Public Finance
Instructor: John Hartman
Today: An introduction to Econ 130
A review of microeconomics
Introduction to public finance
Before we begin…
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Remember that this is a small class  Ask
questions if things are not clear
The syllabus is posted online  See
http://econ.ucsb.edu/~hartman/
For most of you, attendance is important if
you want to get a good grade
Before we begin…
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I expect you to know the following tools
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Calculus
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Microeconomics
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Econ 1, Econ 100A or 104A, Econ 100B or 104B
Macroeconomics (although not as important for public
finance)
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Derivatives, integrals, partial derivatives
Econ 2, Econ 101 or 105
If you are lacking on any of these skills, please
make sure you are comfortable with these skills by
next week
Structure of learning
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Expected time to spend on this class
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3 hours per unit per week
12 hours per week total
Format of learning
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Read first
Lecture
Do problems on your own
Solve problems in class and review sessions
Textbook for this class
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Rosen/Gayer
Public Finance, 8th edition
Published by McGraw-Hill/Irwin
Office hours and review sessions
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Office: NH 2028
Office hours:
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Mondays 10:30-11:30 am
Wednesdays 9:30-10:30 am
I plan on conducting one review session
before each test
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Time and location to be announced
Tests
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Three tests, as of now scheduled for:
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Monday, April 28 (in lecture)
Monday, May 19 (in lecture)
Monday, June 8 (final, 4-6:30 pm)
Some problems on tests will be similar to
what we cover in practice problems
Some questions will require you to learn
material and think your way through
Lecture slides
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I will post a subset of lecture slides on-line
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Usually posted 2 days to a week before lecture
Tables and figures from your textbook will often
not be posted
On-line slides are not meant to be a
replacement to lecture
Grading
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If you do not miss a test:
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Two best tests count 40% each
Lowest test counts 20%
Exception: If your best test is the final, the final
will count 60% and the other two tests count 20%
each
If you do miss a test, check the syllabus for
details
Grading
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Typical upper division Econ field class curve
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20-25% A+, A, or A30-35% B+, B, or B25-30% C+, C, or CRemaining students: D+, D, D-, or F
However, I will reward the class if you score
well as a group
More on this class
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Early on, I will lecture the entire time
Later on many lectures will be about 55-60
minutes, followed by problem solving
Some classes will be devoted to a single
topic
Some classes will consist of two to four “minilectures”
Problems
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Each week, I will post a few problems
The following week, I will solve some of the
problems at the end of each lecture, as time
permits
I will also solve some problems at each
review session
Today
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An introduction to Econ 130
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A brief review of Microeconomics (read Appendix)
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What will we cover over the next 10 weeks?
Supply, demand, and equilibrium
Utility
Budget constraints
Substitution and income effects
Consumer and producer surplus
Introduction to public finance: Begin Chapter 1
An introduction to Econ 130
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This class covers four “units,” each with three
to five lectures
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Unit 1: Introduction and Microeconomic tools
Unit 2: Public goods, externalities, and
government
Unit 3: Health care and income redistribution
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Includes guest lecture by Ted Bergstrom
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Tentative topic: Bone marrow as a public good
Unit 4: Primary and secondary effects of taxes
Unit 1 (begins today)
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Introduction and Microeconomic tools
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Appendix: Microeconomics review and marginal
analysis
Chapter 1: Introduction to public finance and
government
Chapter 2: Empirical tools
Chapter 3: Economic theory tools
Chapter 8: Cost-benefit tools
Unit 2
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Public goods, externalities, and government
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Chapter 4:
Chapter 5:
Chapter 6:
Chapter 7:
Public goods
Externalities
Government and political economy
Government spending on education
Unit 3
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Health care and income redistribution
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Chapter 9: Problems of insurance in the health
care market
Chapter 10: Government’s role in health care
Chapter 11: The structure of Social Security;
stresses caused by the baby boom generation
Chapter 12: Conceptual issues of income
redistribution
Chapter 13: Programs for the poor
Unit 4
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Primary and secondary effects of taxes
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Chapters 14 and 15, and parts of Chapter 16:
Taxation, income distribution, and efficiency
Parts of Chapters 17-21: Taxation on the national
level
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Personal taxes
Corporate taxes
Deficit finance
Tax reform
Chapter 22: Taxation on a state and local level
Microeconomics review
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Some topics you should already know
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We will assume standard cases
If you need review on these topics, look in the
Rosen/Gayer (“R/G”) appendix, or books that you
used in introductory or intermediate
microeconomics classes
Supply, demand, and equilibrium
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In equilibrium, the supply and demand curves
intersect
When quantity supplied is higher than
quantity demanded, there is a push for prices
to go down
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Excess supply
When quantity supplied is lower than quantity
demanded, there is a push for prices to go up
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Excess demand
Supply and Demand
Equilibrium: Q = 4, P = 6
Example of excess demand
Factors of demand
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Price: Higher price  lower quantity
demanded
Income: Most goods are normal
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Normal goods: Higher income means higher
demand
Price of related goods (complements,
substitutes)
“Tastes and preferences”
Factors of supply
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Price: Higher price  higher quantity
demanded
Price of inputs
Technology
Weather
Shift in demand;
movement along supply curve
Utility
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Utility is used by economists to note a level of
satisfaction
The higher the utility, the higher the
satisfaction
Bananas and utility
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Notice this example,
where the utility
level is a function of
the number of
bananas consumed
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Common unit of utility
is called a “util”
Typically assume
non-satiation
Banana
quantity
(bananas)
Total utility
(utils)
0
0
1
70
2
120
3
150
4
160
5
165
Two goods and utility
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An indifference curve
that is further from the
origin has higher
utility
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U2
Increasing
utility
U1
U0
U2 > U1 > U0
Budget constraints
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We assume each person has wants that are
above the resources available to her/him
Consumption must be made from resources
available
Budget constraints with no money
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Becky has a
given number of
hours per day
Feasible
bundles: t, v, w,
x, y, z
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Point t does not
use up her time
allotment
Point u is
infeasible
Budget constraints with no trade
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If there is no
trade:
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Becky chooses
production to
maximize her
utility
This occurs where
budget constraint
is tangent to an
indifference curve
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Point E1
E1
Substitution and income effects
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When the price of a good changes, two
things happen
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Income effect: How much does quantity change
due to lower income?
Substitution effect: How much does quantity
change due to change in relative prices?
Substitution and income effects
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Income effect
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Substitution effect
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E1 to Ec
Ec to E2
Note that budget lines
to calculate income
effect are parallel
Consumer surplus
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Height of triangle is
($6 – $3), or $3.
Length of triangle is
(6 – 0), or 6
Area of triangle is onehalf times length times
height
CS = $9
The area of this
triangle is a good
approximation of
CS
Producer surplus
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When P = 25 per unit,
shaded area is
approximate producer
surplus
Area is a triangle, onehalf times length times
height
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0.5  10  25 = 125
Summary: Microeconomics review
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Many microeconomic tools are needed to do
public finance
Some of the tools that we will use are based
on supply, demand, utility, and budget
constraints
Introduction to public finance
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This class is meant to cover public finance to
students that have no direct background in the topic
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Two topics will be covered in this “mini-lecture”
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Some knowledge on public goods and externalities is
useful, but not required
What is studied in a public finance class?
What kinds of views do people have about public finance?
Government will be addressed more in later lectures
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Size of government will be covered in the next lecture
Growth of government will be covered in week 4
Public finance
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Public finance, as defined by R/G (p. 2)
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“The field of economics that analyzes government
taxation and spending policies”
Public finance, as described by Former
Czech Prime Minister Vaclav Klaus (From
R/G, p. 2)
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“Public finance is nothing else than a
sophisticated discussion of the relationship
between the individual and the state”
Public finance
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We will study topics in which many argue that
government intervention is justified
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Public goods and markets with externalities
Subsidized education
Health care, Social Security, and income
redistribution
Public finance and taxes
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Many programs require tax money to operate
We will study how the governments on the
local, state, and national level operate
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Personal income tax
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Reaction to labor/leisure choices
Corporate taxes
Deficit financing
Potential reforms to the current tax structure
Public _____
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There are at least two other terms that mean
the same thing as public finance
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Public sector economics
Public economics
Although I may use the three terms
interchangeably to mean the same thing, I
will usually use the term “public finance”
What views do people have?
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Different people have different views about
public finance
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Organic view of government
Mechanistic view of government
Organic view of government
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Government treats an entire society as a
natural organism
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Each individual is part of the organism
The government is the heart
Although individual goals differ, some goals
are naturally needed for the societal
organism
Mechanistic view of government
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Government is needed for individuals to
pursue their individual goals
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“Invisible hand” (Adam Smith)
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Efficient markets under certain sets of conditions
Property rights and lack of violence needed to have
efficient markets
How much government beyond this is
debatable
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Libertarian: Small government
Social democrats: Larger government needed
What this class does
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Some analysis is done on a society-wide
scale
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Social costs and benefits
Cost-benefit analysis on a nationwide scale
Other topics talk about individual analysis
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Voting theory
Individual reaction to taxes and credits on labor
Determining what is “good”
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What is “good” to one person may be viewed
as bad as others
Let’s do an activity to illustrate this
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Everyone starts by standing up
I will show a statement
Stay standing if you agree with the statement
Sit down if you disagree with the statement
There is no “right” answer to any question
Time to stand up
Statements 1-3
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I believe that reckless driving should be
stopped through government actions (such
as the use of police)
I think that government should build and
maintain roads and highways
I believe that each baby needs to be securely
buckled into a car seat while riding in a car, to
be enforced by the government
Statements 4-6
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I believe that each person in a moving car
needs a seat belt on, to be enforced by the
government
I believe each driver needs liability insurance,
to be enforced by the government
I believe the government has a right to
regulate when each person can use the
roads, and the route they take, in order to
control traffic patterns
Statements 7-9
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I believe that the government has a right to
prevent pilots of commercial aircraft from
using a cell phone while actively flying
I believe that the government has a right to
prevent drivers of cars from using a cell
phone while driving
I believe that the government should charge
a 90% tax rate on all income I earn in my
lifetime
Does everyone agree?
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No
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Different people have different opinions about
what the government should do
Experts often disagree about what
government should do
We will often assume that the experts in other
disciplines have gotten costs and benefits
right
Summary: Introduction to Public Finance
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Many topics studied in public finance
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Topics related to government intervention
Tax-related topics
Different viewpoints about government
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Organic view
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Society is an organism
Mechanistic view
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Government used to reach individual goals
Some ground rules at the end of lecture
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I will always try to be done by 3:15 pm
In return, I expect your attention until the final
slide
If you must leave early:
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Please do so no later than 3:05 pm
Sit near an exit
Leave quickly and quietly
Example of final slide
Some ground rules at the end of lecture
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After many of the lectures
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Problem solving
Your questions (especially near test time)
Review of test questions
You are welcome to leave after lecture is
finished
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Please do so quickly and quietly