Lecture 2 - The four questions of PF

Question 1

Goal of Public Finance vs. Private Economy.

Answer 1

Public:
are in the interest of the entirety (of the state); politically determined; as far as possible realization of the economic principle.
Private:
are in the interest of the individual; subjective; profit maximizing as much as possible (WHU: max. Students)

Question 2

Means (=Money) of PF vs. Private Economy

Answer 2

Public:
Compulsory revenues, fees, contributions, public credits
Private:
Equity, debts loans from the public and
private sector

Question 3

Risk of PF vs. Private Economy

Answer 3

Public:
Entirety of taxpayers and entirety of citizens, limitedrecourse liability of administration.
Private:
for the individual economic agent (individual/organization/business)

Question 4

Sanctions of PF vs Private Economy

Answer 4

PF:
primarily pol. nature; in dem. societies loss of votes

Priv. Economy: profit losses up to bankruptcy

Question 5

Cost Benefit Analysis of PF vs Private Economy

Answer 5

PF:
predefined pol. goals; mostly for new investment projects

Priv. Economy: ongoing basis with aim of profitability

Question 6

What is the definition of Efficiency?

Answer 6

Economy= series of trades between producers (firms) and consumers
Trade is efficient if it makes at least one party better off w/o making the other party worse off
Total efficiency maximized when as many efficient trades as possible are made
Micro: competitive market equilibrium is the most EFFICIENT outcome for society (maximizes gains from efficient trades)

Anschaulich: game theory: beide kooperieren: 10 jew., keiner kooperiert 1 jew, nur einer kooperiert (anderer bekommt 7; der der kooperiert nur 5)

Question 7

Prisoner´s Dilemma Game Theory

Answer 7

weniger ist besser hier

beide kooperieren: jew. 4
beide schweigen: beide 2
einer schweigt: anderer bekommt 6, man selber nur 1

Question 8

What is the definition of the Free Rider Problem

Answer 8

The free-rider problem is a type of market failure that occurs when those who benefit from resources, public goods, or services of a communal nature do not pay for them or under-pay.

Beispiele:
1. In Australia until 2012 fire services were financed by a tax on fire insurance policies. Individuals who did not insure still received services. => financing fire services through property taxes
2. Public Art Institutions: significant feree rider problem for free M;useums. “recommended” donation => onbly 17% pay full charge => Solution: charging out of town visitors
3. Wikipedia: over 490 (out of 500) million free ride on both: the editorsw´efforts and the donors´money

Question 9

Examples of Socially Prefered Behaviour

Answer 9

If participants in the traffic do not oblige to certain rules, the police will penalize certain behavior.
This can include direct costs such as penalty fees or withdrawal of driving permits. Both intervention cause a decrease in utilities for the individuals.
Another example is shoplifting. The thrill of stealing and the reward caused by the adrenalin and the item for free increase the individual utility but the risk of being caught and the
penalty decrease the expected utility.

Question 10

What are pure and impure public goods?

Answer 10

1. Excludability
2. Rivalry

excludable& rival in consumption: PRIVATE good (ice cream); hier: lack of property goods
excludable& not rival in consumption: Impure public good (TV streaming) = CLUB GOOD
not excludable& rival in consumption: Impure public good (crowded city sidewalk) = COMMON RESOURCE = Extortion (Erpressung)
not excludable&not rival in consumption: pure public good (national defense); Underprovision

WHU: easy to include and no (real) rivalry

Question 11

Problem with Pure Public Goods

Answer 11

Everyone maximizes their extraction
Everyone minimizes their input
The public resource is overused and
disappears.

Question 12

Problem with common goods

Answer 12

In case of common goods, other market participants are excludable

Everyone maximizes their extraction
Everyone minimizes their input
The public resource is overused and
disappears.

Question 13

Solutions to the problem of Public and Common goods

Answer 13

Coase Theorem
The distribution of property rights
=>eliminates the danger of free riders (Attention now no longer a common good).
Extraction
Investment (Maintenance)
Disadvantage: The individual areas are too small to recover. Fewer grazing animals need to be kept than in the case of collective use. => da “eingezäunt”
->Loss of efficiency

Question 14

Monopoly solution

Answer 14

monopolistic A maximizes own utility to survive on the market longterm
collective use guarantees the max long term return
he pays wages, invests the labor and the extracts the return
Disadv.: efficiency losses due to admin costs & employee motivation (no own incentive)

Question 15

Solution: State System establishes rights of use

Answer 15

state puts sanctions on ppl and controls them
the ppl invest labor and extract it afterwards from the pasture
Disadv.: enormous efficiency losses due to admin costs, costs for control& sanctions and still incentive for free riders

Question 16

Solution 2: State system takes over the planning = POLANWIRTSCHAFT

Answer 16

state sanctions, controls and pays ppl
ppl invest labor that the stat then extracts

Disadv.: enormous efficiency losses due to admin costs, costs for control& sanctions, incentive for free riders is withdrawn, however, poor employee motivation (no own incentives and free-riders at work)

Question 17

Optimal Provision of Public Goods in PRIVATE GOODS MARKET

Answer 17

How much should society provide?
Markets will not provide the correct amount
Reconsider market: review conditions for optimal provision of private goods
Ben & jerry deciding between cookie (1$) and ice cream

a) and b) show the individual demand curves for ice cream cones:
= Number of ice cream cones that each would demand at each price

c) market demand curve= horizontal sum of both individual demands (bei 2$ würde ben 2 und Jerry 1 Ice cream kaufen => market demand at 2$ = 3 ice cream)
in c) demand curve= social marginal Benefit (SMB) value to society from the consumption of that cone)

in c) market supply curve= marginal costs of producing ice cream cones for a firm
MARGINAL COST OF PRODUCING = SOCIAL MARGINAL COST (SMC) (in a market with no failures) (cost to society from the production of that cone)

In a private market Equilibrium where SMB=SMC
Key feature: consumers demand different quantities of the good at the same price
Market: adding up the demands and meeting them with aggregate Supply (Ben likes ice cream more than jerry he gets two of the three cones)

Marginal Utility von Ben von Eis/ MU von B von Cookies= MRS von B ice/cookies= MRS von J ice/cookies= PicePcookies

MRSBic,c= PicPc (ratio of prices of ice cream and of cookies)= Pic
Bedeutet: Ben and Jerry each consume cookies and ice cream until: their relative marginal utilities=relative price of the goods

PicPc= price ratio: cookie is 1$ and ice cream is 2$ (2/1) =2 (d.h. each individual is indifferent between trading 2 cookies for 1 ice cream
Ben: likes ice cream more: willing to make this trade when he is having two ice cream; jerry würde das nur bei der ersten ice cream cone machen, danach nicht mehr

Supply side: ice cream cones are produced until MC= MB (in competitive Market=P)
MCic = Pic

Von vorhin (da price ratio=P ice cream war): MRSBic,c= Pic
Daher: MRSB = MC

Question 18

Why is the private market equilibrium also the social efficiency maximizing one? (Maximizes social surplus):

Answer 18

• Because when there are no market failures, MRS (for any quantity of ice cream) = SMB of that quantity
• (bedeutet: value to society= marginal value to any individual in perfectly competitive market)
• MC=SMC (when no failures)
• (bedeutet: marginal cost to society = marginal cost to producers in a perfectly competitive market)
• PRIVATE MARKET EQUILIBRIUM: SMB=SMC
• efficiency maximating point: marginal value of consuming the next unit (to any consumer) = marginal cost of producing an additional unit

Question 19

Optimal Provision of public Goods ion Public Goods Market

Answer 19

BEISPEIEL FRAGESTELLUNGEN: How big should a park be built? How many lanes should a motorway have? How much air pollution should be tolerated?

Jetzt können ben und Jerry zwar immer noch verschiedene utilities habe; jedoch ist (mind. 1) Good ein Public good (e.g. missiles); no rivalry in ist use (deswegn sollte auch no exclusion be pursued)
Sie können nicht mehr maßschneidern (tailor) ihre eigenen Konsum, da das public good von allen konsumiert werden muss
Jeder ist jetzt dazu gezwungen eine gemeinsame Anzahl des common goods zu wählen. (wieder verschiedene Geschmäcker => verschiedene WTP)

Whatever number of missiles is chosen applies to B and J equally

Compare advantage (sum of wtp) mit disadvantage of providing it (cost)
=> discrete public good should be provided when costs are smaller than the sum of all users´ WTP

c) supply curve for missiles= marginal cost of production
socially optimal level: wo sich Supply mit demand schneidet (hier: 5 missiles)

Marginal Missile is worth MRSBm,c to Ben and MRSJm,c to Jerry
 total value to society: MRSBm,c + MRSJm,c
Social marginal Benefit (SMB) of the next missile is the sum of B and J MRS (represents their valuation of that missile)
SMC (same as earlier): marginal cost of producing a missile
Social efficiency maximizing condition: MRSBm,c + MRSJm,c= MC
(sum of MRS not of individual MRS)

For private goods: optimal for firms to produce until MC= benefit of marginal consumer
Da private good is rival: once it is consumed by any one consumer; it´s gone

For public goods: socially optimal for firms to produce until MC= Benefit to all customers combined
Da: non-rival, can be consumed jointly by all consumers; society would like to take into account sum of all consumers´preferences

Slide?: transformation function H(x ;G) describes the efficient production possibilities
G= publig good
X= private Good

Question 20

Optimal Provision of Public Goods

Answer 20

SAMUELSON CONDITION WDH und verstehen!!

Question 21

Samuelson rule

Answer 21

the quantity of a public good should be expanded until the sum of the MWP for the public good is equal to the MC of the last unit provided
optimal size= Gopt
economic rent from the provision of the good can be seen in the ABC

Question 22

Conclusion

Answer 22

As with private goods, can we hope that laissez-faire on the part of the state will lead to the private provision of public goods on an efficient scale?
No, because of the free-rider problem, private provision leads to an undersupply of public goods.
Consider how the free rider problem comes into play here.

Question 23

Discrete Provision Example

Answer 23

Assumption: Public goods can only be provided in quantities of 0,1,2. 2 individuals, i = 1, 2, can each contribute one unit (B) or not (NB).
Provision of a unit causes benefits (per person) of v, i.e. v is the willingness to pay for a unit of G, and provision costs of c:
ui =v*G-cgi
with G = g1 + g2 and gi ∈ {0, 1}: Contribution of player I.

Payouts:
provision of another unuit is efficient as long as sum of benefits is greater than costs (Samuelson rule)
2 mal benefit da 2 personen > provision costs
non rivalry& -excludability

Beide machen: 2v-c, 2v-c
nur einer zahlt: der dann v-c; anderer c
beide zahlen nicht: 0

WENN ABER C>V : Do not contribute is the dominant strategy
nash equilibrium is nichts tun, nichts tun: prisoner´s dilemma
wenn v=100 und c=150
nur wenn beide machen, für beide payot
wenn keiner dann 0
wenn einer dann derjenige -50 und anderer 100

WENN ABER V>C:
nash equilibrium is beside zahlen dann 150 für beide
wenn nur einer, dann dieser 50, der andere 100

Question 24

Free Riding

Answer 24

Benefits are higher if you do not contribute anything yourself.
Nash equilibrium is inefficient:

Although 2v > c, it is not worthwhile for individuals to contribute because the individual benefit is smaller than the cost, i.e. v < c.
Collective and individual rationality fall apart. (wenn beide zahlen würden: 2V>C)

Starting point for state intervention: If the state knows the willingness to pay, it can provide the efficient quantity and finance it through flat-rate taxes.

Question 25

Market failure occurs, when the market does not provide an optimal allocation. How does this happen?

Answer 25

When gov. to intervene=> when non-rivalry and non-consumption => good will be underprovided compared to social optimum => FREE RIDER PROBLEMIf the individuals optimize for themselves, but the overall optimum consequently decreases.
The opportunity of free riding
External effects
Alternative reasons for market failure are:
* Incomplete Information
* Monopoly/Oligopoly
* Lack of market participants
* Lack of property rights and law enforcement
* Adverse selection

Question 26

How might the Government Intervene?

Answer 26

Tax or subsidies
-Restrict or Mandate sale or Purchase

Question 27

Explain how Tax and Subsidies Work

Answer 27

Use the price mechanism, changing the price of a good to encourage or discourage use.

Taxes raise the price for private sales or purchases of goods that are overproduced.

Subsidies lower the price for private sales or purchases of goods that are underproduced

Question 28

Explain how Quotas and Mandates Work

Answer 28

Quotas restrict private sale of goods that are overproduced.
Mandates require private purchase of goods that are underproduced.

Question 29

Explain what Public Provision and Public Financing of private Provision is.

Answer 29

Public Provision
* The government can provide (+produce) the good directly.
Public Financing of Private Provision
* Governments pay; private companies produce

Question 30

4 Questions of Public Finance

Answer 30

1.When should the government intervene in the economy?
2.How might the government intervene?
3.What is the effect of those interventions on economic outcomes?
4.Why do governments choose to intervene in the way that they do?

Question 31

What is the Model by Musgrave?

Answer 31

1. Allocation
   - reallocation of resources especially in the case of specifically public needs; funds durch tax collection
2. Distribution
   - establishment of correct distr& its maintenance; funds durch tax & transfer payment system from one indiv. to another
3. Stabilization
   - maintaining a high level of utilization of prod. forces& stable monetary value; funds durch fiscal policy; surplus/ deficit allowed

Question 32

Effects of Interventions on Economic
Outcomes

Answer 32

Direct and Indirect Effects
Direct effects: The effects of government interventions that would be predicted if individuals did not change their behavior in response to their interventions.
e.g. if no fathers allowed in Geburtsstation, less possibilities for covid infection

Indirect effects: The effects of government intervention that arise only because individuals change their behavior in response to the interventions.
da aber frauen ihren mann dabei haben wollen => Hausgeburten => höheres Risiko für Kind und Mutter

Question 33

Why do governments choose to intervene the
way that they do?

Answer 33

Governments do not always choose efficient or socially desirable outcomes.
Governments face enormous challenges in figuring out what the public wants and how to choose policies
that match those wants.
Political economy: The theory of how the political process produces decisions that affect individuals and
the economy

Question 34

The primary motive for government invention: Market failure

Answer 34

Market failure= a problem that causes the market economy to deliver an outcome that doesn´t maximize efficiency

Wenn nicht pareto optimal : market intervention ! = sufficient condition

Beispiel Market failure: Health insurance market
Ein unversicherter Mann entscheidet sich gegen das Impfen: höheres Risiko für sich und andere
When dealing whether to get the vaccine, the man only considers the costs to himself
=>negative externality (man´s decision imposes costs on others that he doesn´t bear)

2nd reason for government intervention:
Even if market is well functioning; efficient outcome not necessarily socially desirable => Redistribution (=shifting of resources from some groups in society to others)
Usually entails efficiency loss => efficiency-equity trade-off (larger pies or more equally distributed)