Introduction: Principles of Public Finance

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Introduction Principles of Public Finance
PA 546 Constantine Hadjilambrinos

• Lecture 1
• August 30, 2005

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GovernmentWhat is it good for?
PA 546 Constantine Hadjilambrinos

• Set common rules of behavior
• Protect citizens from external threats
• Pool resources for the common good
• Address and correct market failures

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PA 546 Constantine Hadjilambrinos
The Elements of Nonappropriability
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PA 546 Constantine Hadjilambrinos

• Non-rival use Once a good is provided for one
  consumer, the cost of supplying it to another
  consumer is zero. (Marginal cost 0)
• Non-exclusion Once a good is provided for one
  consumer all other consumers can use itcost
  allocation is impossible.
• Free rider A consumer who uses a benefit
  intended to promote certain behavior but who
  would have engaged in this behavior anyway.

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PA 546 Constantine Hadjilambrinos

• Externality Effect of market transaction
  imposed on a third party (neither producer nor
  consumer of the transaction good).
• Positive Third party receives benefits from
  transaction (vaccinations)Hidden benefits
  undersupply of good.
• Negative Third party incurs costs from
  transaction (factory pollution emissions)Hidden
  costs oversupply of good.

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Criteria for undertaking government action
PA 546 Constantine Hadjilambrinos

• Cost-benefit Do benefits to society exceed
  costs? (No distribution considerations) Kaldor
  Those benefiting could compensate losers.
• Pareto (optimal) Do at least some members of
  society benefit without any losing out?
• Majority rule (democracy) Do more members of
  society benefit than lose?
• Oligarchic (elite rule) Do those who control
  society benefit?
• Social justice (re-distributive) Do worse off
  members of society benefit?

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PA 546 Constantine Hadjilambrinos
Total benefit exceeds total cost (Benefit
36,000 Cost 20,000) Individual cost (evenly
distributed) is 4,000 ( 20,000/5 ) All
individuals benefit from the project Benefit is
not equal for each individual, ranging from
1,000 for C and E to 5,000 for D
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PA 546 Constantine Hadjilambrinos
Total cost exceeds total benefit (Benefit
19,000 Cost 20,000) Individual cost (evenly
distributed) is 4,000 ( 20,000/5 ) Three
individuals benefit from the project. Two
lose. If decision based on majority rule, and if
everyone voted strictly on self interest, project
would go forward, even though costs exceed
benefits.
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PA 546 Constantine Hadjilambrinos
Total benefit exceeds total cost (Benefit
20,000 Cost 12,500) Four individuals benefit
from the project. One loses. Costs can be
re-distributed, so they are proportional to
benefits (i.e., if one receives 15 of benefit,
he/she should pay 15 of the cost). In this way,
everyone benefits.
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Calculation of Individual Share of Total Benefits
and Benefit-Based Cost Share for Example 3
PA 546 Constantine Hadjilambrinos

• First, calculate the percent share of the total
  benefit for each individual

For example, for Individual A, the Individual
Share of Total Benefit is
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Calculation of Individual Share of Total Benefits
and Benefit-Based Cost Share for Example 3
PA 546 Constantine Hadjilambrinos

• Next, calculate the benefit-based cost share for
  each individual

For example, for Individual A, the benefit-based
cost share is