determining economic policy, governments are faced with two conflicting aims. They are all concerned
with organizing economic activity so that the best use is made of economic resources. This is the _______
side of policy design.
efficiency
To varying degrees, governments are also concerned to see that the benefits of
economic activity are distributed fairly. This is the________aspect of policy design.
equity
attempts to understand both how the government makes decisions and what decisions it
should make.
Public economics
This is a broad range of strategies employed by governments to
influence the economy and optimize economic performance.
economic policy
These are typically implemented and
administered by the government.
Economic policies
There are two major components of economic policy:
fiscal policy and monetary policy.
Government policies related to
taxation and public spending to
influence economic activity.
Fiscal Policy
Policies controlled by the central
bank to regulate money supply,
interest rates, and credit
conditions.
Monetary Policy
Fiscal policy is controlled by
Government (Ministry of
Finance, Treasury, or
Congress/Parliament).
Monetary Policy is controlled by
Central Bank (e.g., Federal
Reserve, European Central
Bank, Bank of England).
Tools used: Taxation (income tax, corporate
tax, VAT) Government spending
(infrastructure, social welfare,
public services)
Fiscal Policy
Tools used: Interest rates (increasing or
decreasing borrowing costs) Open market operations
(buying/selling government
bonds)
Monetary Policy
Primary Objective of fiscal policy
Stimulate economic growth
during recessions.
Reduce inflation or slow an
overheated economy.
Reduce income inequality
through redistribution.
Primary Objective of Moentary Policy
Control inflation and stabilize
prices.
Influence credit availability and
economic activity.
Maintain financial stability.
T or F in terms of speed of implementation fiscal policy is much faster than monetary policy
False
Can lead to increased public
debt if government spending
exceeds revenue.
Fiscal Policy
Can affect investment and
exchange rate.
Monetary Policy
A system that combines elements of both market economies (where private
individuals and businesses make economic decisions) and command economies (where the government
has significant control over economic activities).
mixed economy
where private
individuals and businesses make economic decisions
market economies
where the government
has significant control over economic activities
command economies
This balance allows the economy to benefit from the
efficiency and innovation of the private sector while ensuring stability and equity through government
intervention.
mixed economy
characterizes a mixed economy
- Coexistence of Private and Public Sectors
- Government Regulation and Intervention.
- Public Services and Welfare Programs
- Market Freedom with Social Welfare Considerations.
- Flexibility and Adaptability.
- Foreign Trade and Investment.
- Promotion of Economic Growth. T
encouraged the government
to actively participate in trade and industry.
mercantilism
Adam Smith pushed for the limited
role of the government, arguing that competition and profit motive of individuals would eventually lead to
serving the public interest, as if led by an
invisible hand.
John Stuart Mill and Nassau Senior formulated the principle known
as
laissez faire
Economic Roles of the Government
- Allocative role.
- Distributive Role.
- Stabilization role.
- Regulatory role.
This involves the government’s role in deciding how resources should be allocated
within the economy. This includes decisions on public spending, such as funding for healthcare,
education, and infrastructure projects. Government investments in public goods like roads, schools,
and national parks are examples of allocative decisions. These investments aim to ensure that
essential services are available to all citizens.
Allocative role.
This role focuses on redistributing income or wealth within society. This is typically
achieved through taxation policies where higher-income individuals or corporations pay more taxes
compared to lower-income groups. Progressive taxation systems where higher earners pay a larger
percentage of their income compared to lower earners is a common distributive role example.
Distributive Role.
The goal is to maintain economic stability by controlling inflation and
unemployment rates. Governments use monetary policies (e.g., adjusting interest rates) and fiscal
policies (e.g., increasing government spending) to achieve this goal. Central banks lowering interest
rates during economic downturns to stimulate borrowing and spending is an example of stabilization
policy.
Stabilization role.
This role ensures fair competition and consumer protection. Governments establish
laws that protect intellectual property rights, ensure product safety standards are met, prevent
monopolies from forming by enforcing antitrust laws, and regulate environmental impacts. Examples
include consumer protection agencies monitoring product quality or antitrust commissions blocking
mergers that could lead to monopolies.
Regulatory role.
Government Functions in the Economy
- Provide public goods.
- Maintain competition.
- Correct externalities.
- Stabilize the economy.
- Redistribute income.
Fundamental Economic Questions:
- What is to be produced?
- How is it to be produced?
- For whom is it to be produced?
- How are these decisions made?
This answers how much of our resources should be devoted to the
production of public goods, such as defense and highways, or how much of our resources should be
utilized for the production of private goods.
What is to be produced?
This involves decisions such as whether to produce privately or publicly,
to use more capital and less labor or vice versa, or to employ energy-efficient technologies.
Government policy affects how firms produce the goods they produce: environmental protection
legislation restricts pollution by firms; pay- roll taxes that firms must pay on the workers they employ
may make labor more expensive and thus discourage firms from using production techniques that
require much labor.
How is it to be produced?
Government decisions about taxation or welfare programs affect
how much income different individuals have to spend. Similarly, the government must decide what
public goods to produce. Some groups will benefit from the production of one public good, others
from another.
For whom is it to be produced?
In the public sector, choices are made collectively. Collective
choices are the choices that a society must make together, for instance, choices concerning its legal
structure, the size of its military establishment, its expenditures on other public goods, and so on.
How are these decisions made? I
Analyzing the Public Sector
four general stages of analysis to address the
fundamental economic questions.
- Knowing what activities the public sector engages in and how they are organized
- Understanding and anticipating the full consequences of these government activities
- Evaluating alternative policies
- Interpreting the political process
These are simplified representations of economic processes that help
economists analyze government policies and predict their outcomes. In the context of public economics, these
models are commonly used:
Economic models
These models use mathematical equations and logical reasoning to describe economic
behavior and government policy outcomes.
▪ One example is the General Equilibrium Model that analyzes how government policies affect
markets and resource allocation.
Theoretical Model
These models rely on real-world data to test economic theories and measure policy impact.
▪ Regression Analysis is used to study the effect of taxation on economic growth
Empirical Model
These models incorporate insights from psychology and behavioral economics to study how
individuals and businesses respond to government policies.
▪ Prospect Theory explains why people may not react rationally to tax incentives or social
programs.
Behavioral Model
Used to analyze strategic interactions between different economic agents, such as
governments, businesses, and consumers.
▪ Public Goods Game model explains how individuals contribute (or free ride) to government
provided services.
Game Theory Model
These are complex models that simulate the entire economy to analyze policy changes.
▪ CGE models are used to assess the effects of trade policies or tax reforms on GDP and
employment.
Computable General Equilibrium (CGE) Model
This attempts to describe how the economy and economic policies work
without resorting to value judgments about which results are best.
Positive economics.
It looks at the scope of government
activities and the consequences of the various government policies, to put simply, it is concerned with
“what is”.
Positive economics.
This involves the use of value judgments or policy recommendations to
assess the performance of the economy and economic policies.
Normative economics.
refer to the outcomes of government policies that were not anticipated or planned
by policymakers.
Unintended consequences
