PUBLIC ECONOMICS
Manuela Samek Lodovici – LIUC (msamek@irsonline.it)
James Wickham – Trinity College Dublin
Aim of the course
To examine the role of the public sector in modern
economies

To provide an understanding of the economic
rationale for government intervention,

To discuss the effects of government’s actions in
terms of efficiency and equity

Course outline
The course is organised into the following units:
1 - An introduction to public economics: the economic roles of government, the rationale and
limits of public intervention according to economic theory, its effects in relation to efficiency and
equity trade offs;
2 - Public expenditures: basic theory and application to some expenditure programmes, i.e.
welfare policies, education policies, employment policies, health care policies;
3 - Taxation: microeconomic and redistributive effects of fiscal policy and of the structure of
taxation.
4 – Welfare states and inequalities (Prof. Wickham)
References:

Lecture Slides

Textbooks on Public Economics :

E. Stiglitz, Economics of the public sector, W.W. Norton & Company, 3rd edition, 2000,
chapters 3,4,5, 6,7,8,9, 10,14, 15,16,17,19,20,26; or

J. Gruber, Public Finance and Public Policy, 2007. Chapters 2, 5, 6, 7, 11, 12,13, 14,17,
18,19, 20

in alternative other textbooks in the library , such as A.L. Hillman, Public Finance and Public
Policy, Cambridge, 2003.

Optional readings will be mentioned in the course
Examination
2 hours written examination at the end of the course;
optional: short paper (4-5 pages) and eventual oral presentation on one/two articles (+ 0-2
points on the grade of the written exam). The list of articles will be available by early November,
short papers to be handed in by December 21.
1. Introduction to public
economics





Public intervention is widespread and largely influence
our daily life:
The government provides goods and services (health,
assistance, education, defence, environment,
infrastructures, etc.),
it defines the rules for socio economic behaviour
(legal structure and property rights, environmental
regulation and protection of natural resources, safety
regulations, employment regulations, etc.)
it ensures a stable economic environment;
it finances its activities with taxation and this affects
the agents’ decisions on labour demand and supply and
on consumption.
The ratio public Deficit/GDP in the EU
= (TOTAL REVENUES – TOTAL EXPENDITURES)/GDP
Source: EC and Eurostat
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Austria
-4.2
-4.9
-5.6
-3.9
-1.8
-2.3
-2.2
-1.5
0.3
-0.2
-1.1
-1.3
Belgium
-7.3
-5.0
-4.3
-3.8
-2.0
-0.7
-0.4
0.2
0.6
0.1
0.4
0.1
Germany
-3.1
-2.4
-3.3
-3.4
-2.7
-2.2
-1.5
1.3
-2.8
-3.7
-3.8
-3.7
Greece
-13.4
-9.4
-10.2
-7.4
-4.0
-2.5
-1.8
-4.1
-3.6
-4.1
-5.2
-6.1
Finland
-7.3
-5.7
-3.7
-3.2
-1.5
1.5
2.2
7.1
5.2
4.3
2.5
2.1
France
-6.0
-5.5
-5.5
-4.1
-3.0
-2.7
-1.8
-1.4
-1.5
-3.2
-4.2
-3.7
Ireland
-2.7
-2.0
-2.1
-0.1
1.1
2.4
2.4
4.4
0.9
-0.4
0.2
1.3
Italy*
10.3
-9.3
-7.6
-7.1
-2.7
-2.8
-1.7
-0.8
-3.1
-2.9
-3.4
-3.4
Luxembourg
1.5
2.7
2.1
1.9
3.2
3.2
3.7
6.0
6.2
2.3
0.5
-1.1
Netherlands
-2.8
-3.5
-4.2
-1.8
-1.1
-0.8
0.7
2.2
-0.1
-1.9
-3.2
-2.5
Portugal
-8.9
-6.6
-4.5
-4.0
-3.0
-2.6
-2.8
-2.8
-4.4
-2.7
-2.9
-2.9
Spain
:
:
:
-4.9
-3.2
-3.0
-1.2
-0.9
-0.5
-0.3
0.3
-0.3
Euro-zone
(12
countries)
:
:
:
-4.3
-2.6
-2.2
-1.3
0.1
-1.7
-2.4
-2.8
-2.7
-4.9
-3.6
-3.1
-2.2
-0.8
0.4
0.9
1.6
-0.4
-3.8
-4.6
-4.4
United
States
2) Ratio Public Debt/GDP
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Austria
60.5
63.4
67.9
67.6
63.8
64.2
66.5
67.0
67.1
66.7
65.4
65.2
Belgium
137.
9
135.
9
134
130.2
124.8
119.6
114.8
109.1
108
105.4
100
95.6
Finland
55.9
58
57.1
57.1
54.1
48.6
47
44.6
43.8
42.5
45.3
45.1
France
45.3
48.4
54.6
57.1
59.3
59.5
58.5
56.8
57
59
63.9
65.6
Germany
46.9
49.3
57
59.8
61
60.9
61.2
60.2
59.4
60.9
64.2
66
Greece
110.1
107.
9
108.7
111.3
108.2
105.8
105.2
114.0
114.8
112.2
109.3
110.5
Ireland
95.1
89.6
81.8
73.3
64.5
53.8
48.6
38.3
35.8
32.6
32
29.9
Italy
118.
7
124.
8
124.
3
123.
1
120.
5
116.
7
115.
5
111.
2
110.
7
108
106.
8
106.
6
Luxembou
rg
6.8
6.3
6.7
7.2
6.8
6.3
5.9
5.5
7.2
7.5
7.1
7.5
Netherlan
ds
79.3
76.4
77.2
75.2
69.9
66.8
63.1
55.9
52.9
52.6
54.3
55.7
Portugal
59.1
62.1
64.3
62.9
59.1
55
54.3
53.3
55.9
58.5
60.1
61.9
Spain
58.4
61.1
63.9
68.1
66.6
64.6
63.1
61.1
57.8
55
51.4
48.9
Euro-zone
(12
countries)
66.2
68.9
73.6
75.2
74.9
74.2
72.7
70.4
69.6
69.5
70.8
71.3
United
States
75.4
74.6
74.2
73.4
70.9
67.7
64.1
58.2
57.9
60.2
62.5
63.4
Japan
74.9
79.7
87.1
93.9
100.3
112.2
125.7
134.1
142.3
149.5
157.6
164
Fundamentals of public economics

Public economics studies: the role of the government in market
economies, the rationale of its intervention and the economic and
social effects in terms of the efficiency and equity trade offs.

MAIN QUESTIONS:

When should the government intervene in the economy
(should the government intervene more or less than it
does?)
How might the government intervene (should it intervene
differently?)
What are the effects of public intervention?
How social choices are made?



When should the government intervene
in the economy?
Roles and instruments of Government
intervention





The public sector has different roles in market
economies:
Allocation of resources (efficiency goal)
Income (re)Distribution (equity goal)
Stabilisation fo the economic cycle
these roles interact with each other
When and how to intervene/1
Allocation role (efficiency)




The ALLOCATION ROLE is to provide efficiently
(increasing the size of the pie) goods and services
when the market is not able to produce them efficiently
(market failures) through:
The production of public goods or the public
financing of private provision: i.e. all those goods and
services which are not produced (or would be produced
inefficiently) by the market, due to market failures;
The regulation of market activities to support market
competition (property rights, legal system, restrictions )
Taxes and subsidies which change the market price of
goods/services
When and how to intervene/2
Redistributive role




The aim is to foster equity correcting the distribution
of resources resulting from market mechanisms by
shifting resources from some groups in society to
others and/or by changing initial endowments
through:
Monetary transfers (such as welfare benefits to
support the income of the poor or the unemployed)
Transfers in kind (provisions of public services
such as education, health services, social services)
Taxes/subsidies (for example with progressive
taxation or exemptions)
When and how to intervene/3
Stabilisation role



Smoothing over the business cycle and
external shocks, supporting full employment
and controlling inflation through:
Fiscal policy (transfers and taxation,
automatic stabilizers, public expenditures)
Support to productive activities
What are the effects of government
intervention: The analysis of government
failures






Behind public intervention in modern market economies
is the need to correct actual or perceived market
failures (efficiency goal) and to ensure and
equitable distribution of resources (equity goal)
However government intervention may also produce
negative direct and/or indirect effects (government
failures) due to:
Limited information
Limited control on private markets responses to public
intervention
Limited control over the public bureaucracy
Limitations imposed by the political process
What are the effects of public
intervention

Need to consider direct and indirect effects of public
intervention on individuals and markets:

Direct effects are those expected assuming that the
behaviour of economic agents do not change as a
consequence of government intervention

Indirect effects are those that arise because agents
change their behaviour in response of the
intervention (for example increasing taxation may
reduce labour supply)

Difficult to measure impacts and especially to
establish causation (see Gruber ch.3 if interested)
How decisions are taken?The analysis
of social choices



Political economy studies how the political
decision making process produces decisions that
affect individuals and the economy
This part of public economics analyses how socially
desiderable goals are chosen
Socially desiderable goals relate to:
- the capacity to support socio-economic growth
- the capacity to guarantee adequate living
conditions to citizens
- the capacity to guarantee equality in
opportunities for all
Key economic questions in public
economics








Efficiency:
What is produced, how it is produced and how much it is
produced (public vs private goods/services): given available
resources make the pie as large as possible
Equity
For whom it should be produced and who should pay for it:
distribute the pie in the most equitable way
How are decisions taken?
Trade offs:
an efficient outcome could be not equitable
an equitable outcome could be inefficient
Theoretical tools needed for Public
Economics (Stiglitz ch.3,5; Gruber ch.2)

Consumer theory (constrained utility
maximization)

Production theory

Equilibrium and social welfare theory