Efficient
Inefficient
Consumption Goods
D = MSB
0
Q1 Qe
Q2
Apples
business cycle
recessions economic booms
Redistribution
redistributive tax structure redistribution in cash and in kind
Stabilization
fiscal policy monetary policy
Allocation
Externalities
Negative externality
costs not accounted for by economic decision maker
Positive externality
benefits not accounted for by economic decision maker
Causes divergence between market supply and MSC or market demand and MSB Thus, market equilibrium not efficient
that is, the market fails to achieve an efficient state society stands to gain from government correction of the market failure
B A
External cost
ABC = welfare loss triangle = net social gain from reducing output to Qeff
D=MSB
0
Qeff Qmarket
overproduction
Education
students receive private benefits from education others receive benefit of associating with educated person student cannot capture this public benefit
i.e., lacks property right needed to charge for this service to others
ABC = welfare loss triangle = net social gain from increasing output to Qeff
MSB D
0
Qmarket Qeff
Externality Policies
Pollution
Pigouvian taxes
tax factory
shifts S up to MSC how to measure value of pollution/amount of tax not common gas tax tax the product works in short run but no incentive to find less polluting technology tax the pollutant better long run incentives
pollution rights
1990 Clean Air Act
radical market-based departure from traditional reliance on standards power generating firms issued rights to pollute
these rights were for a level of pollution much lower than then-current levels
more pollution reduction by allowing firms that can reduce at lowest cost to reduce the most incentive to find new ways to produce power with less pollution anyone can buy, including environmental groups
want to rid the Earth of a ton of S02 each year? Itll cost you about $200!
Public Goods
an apple is a PRIVATE good national defense is a PUBLIC good What distinguishes private goods from public goods?
private goods are EXCLUDABLE public goods are NONEXCLUDABLE
an apple is a private good because a consumer who does not pay the price can be excluded from consuming it no one can be excluded from consuming public goods -- can anyone not be protected?
private goods are RIVAL in consumption public goods are NONRIVAL in consumption
if I eat an apple, you cannot when I consume national defense, its still there for you to consume
therefore, it costs nothing to provide to additional consumers therefore, the efficient price is zero
since no one can be excluded from consuming a public good, and since the efficient price is zero, the private sector would ordinarily not be able to provide it
WARNING! A good is public or private because of these characteristics, not because the government provides it or doesnt
governments provide all sorts of things, including private goods
e.g., electricity, steel
Government provides public goods at zero price Funding out of general budget
we pay taxes based on income, consumption, etc., not on the amount of public goods we consume
for example, a household earning $100,000 pays more tax than a household earning $10,000 but both consume the same national defense
Mixed Goods
Mixed goods have characteristics of both private and public goods
sometimes characteristics depend on circumstances
highways are nonrival as long as few drivers are on them but become rival with congestion
Monopoly
Perfectly competitive firms produce efficient output
efficient output where P=MC
Monopoly MC
Monopoly welfare loss
$ PM
Peff
D
0
QM
Qeff MR
Natural
very high fixed costs must be spread over whole market
breaking up makes no sense as it would raise average fixed costs that would be passed on to consumers
Monopoly Policy
Artificial
break up
prohibit collusion
anti-trust law
Natural
two possibilities
regulate to force firm to act as if it were a perfectly competitive firm
the usual response to natural monopoly
state provision
the usual response everywhere else
demerit
tobacco alcohol
Direct provision
Medicaid
Redistribution
Society cares about equity or fairness as well as efficiency Thus a role of government is to create a more fair distribution than the market produces
distribution of income distribution of opportunity
education health
What is Fair?
We know what an efficient allocation is We have no idea what a fair distribution is
equal income for all?
Mechanisms to Redistribute
Via the tax structure
progressive taxation negative income tax
Transfers
cash in-kind
Progressive Taxation
A progressive tax makes the aftertax (disposable) income more equal Burden of tax rises as income rises
as income rises, proportion of income paid as tax rises
in U.S., Federal Personal Income Tax
NIT Advantages/Disadvantages
Advantages
simple and straightforward
would be administered through income tax
Disadvantages
either t has to be high or IG low or NIT gets to be very expensive
Credits depend on income, children, and other factors affecting living expenses
States also have general assistance programs for singles or childless couples
energy assistance
maximum lifetime benefit of five years states may waive above requirements for disabled and others unable to work
no more than 20% of caseload
teen mothers on TANF required to live at home with responsible adult and attend school unmarried mothers who do not help establish paternity lose 25% of benefits
funds available to help enforce child-support laws states that reduce out-of-wedlock births the most receive bonus from Federal government
Each state responsible for establishing its own rules within Federal requirements
Florida cuts payments for additional children born to those on TANF Massachusetts limits support for two years in any five-year period Wisconsin exempts virtually no one from work requirement Mississippi has very low benefits and urges churches and charities to play greater role
Medicaid
Health care for the poor under 65 Jointly funded by Federal governments and states Eligibility determined by states
generally eligible if on TANF or SSI
Food Stamps
Federally funded and state administered Recipients receive coupons that can be redeemed for food and related items Varies with income and household size
Housing Assistance
Subsidized housing for the poor Public housing at low rents that vary by income Subsidies for private housing
% Total
Federal Program
Amount
Minimum Wage
Government legislation requiring firms to pay workers no less than a minimum wage
currently $5.15 per hour
Purpose to assure workers receive a living wage Makes low-skilled workers less employable
SL I: Better off - working at higher wage II: Worse off unemployed III: Want to work at higher wage but cannot find work DL
WMin WE
LMin LE
LS
Labor
II
III
Percent poor fell steeply from 1960 (22.2%) to 1973 (11.2%), rose to new high in 1983 (15.2%) and fell to 13.8% in 1995, 12.7% in 1998, and 11.8% in 1999
Ratio of rich to poor has risen steadily, however In 1947 ratio of richest fifth to poorest fifth of households was 8.6 In 1997 ratio was 13.7
Lorenz Curves
Graphical representation of distribution of income Table shows distribution by quintiles for 1968 and 1992
The diagonal represents perfect equality The more unequal, the more bowed out from the diagonal Good way to visualize, but not good when quantification needed
Gini Coefficient
100%
Percent income
Lorenz Curve
B
0%
100%
Gini coefficient takes value of zero with perfect equality and 1 with perfect inequality Gini coefficient makes it easy to plot distribution of income over time, as in the following graph
Increasing equality until late 60s followed by increasing inequality Table and graphs on Lorenz curve and Gini coefficient from
http://www.panix.com/~dhenwood/ Gini_supplement.html
Social Security
Several programs all funded through payroll taxes
government-provided pension
what most think of by the term Social Security
Brookings:
http://www.brookings.org/es/research/areas/soc ial/socsec.htm
NBER:
http://www.nber.org/socialsecurity/
Pension amount a function of past earnings, age, marital status, number of dependents, etc.
must have paid Social Security taxes for at least forty quarters to qualify
Pensions also paid to dependent spouses over 65 at one-half the workers pension
widows/widowers get what the spouse would have gotten
Incentive effects
obvious disincentive to work past 65
many opt to retire at 62 when Social Security becomes available at a reduced rate
Medicare spending amounts to over 11% of total federal spending or 2.4% of GDP
Unemployment Compensation
Income support for workers temporarily out of work
temporarily laid off lost job through fault not of their own
does not cover loss of job through misconduct does not cover work loss due to labor disputes
worker must be full-time and have worked a minimum time to qualify for benefits
Benefits normally last only for a maximum of 26 weeks Benefits extended 13 weeks in recessions Congress may extend even further Average worker uses only 8 weeks
Incentive effects
availability of unemployment compensation makes the period of unemployment easier to take both negative and positive effects
reduces incentive to look for a job
increases unemployment rate one study estimates that a ten percentage point increase in replacement rate increases unemployment by 1.5 weeks