CHAPTER 16 Public Goods and Tax Policy Goods
CHAPTER 16 Public Goods and Tax Policy
Goods Classifications: n Excludable – can prevent people from consuming without paying n Rival in consumption – can not be consumed by more than one person at the same time
Four types of goods n Private goods: – excludable and rival in consumption n Collective goods (Artificially scarce goods): – excludable and non-rival in consumption n Commons goods (common resources): – non-excludable and rival in consumption n Public goods: – non-excludable and non-rival in consumption
Four types of goods
Goods Classification Rival Excludable Non-excludable Non-rival Private good (wheat) Collective good (pay-per-view TV) Commons good (fish in the ocean) Public good (national defense) From Table 16. 1, P. 365
HW 5 n Explain the characteristics of the 4 types of goods n 4 types: private; collective; common; public n List 5 goods that belong to each of the 4 types and explain
Private Goods: n Excludable and rival in consumption n Non-payers can be easily excluded n Each unit consumed by one person means one less unit available for others n the only goods that can be efficiently produced and consumed by market
Collective Good: (Artificially Scarce Goods) n Excludable but non-rival in consumption – It is not really scarce: use by one person does not reduce its availability to others – But it can be excludable: people who do not pay can be prevented from using it
Artificially Scarce Goods An artificially scarce good is excludable and non-rival in consumption. It is made artificially scarce because producers charge a positive price but the marginal cost of allowing one more person to consume the good is zero.
Common Goods: (Common Resources) n Non-excludable and rival in consumption – Non-payers cannot be easily excluded – Each unit consumed by one person means one less unit available for others n The problem of overuse - a user depletes the amount of the common resource available to others but does not take this cost into account when deciding how much to use the common resource
A Common Resource Fishing in a public river: Each fisherman’s individual marginal cost does not include the cost that his or her actions impose on others: the depletion of the common resource the marginal social cost curve, MSC, lies above the supply curve; in an unregulated market, the quantity of the common resource used, QMKT, exceeds the efficient quantity of use, QOPT.
The Efficient Use and Maintenance of a Common Resource n Use taxes n Make it excludable and assign property rights n Create of a system of tradable licenses for the right to use the common resource
Public Good: n. A good or service that, at least to some degree, is both non-rival and nonexcludable – Non-rival Good • A good whose consumption by one person does not diminish its availability to others – Non-excludable Good • A good that is difficult, or costly, to exclude nonpayers from consuming
If non-excludable: n Rational consumers won’t be willing to pay for the good n People who do not pay can not be prevented from consuming n Free-rider problem: individuals have no incentive to pay for their own consumption n Inefficiently low production
If non-rival in consumption n Marginal cost = 0 n Price should be 0 n Inefficiently low consumption
What goods and services should government provide? n Pure Public Good – A good or service that, to a high degree, is both non-rival and non-excludable n Pure public goods should be provided by government because: – For-profit private firms would find it difficult to recover their costs of production. – Since the MC of serving additional users is zero once the good has been produced, then charging for the good would be inefficient.
Cost-Benefit Analysis n Social costs and social benefits n People have no incentive to pay for efficient quantity of public goods n People tend to overstate the value of public goods (people tend to prefer too much of the goods when they don’t have to pay for it: marginal cost is 0)
Advantages of Using Government to Provide Public Goods n Cost of adding a tax is relatively low n Minimizes the difficulty in determining who will bear what share of the tax burden n May be the only feasible provider
Government Provision n. A pure public good should be provided by the government only when the benefit exceeds the cost. n The cost of the public good is the sum of the explicit and implicit costs incurred to produce it. n The benefit of the public good is the sum of the reservation prices of all people who want the good.
Government taxes: the way to finance public goods n Paying for Public Goods – Not everyone benefits equally from a public good or service. – Therefore, the most equitable way to pay for the public good or service is to tax people in proportion to their willingness to pay.
Tax System n Head Tax – A tax that collects the same amount from every taxpayer – A head tax rule will rule out the provision of many worthwhile public goods. n Proportional Income Tax – A tax under which all taxpayers pay the same proportion of their incomes in taxes
Tax System n Regressive Tax – A tax under which the proportion of income paid in taxes declines as income rises n Progressive Tax – One in which the proportion of income paid in taxes rises as income rises.
Alternatives to using taxes to fund public goods: n Funding by donation n Development of new means to exclude non-payers n Private contracting n Sale of by-products
Tax System n Trade-off between equality and efficiency – Equity: fairness, the “right” people actually bears the tax burden – Efficiency: minimizes the direct and indirect tax collection costs to the economy
Tax Efficiency n. Minimizing administration costs (direct costs) n. Reducing deadweight loss (indirect costs)
Recall: excise tax
To Reduce Deadweight Loss n Taxes decreases the price the producers receive and increases the price the consumers pay n The incidence of tax is determined by the elasticities of demand supply n To reduce the deadweight loss caused by tax, impose taxes on the ones who have the most inelastic responses
To Lower Administration Costs n Administration costs: the resources actually spent on collecting and paying the taxes n The difficulties of calculating, collecting and paying the taxes
Tax Fairness n The benefits principle – The ones who benefit from the spending should pay for it n The ability to pay principle – The ones who are more able to pay should pay for it
The Tax System n Tax bases: the income or property value that determines how much tax an individual pays n Tax Structure: how the tax depends on the tax base – Proportional – Progressive – Regressive
Income Redistribution through Taxes and Government Spending n Progressive taxes: taking more money away from the rich to provide supports for the poor n Government Spending: transfer payments – Welfare – In-kind transfers – Negative income tax
Income Redistribution: Social Security n. Progressivity (vertical equity) n. Individual equity n. Horizontal equity n. Economic efficiency
Progressivity: Redistribution from the better-off to the less well-off n Redistribute resources to the elderly from the rest of the population (intergenerational redistribution n Higher rate of return on the contributions of workers with lower wages than for those with higher wages
Individual Equity Ensuring a fair return on contribution n Individuals should be paid retirement benefits that, on average, equal their contributions plus a fair interest rate n The allocative and distributive functions of government are combined into a single program n Benefits are paid out before adequate contributions have been built up
Horizontal Equity Equal treatment for equals n Equal assessment of payroll taxes on those with equal earnings n Equal benefits to those born in the same year, with equal earnings histories, and of the same family type
Economic Efficiency Achieving maximum benefit to society from available resources n Minimize any losses of efficiency that might arise unintentionally
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