Chapter 5 (pp 99-end) Public Goods and Externalities The economic role for government Public goods vs. private goods Externalities (spillover costs and benefits) Solving market failures

Public goods vs. Private Goods Private goods: rivalry and excludability When one person buys and consumes a product, it’s not available for another person to buy and consume. Sellers can keep those who do not pay for a product from obtaining its benefits. Public goods: nonrivalry and nonexcludability One person’s consumption does not preclude consumption of the good by others. No effective way to exclude individuals from the benefit of the good once it comes into existence.

Public Goods eliminate the Free Rider Problem Public goods, once provided, are “free” and the benefit can be obtained without voluntarily paying for it. Examples? How do governments determine the optimal quantity of public goods? Answer: Cost-Benefit analysis. Allocative efficiency: MB=MC. Collective “willingness to pay” and rising marginal costs due to the law of D.R.

Externalities Externalities occur when the costs of producing or the benefits of consuming a good “spill over” onto those who are neither producing nor consuming the good.

Positive or Negative?

Positive or Negative? Spillover costs—negative externalities Overallocation of resources to production Supply (MC) curve does not reflect all costs To correct, either 1) outlaw/penalize, or 2) tax Graph Spillover benefits—positive externalities Underallocation of resources to production Demand (MB) curve does not consider all benefits To correct, 1) subsidize consumers, 2) subsidize suppliers, or 3) government provides goods

Classic Example: Pollution Pollution is an economic “bad.” It reduces the utility of those affected. Should government eliminate all of this “bad?” Society must decide how much of a reduction it wants to “buy.” Because of the law of D.R., cleaning up all pollution would be very costly. The marginal cost to the firm, and hence to society, rises as more and more pollution is reduced. Likewise, the marginal benefit of reducing pollution decreases as more and more pollution is removed. (graph) Curves shift over time: 1) new technologies and 2) new research.

Public Finance: Tax Structures (Chapter 16 pp. 345-346) Proportional Taxes A proportional tax is a tax for which the percentage of income paid in taxes remains the same for all income levels. aka Flat Tax e.g. Social Security (up to $118,500,) many Eastern European countries, some state taxes, Medicare payroll tax1.45%

Tax Structures Progressive Taxes A progressive tax is a tax for which the percent of income paid in taxes increases as income increases. e.g. U.S. federal income tax with 7 brackets

Tax Structures Regressive Taxes A regressive tax is a tax for which the percentage of income paid in taxes decreases as income increases. (the more you make, the less you pay) e.g Sales tax, gas tax, Social Security over $118,500

Is there a good tax? A good tax has the following characteristics: Simplicity Tax laws should be simple and easily understood. Efficiency Government administrators should be able to collect taxes without spending too much time or money. Certainty It should be clear to the taxpayer when the tax is due, how much is due, and how it should be paid. Equity The tax system should be fair, so that no one bears too much or too little of the tax burden.

The ideal tax?

Estate tax on the value of all property owned at death Estate tax on the value of all property owned at death. Begins at over $5,000,000 (max rate of 40%) Why do the super wealthy set up charitable foundations, trusts, and life insurance policies?

Tax Incidence & Efficiency Loss Who pays the tax? Producers or Consumers? Elasticity and Tax Incidence A per-unit tax increases the cost of the product and shifts supply curve to the left. The tax results in a decrease in the quantity. The more inelastic the demand for the product, the larger the portion of the tax shifted to consumers. Decline in equilibrium quantity is smaller when demand is more inelastic. (This is why inelastic goods are targets of gov’t taxes, i.e. “sin taxes”) With a specific demand, the more inelastic the supply, the larger the portion of the tax is paid by producers. (Ch. 16 pp. 347-350)

Efficiency Loss of a Tax Efficiency Loss (deadweight loss)—loss is society’s sacrifice of net benefit because the tax reduces consumption below where MB=MC. Key Point: If the Q is not at MB=MC, there is a deadweight loss! Role of Elasticities—other things equal, the greater the elasticities of supply and demand, the greater the efficiency loss of a tax. Taxes are sometimes used to reduce negative externalities and increase efficiency.

Points for discussion? Based on AGI in 2006, the top 1% of New York income tax filers represented 28.7% of all income in NYS. (The bottom 50% represented 10.7% ) Since 2002, 95% of New Yorkers have experienced no income growth. (The top 5% have doubled their income) Richest 10% own more than 70% of nation’s wealth—largest share than in 1913—and half of that is owned by the top 1%.

Distribution of Income (Ch. 20 pp. 410-416) Market economies create wealth, but that wealth is distributed unequally. Problem? Lowest fifth (20%) of households, up to approx. $20k, receive 3.1% of total income. Highest fifth, above approx. $102k, receive 51.1% of total income. (Census Bureau 2015) Lorenz Curve depicts income inequality. Gini ratio quantifies income inequality. The higher the ratio, the greater the income inequality. (U.S.=0.477 [2015: .482], Sweden=0.230, South Africa=0.650.) [M-B 20th ed.]

Income Inequality—cont. Income Mobility—over time, families have the ability to increase or decrease their income. Between ‘96 and ‘05, half of those in the lowest quintile moved to a higher income quintile. Not permanent! (but it’s gotten harder to move) Government Redistribution Cash transfers—welfare, unemployment In-kind transfers—medicare, food stamps, housing Taxes and transfers result in a lower gini ratio and flatter Lorenz Curve.

What’s poverty? Who is impoverished? http://aspe.hhs.gov/poverty/15poverty.cfm TANF (Temporary Assistance for Needy Families) Work requirement “workfare”--W to W (welfare to work) Time limit (5 yr. lifetime limit) Since 1996, designed to be temporary & transitional SNAP (Supplemental Nutrition Assistance Program) “food stamps” Earned Income Tax Credit (EITC)—subsidy to low income workers Section 8 Housing (HUD) Medicaid