Public Finance Instructor: John Hartman

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Public FinanceInstructor John Hartman

• Today An introduction to Econ 130 A review
  of microeconomics Introduction to
  public finance

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Before we begin

• Remember that this is a small class ? Ask
  questions if things are not clear
• The syllabus is posted online ? See
  http//econ.ucsb.edu/hartman/
• For most of you, attendance is important if you
  want to get a good grade

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Before we begin

• I expect you to know the following tools
• Calculus
• Derivatives, integrals, partial derivatives
• Microeconomics
• Econ 1, Econ 100A or 104A, Econ 100B or 104B
• Macroeconomics (although not as important for
  public finance)
• Econ 2, Econ 101 or 105
• If you are lacking on any of these skills, please
  make sure you are comfortable with these skills
  by next week

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Structure of learning

• Expected time to spend on this class
• 3 hours per unit per week
• 12 hours per week total
• Format of learning
• Read first
• Lecture
• Do problems on your own
• Solve problems in class and review sessions

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Textbook for this class

• Rosen/Gayer
• Public Finance, 8th edition
• Published by McGraw-Hill/Irwin

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Office hours and review sessions

• Office NH 2028
• Office hours
• Mondays 1030-1130 am
• Wednesdays 930-1030 am
• I plan on conducting one review session before
  each test
• Time and location to be announced

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Tests

• Three tests, as of now scheduled for
• Monday, April 28 (in lecture)
• Monday, May 19 (in lecture)
• Monday, June 8 (final, 4-630 pm)
• Some problems on tests will be similar to what we
  cover in practice problems
• Some questions will require you to learn material
  and think your way through

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Lecture slides

• I will post a subset of lecture slides on-line
• Usually posted 2 days to a week before lecture
• Tables and figures from your textbook will often
  not be posted
• On-line slides are not meant to be a replacement
  to lecture

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Grading

• If you do not miss a test
• Two best tests count 40 each
• Lowest test counts 20
• Exception If your best test is the final, the
  final will count 60 and the other two tests
  count 20 each
• If you do miss a test, check the syllabus for
  details

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Grading

• Typical upper division Econ field class curve
• 20-25 A, A, or A-
• 30-35 B, B, or B-
• 25-30 C, C, or C-
• Remaining students D, D, D-, or F
• However, I will reward the class if you score
  well as a group

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More on this class

• Early on, I will lecture the entire time
• Later on many lectures will be about 55-60
  minutes, followed by problem solving
• Some classes will be devoted to a single topic
• Some classes will consist of two to four
  mini-lectures

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Problems

• Each week, I will post a few problems
• The following week, I will solve some of the
  problems at the end of each lecture, as time
  permits
• I will also solve some problems at each review
  session

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Today

• An introduction to Econ 130
• What will we cover over the next 10 weeks?
• A brief review of Microeconomics (read Appendix)
• Supply, demand, and equilibrium
• Utility
• Budget constraints
• Substitution and income effects
• Consumer and producer surplus
• Introduction to public finance Begin Chapter 1

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An introduction to Econ 130

• This class covers four units, each with three
  to five lectures
• Unit 1 Introduction and Microeconomic tools
• Unit 2 Public goods, externalities, and
  government
• Unit 3 Health care and income redistribution
• Includes guest lecture by Ted Bergstrom
• Tentative topic Bone marrow as a public good
• Unit 4 Primary and secondary effects of taxes

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Unit 1 (begins today)

• Introduction and Microeconomic tools
• Appendix Microeconomics review and marginal
  analysis
• Chapter 1 Introduction to public finance and
  government
• Chapter 2 Empirical tools
• Chapter 3 Economic theory tools
• Chapter 8 Cost-benefit tools

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Unit 2

• Public goods, externalities, and government
• Chapter 4 Public goods
• Chapter 5 Externalities
• Chapter 6 Government and political economy
• Chapter 7 Government spending on education

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Unit 3

• Health care and income redistribution
• Chapter 9 Problems of insurance in the health
  care market
• Chapter 10 Governments role in health care
• Chapter 11 The structure of Social Security
  stresses caused by the baby boom generation
• Chapter 12 Conceptual issues of income
  redistribution
• Chapter 13 Programs for the poor

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Unit 4

• Primary and secondary effects of taxes
• Chapters 14 and 15, and parts of Chapter 16
  Taxation, income distribution, and efficiency
• Parts of Chapters 17-21 Taxation on the
  national level
• Personal taxes
• Corporate taxes
• Deficit finance
• Tax reform
• Chapter 22 Taxation on a state and local level

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Microeconomics review

• Some topics you should already know
• We will assume standard cases
• If you need review on these topics, look in the
  Rosen/Gayer (R/G) appendix, or books that you
  used in introductory or intermediate
  microeconomics classes

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Supply, demand, and equilibrium

• In equilibrium, the supply and demand curves
  intersect
• When quantity supplied is higher than quantity
  demanded, there is a push for prices to go down
• Excess supply
• When quantity supplied is lower than quantity
  demanded, there is a push for prices to go up
• Excess demand

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Supply and Demand
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Equilibrium Q 4, P 6
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Example of excess demand
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Factors of demand

• Price Higher price ? lower quantity demanded
• Income Most goods are normal
• Normal goods Higher income means higher demand
• Price of related goods (complements, substitutes)
• Tastes and preferences

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Factors of supply

• Price Higher price ? higher quantity demanded
• Price of inputs
• Technology
• Weather

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Shift in demandmovement along supply curve
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Utility

• Utility is used by economists to note a level of
  satisfaction
• The higher the utility, the higher the
  satisfaction

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Bananas and utility

• Notice this example, where the utility level is a
  function of the number of bananas consumed
• Common unit of utility is called a util
• Typically assume non-satiation

Banana quantity (bananas) Total utility (utils)
0 0
1 70
2 120
3 150
4 160
5 165
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Two goods and utility

• An indifference curve that is further from the
  origin has higher utility
• U2 gt U1 gt U0

U2
Increasing utility
U1
U0
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Budget constraints

• We assume each person has wants that are above
  the resources available to her/him
• Consumption must be made from resources available

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Budget constraints with no money

• Becky has a given number of hours per day
• Feasible bundles t, v, w, x, y, z
• Point t does not use up her time allotment
• Point u is infeasible

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Budget constraints with no trade

• If there is no trade
• Becky chooses production to maximize her utility
• This occurs where budget constraint is tangent to
  an indifference curve
• Point E1

E1


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Substitution and income effects

• When the price of a good changes, two things
  happen
• Income effect How much does quantity change due
  to lower income?
• Substitution effect How much does quantity
  change due to change in relative prices?

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Substitution and income effects

• Income effect
• E1 to Ec
• Substitution effect
• Ec to E2
• Note that budget lines to calculate income effect
  are parallel

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Consumer surplus

• Height of triangle is (6 3), or 3.
• Length of triangle is (6 0), or 6
• Area of triangle is one-half times length times
  height
• CS 9

The area of this triangle is a good approximation
of CS
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Producer surplus

• When P 25 per unit, shaded area is approximate
  producer surplus
• Area is a triangle, one-half times length times
  height
• 0.5 ? 10 ? 25 125

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Summary Microeconomics review

• Many microeconomic tools are needed to do public
  finance
• Some of the tools that we will use are based on
  supply, demand, utility, and budget constraints

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Introduction to public finance

• This class is meant to cover public finance to
  students that have no direct background in the
  topic
• Some knowledge on public goods and externalities
  is useful, but not required
• Two topics will be covered in this mini-lecture
• What is studied in a public finance class?
• What kinds of views do people have about public
  finance?
• Government will be addressed more in later
  lectures
• Size of government will be covered in the next
  lecture
• Growth of government will be covered in week 4

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Public finance

• Public finance, as defined by R/G (p. 2)
• The field of economics that analyzes government
  taxation and spending policies
• Public finance, as described by Former Czech
  Prime Minister Vaclav Klaus (From R/G, p. 2)
• Public finance is nothing else than a
  sophisticated discussion of the relationship
  between the individual and the state

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Public finance

• We will study topics in which many argue that
  government intervention is justified
• Public goods and markets with externalities
• Subsidized education
• Health care, Social Security, and income
  redistribution

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Public finance and taxes

• Many programs require tax money to operate
• We will study how the governments on the local,
  state, and national level operate
• Personal income tax
• Reaction to labor/leisure choices
• Corporate taxes
• Deficit financing
• Potential reforms to the current tax structure

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Public _____

• There are at least two other terms that mean the
  same thing as public finance
• Public sector economics
• Public economics
• Although I may use the three terms
  interchangeably to mean the same thing, I will
  usually use the term public finance

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What views do people have?

• Different people have different views about
  public finance
• Organic view of government
• Mechanistic view of government

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Organic view of government

• Government treats an entire society as a natural
  organism
• Each individual is part of the organism
• The government is the heart
• Although individual goals differ, some goals are
  naturally needed for the societal organism

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Mechanistic view of government

• Government is needed for individuals to pursue
  their individual goals
• Invisible hand (Adam Smith)
• Efficient markets under certain sets of
  conditions
• Property rights and lack of violence needed to
  have efficient markets
• How much government beyond this is debatable
• Libertarian Small government
• Social democrats Larger government needed

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What this class does

• Some analysis is done on a society-wide scale
• Social costs and benefits
• Cost-benefit analysis on a nationwide scale
• Other topics talk about individual analysis
• Voting theory
• Individual reaction to taxes and credits on labor

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Determining what is good

• What is good to one person may be viewed as bad
  as others
• Lets do an activity to illustrate this
• Everyone starts by standing up
• I will show a statement
• Stay standing if you agree with the statement
• Sit down if you disagree with the statement
• There is no right answer to any question
• Time to stand up

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Statements 1-3

• I believe that reckless driving should be stopped
  through government actions (such as the use of
  police)
• I think that government should build and maintain
  roads and highways
• I believe that each baby needs to be securely
  buckled into a car seat while riding in a car, to
  be enforced by the government

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Statements 4-6

• I believe that each person in a moving car needs
  a seat belt on, to be enforced by the government
• I believe each driver needs liability insurance,
  to be enforced by the government
• I believe the government has a right to regulate
  when each person can use the roads, and the route
  they take, in order to control traffic patterns

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Statements 7-9

• I believe that the government has a right to
  prevent pilots of commercial aircraft from using
  a cell phone while actively flying
• I believe that the government has a right to
  prevent drivers of cars from using a cell phone
  while driving
• I believe that the government should charge a 90
  tax rate on all income I earn in my lifetime

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Does everyone agree?

• No
• Different people have different opinions about
  what the government should do
• Experts often disagree about what government
  should do
• We will often assume that the experts in other
  disciplines have gotten costs and benefits right

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Summary Introduction to Public Finance

• Many topics studied in public finance
• Topics related to government intervention
• Tax-related topics
• Different viewpoints about government
• Organic view
• Society is an organism
• Mechanistic view
• Government used to reach individual goals

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Some ground rules at the end of lecture

• I will always try to be done by 315 pm
• In return, I expect your attention until the
  final slide
• If you must leave early
• Please do so no later than 305 pm
• Sit near an exit
• Leave quickly and quietly

Example of final slide
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Some ground rules at the end of lecture

• After many of the lectures
• Problem solving
• Your questions (especially near test time)
• Review of test questions
• You are welcome to leave after lecture is
  finished
• Please do so quickly and quietly