The role of government
Today: Public goods; government
failure; taxation
Today

Three mini-lectures on the role of
government

Public goods


Government failure


Sub-optimal results when privately funded
Pork and political gain
Taxation


How much is “enough?”
What should we tax?
Public goods

Public goods are goods that have some
degree of two characteristics



Nonrival
Nonexcludable
Positive externalities lead to suboptimal
consumption when public goods are
privately purchased
Definitions

Nonrival good (F/B p. 448)


“A good whose consumption by
one person does not diminish
its availability to others”
Nonexcludable good (F/B p.
448)

A good that is difficult, or
costly, to exclude nonpayers
from consuming

Pure public good
(F/B p. 448)

A good or service
that, to a high
degree, is both
nonrival and
nonexcludable
Categories of goods
Nonexcludable
Nonrival
Low
High
High
Commons good
(oxygen that you
breathe)
Public good
(lighthouses)
Low
Private good
(pens)
Collective good
(copyrighted books)
Categories of goods
Nonexcludable
Nonrival
Low
High
High
Commons good
(oxygen that you
breathe)
Public good
(lighthouses)
Low
Private good
(pens)
Collective good
(copyrighted books)
Covered in earlier chapters; uses basic
supply/demand theory
Categories of goods
Nonexcludable
Nonrival
Low
High
High
Commons good
(oxygen that you
breathe)
Public good
(lighthouses)
Low
Private good
(pens)
Collective good
(copyrighted books)
Covered in Chapter 12
Categories of goods
Nonexcludable
Nonrival
Low
High
High
Commons good
(oxygen that you
breathe)
Public good
(lighthouses)
Low
Private good
(pens)
Collective good
(copyrighted books)
Goods with copyright or patent protection
have some level of market power
Public goods

We will examine pure public goods



Highly nonrival
Highly nonexcludable
Marginal analysis is used to find the
optimal quantity

Optimal quantity is where PUBLIC MB
equals MC
Example

Fireworks show off of a tiny coastal
community


25 people live here
Each person has the same private demand for
fireworks



P = 2 – 0.08 Q
MC for fireworks is 10
Notice that if fireworks were publicly
purchased, nobody would buy them (10 > 2)
Fireworks show as a public
good


Since one person’s enjoyment of
fireworks does not take away from the
enjoyment from others, PUBLIC MB is
the sum of PRIVATE MBs
PUBLIC MB is the vertical summation of
all 25 PRIVATE MBs

P = 25  (2 – 0.08 Q) = 50 – 2Q
Vertical summation

Vertical
summation
of 25
PRIVATE
MB lines
produces
PUBLIC MB
line
PUBLIC
MB
MC
PRIVATE MB
Marginal analysis

To find efficient level of fireworks, set
PUBLIC MB = MC


50 – 2Q = 10
Q = 20
Summary: Public goods



Public goods are goods that are nonrival and
nonexcludable
Private provision of public goods leads to a
quantity provided that is below the optimal
quantity
Vertical summation of PRIVATE MBs
determines PUBLIC MB

Useful in determining optimal quantity of public
good
Government failure


Governments often fail the MB/MC test
on a public scale
Three methods for political gain



Pork barrel legislation
Price supports
Rent seeking
Governments in a democracy

We vote in an indirect
democracy

We elect people to represent
us




US House of Representatives
US Senate
Various state and local elections
We elect these people with
the hope that they serve our
interests, especially with
market failures
Pork barrel legislation

Consider the US Congress

435 members of the House of
Representatives


Each member of the House is interested in
satisfying the people living in her/his district
Each member of the House may decide to try
to pass legislation that is beneficial to her/his
home district, even though people in other
districts pay taxes to pay for the project
Pork barrel legislation

Congress members in the House have
2-year terms


They often act in a way to get re-elected
Bringing spending projects to their home
districts are usually helpful in getting reelected
Pork barrel legislation

Will other Congress members stop pork
barrel practices?


Not if they want their own pork policies
passed
When politicians agree to pass each
other’s pork policies, this is known as
logrolling
Price supports

Another issue related to government
failure involves price supports

Firms try to influence politicians in order to
increase profits for their businesses

Proposals often have big gains to a few and
small losses to many


Example: Agricultural subsidies
These proposals very often lead to lower
efficiency
Price supports

Why do price-support measures pass when
efficiency is lowered?

Those that lose are often unaware of the program


Example: The US has had programs to keep the price of
peanuts artificially high
Finding out information of all governments
programs is costly (Recall Ch. 13)

Most voters will not find out about government programs
that are not in their best interest
Rent-seeking

Sometimes, a government determines a
single winner for a contract


Many firms will often spend a substantial
amount of money to gain the contract


Example: One firm is chosen to establish a type
of beneficial technology
These efforts are unproductive to society; this is
known as rent-seeking
See Example 16.6 (p. 462) for the classic
example of auctioning a $20 bill
Ways to lessen
government failure

Campaign reform laws



Restrict spending and corporate influence
More informed voters
Cost-benefit criteria for government
spending
Summary: Government failure


Governments can step in to correct
market failures
Governments can also make decisions
that lower efficiency



Pork barrel legislation
Price supports
Rent-seeking
Taxation

Taxes are the most important source for
government revenue



Income
Property
Corporate
How much is enough?

Governments can continue to charge
more taxes to get more revenue, right?


No: If taxes were 100%, people would
have no incentive to work
What is the largest amount of tax revenue
that can be generated?
How much is enough?

The taxrevenue
relationship was
popularized by
Arthur Laffer

Maximum tax
revenue occurs
at tax rate t*
What is t*?



There is debate as to what t* is
Most people believe that t* is
substantially less than 100%
This leads to the question…

What should be taxed?
What should be taxed?

There are clearly situations in which the
government’s actions improve overall
efficiency





Schools
Parks
National defense
Roads and highways
What should be taxed to limit DWL?
What should be taxed?

Anything such that the DWL is less than
efficiency gain from the government’s
actions with the money generated


Goods with inelastic demand
Markets with negative externalities

Goods that pollute
Summary: Taxation



Taxes come from many sources
The Laffer curve shows that the tax rate
that maximizes tax revenue is less than
100%
Some goods can be taxed such that the
marginal social benefit is greater than
the DWL of the tax
Lecture material finished