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Book Notes Chapter 1

by: Cindy Osorto

Book Notes Chapter 1 ECO 4504

Cindy Osorto
Public Finance and Public Policy

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This is a detailed account of the introductory chapter for the book. All definitions and main topics are included.
Public Finance and Public Policy
Class Notes
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This 7 page Class Notes was uploaded by Cindy Osorto on Friday January 30, 2015. The Class Notes belongs to ECO 4504 at Florida International University taught by Murgo in Winter2015. Since its upload, it has received 100 views. For similar materials see Public Finance and Public Policy in Economcs at Florida International University.


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Date Created: 01/30/15
COLOR MEANING Blue means chapter highlighted vocabulary word Purple means in chapter vocabulary word CHAPTER 1 Why Study Public Finance 0 Introduction of Chapter The Affordable Care Act ACA is an example of public finance Passed in March 2010 by President Obama it is projected to cost about 1 trillion in the next decade The funding will be divided upon different sectors including cutting current health programs and raising taxes on different sectors The policy was extremely controversial many of the questions asked about the ACA deal with public finance 0 11 The Four Questions of Public Finance Definition Public finance is the study of the role of the government in the economy 9997 When should the government intervene in the economy How might the government intervene What is the effect of those interventions on economic outcomes Why do governments choose to intervene in the way that they do 0 A When should the government intervene in the economy The government should intervene when action would maximize efficiency The economy is assumed to be made up of producers and consumers Efficiency exists when an action or trade makes at least of the parties better off without harming the other party Total efficiency can take multiple trades A crucial lesson of Microeconomics is that competitive market equilibrium is the most efficient outcome for society but there are two cases in which governments intervene in competitive markets market failures and market redistribution O Market Failures I Definition Market Failure is a problem that causes the market economy to deliver an outcome that doesn t maximize efficiency I There are a variety of types of market failures One example is in the health industry A large amount of people though a minority of the population didn t have health insurance prior to the ACA this implied according to economic thinking that people without insurance didn t value it enough to buy at existing prices The competitive market equilibrium left about 49 million people uninsured and this large number amounted to negative extemalities that could be avoided if the uninsured number drastically decreased I Negative externalities are negative costs to others that aren t barred by an individual who made a decision for example an uninsured sick person causing a domino effect of other sick people The government is considered as a healthcare provider because they may have the potential to reduce negative externalities and improve efficiency after all they have access to the costs and benefits of individuals and society as a whole I Application The Measles Epidemic of 1989 1991 A case study that showed successful government intervention in providing a larger percentage of kids with measles vaccination and thus reducing measles sick cases drastically O Redistribution I Definition Redistribution is the shifting of resources from some groups in society to others I If economy is a pie then the size of the whole pie is the size of the economy For example market failures entail a smaller pie and possible government intervention The slice of pie per person also is considered A single dollar for a poor person can be seen as more economically valuable than for a wealthy person because it entails more survival based spending Redistribution can ensue I Redistribution may result in a loss of efficiency Efficiency loss is the shifting of individuals behavior away from their efficiency maximizing point The rich may work less the poor may work less Equity efficiency trade off entails that societies typically have to choose between pies that are larger and more unequally distributed and pies that are smaller and more equally distributed 0 B How might the government intervene O Tax or Subsidize Private Sale or Purchase definition price mechanism is the change of a goods price by the government A tax would increase the price for an overproduced good A subsidize would decrease the price of an underproduced goods The change in price may re ect in producer sales or consumer prices O Restrict or Mandate Private Sale or Purchase Restriction promotes decreasing overproduced goods Mandates promotes increasing underproduced goods example ACA O Public Provision Governments can provide a good directly in order to achieve a certain level of consumption O Public Financing of Private Provision Governments may hire private entities to in uence the public to achieve a certain level of consumption 0 C What Are the Effects of Alternative Interventions O Section intro Involves consideration of effects of each policy option Empirical public finance is the collection of data and statistics to determine how people and firms may react to a policy option O Direct Effects I Definition direct effects are the effects of government interventions that would be predicted if individuals didn t change their behavior in response to the interventions I For example with the ACA the uninsured stay uninsured and the insured remain insured Estimates can be gathered with current data on each group O Indirect Effects I Definition indirect effects are the effects of government interventions that arise only because individuals change their behavior in response to the interventions I For example with the ACA the insured may switch to being uninsured in order to receive free healthcare Estimates would be a little harder to predict in this case 0 D Why Do Governments Do What They Do O Similar question why things are the way they are O Definition political economy is the theory of how the political process produces decisions that affect individuals and the economy O Government failures is a possibility as well interventions may be done inappropriately O 12 Why Study Public Finance Facts on Government in the US and Around the World 0 Governments play a dominant role in daily living Facts O The Size and Growth of Government I figure 1 1 Federal Government Spending as a Percent of GDP 1930 2011 Shows that government spending was 3 in 1930 about 40 during WW2 around 1943 and since then averaged around 20 GS grows during recessions I figurel 2 Total Government Spending Across Developed Nations 1960 2013 Shows that government spending has grown as a whole throughout the world though pace of growth has varied I Question to ponder what explains the growth in government spending over the twentieth century O Decentralization I Centralization entails the division of government spending between higher levels federal and lower levels state local I Figure 1 3 Pie chart of federal expenditures vs state and local expenditures The latter accounts for about a third of total government spending with about 10 of GDP spending Federal accounts for about 20 of GDP I Question to ponder what is the appropriate extent of centralization and decentralization in government activity O Spending Taxes Deficits and Debts I With a budget any excess of income is a cash ow surplus that can be saved to finance other spending any shortfall of income below spending is a cash ow deficit and can be financed by past savings or by borrowing Borrowing results in debt and must be repaid in the future 0 Debt is financed by borrowing from all over the world 0 Figure 1 4 For most of the 20th century revenues and expenditures have been at nearly identical levels except for the world war 2 period until the 1970s The government debt is not at over 60 of GDP 0 The debt of the US is typical of developed nations though there s variation between countries 0 State and local revenues almost always exceed expenditures although surpluses have been near zero recently 0 Questions to ponder What are the costs of having larger deficits and a larger national debt Why are state and local governments able to balance their budgets while the federal government isn t O Distribution of Spending I The composition of government spending has changed over time 0 Figure 1 7 Federal and State expenditures 1960 and 2010 For the federal government defense spending has fallen and social security and health spending has risen For state government the distribution has been relatively constant which a small decline in education and welfare spending and a rise in health spending I Definition public goods are goods for which investment by any one individual benefits everyone in a larger group O The private sector doesn t provide these goods because private sector only considers profit rather than overall wellbeing I Definition social security programs are government provision of insurance against adverse events to address failures in the private insurance market I Question to ponder Are government interventions in insurance markets warranted and do they decrease the likelihood for market failures What is the appropriate type of spending to be done at the federal level versus the state or local levels O Distribution of Revenue Sources I The current major source of income for the federal government is through the collective individuals income tax a tax levied on the income of US residents I Figure 1 8 Distribution of Federal and State Revenues 1960 and 2011 At the federal level there has been a large reduction in corporate and excise tax taxes set on certain goods such as alcohol or tobacco revenues and a rise in payroll tax revenues For state level there has been a decline in property taxes and a rise in income taxes and federal grants I Question to ponder what are the implications of shifting from taxation of property to taxation of income O Regulatory Role of the Government I the government regulates economic and social activities I Main governmental branches include the Food and Drug Administration FDA agency the Occupational Safety and Health Administration OSHA the Federal Communications Commission FCC and the Environmental Protection Agency EPA O 13 Why Study Public Finance Now Policy Debates over Social Security Healthcare and Education Q Social Security I This is a huge issue of our time due to baby boomers There are about 75 million people considered a baby boomer that were born between 1946 aand 1964 they re approaching old age and are in need of retirement aid By 2050 the working age taxpayer to elderly recipients ratio is estimated to be about 3 to l This implies a shortage of fund at present levels I Liberal view The social security system has worked well and we should continue funding revenue may come from income taxes or other taX increases The downside to this is that raising taxes can reduce the economy s efficiency I Conservative view The social security system should be replaced with a system where individuals save for their own retirement instead of having young people pay for the elderly The downside to this is that the elderly can t be left to manage on their own and there must be some form of financing made available for them 0 Question How big of a role should government have in regulating for a person39s retirement How can government best reform social security without having it crumble over time Q Health Care I Health care costs are currently rising much faster than GDP at current levels it is account for about 18 of GDP rather than just 5 in 1950 I Liberal view Government should finance everyone s insurance with centrally imposed cost controls such as Canada I Conservative view Health care problems ca be solved through taX subsidies to private insurance companies and increasing competition by offering more individual choice and information I The ACA doesn t solve all the problems at hand However it did good by offering better insurance regulation mandating everyone to have insurance and introducing large insurance subsidies O Education I A 2009 study found that 15 year olds in America often fall behind other nations kids in areas of reading math and science Among 65 countries America ranked 17th in reading 23rd in science and 35th in math skills I Liberal view There are not enough resources in the educational system Teachers need to be paid better and more resources should be made available in disadvantaged areas I Conservative view Our system is broken and no amount of resources will fiX that Public schools do not have incentives to improve performance since they act as local monopolies School choice should be more competitive O 14 Conclusion O The government plays an important role in the lives of Americans There is widespread disagreement as to the type and size of role they should have


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