The role of governmentTodayPublic goodsDefinitionsCategories of goodsSlide 6Slide 7Slide 8Slide 9ExampleFireworks show as a public goodVertical summationMarginal analysisSummary: Public goodsGovernment failureGovernments in a democracyPork barrel legislationSlide 18Slide 19Price supportsSlide 21Rent-seekingWays to lessen government failureSummary: Government failureTaxationHow much is enough?Slide 27What is t*?What should be taxed?Slide 30Summary: TaxationLecture material finishedThe role of governmentToday: Public goods; government failure; taxationTodayThree mini-lectures on the role of governmentPublic goodsSub-optimal results when privately fundedGovernment failurePork and political gainTaxationHow much is “enough?”What should we tax?Public goodsPublic goods are goods that have some degree of two characteristicsNonrivalNonexcludablePositive externalities lead to suboptimal consumption when public goods are privately purchasedDefinitionsNonrival good (F/B p. 448)“A good whose consumption by one person does not diminish its availability to others”Nonexcludable good (F/B p. 448)A good that is difficult, or costly, to exclude nonpayers from consumingPure public good (F/B p. 448)A good or service that, to a high degree, is both nonrival and nonexcludableCategories of goodsLow HighHigh Commons good(oxygen that you breathe)Public good(lighthouses)Low Private good(pens)Collective good(copyrighted books)NonexcludableNonrivalCategories of goodsLow HighHigh Commons good(oxygen that you breathe)Public good(lighthouses)Low Private good(pens)Collective good(copyrighted books)NonexcludableNonrivalCovered in earlier chapters; uses basic supply/demand theoryCategories of goodsLow HighHigh Commons good(oxygen that you breathe)Public good(lighthouses)Low Private good(pens)Collective good(copyrighted books)NonexcludableNonrivalCovered in Chapter 12Categories of goodsLow HighHigh Commons good(oxygen that you breathe)Public good(lighthouses)Low Private good(pens)Collective good(copyrighted books)NonexcludableNonrivalGoods with copyright or patent protection have some level of market powerPublic goodsWe will examine pure public goodsHighly nonrivalHighly nonexcludableMarginal analysis is used to find the optimal quantityOptimal quantity is where PUBLIC MB equals MCExampleFireworks show off of a tiny coastal community25 people live hereEach person has the same private demand for fireworksP = 2 – 0.08 QMC for fireworks is 10Notice that if fireworks were publicly purchased, nobody would buy them (10 > 2)Fireworks show as a public goodSince one person’s enjoyment of fireworks does not take away from the enjoyment from others, PUBLIC MB is the sum of PRIVATE MBsPUBLIC MB is the vertical summation of all 25 PRIVATE MBs P = 25  (2 – 0.08 Q) = 50 – 2QVertical summationVertical summation of 25 PRIVATE MB lines produces PUBLIC MB lineMCPUBLIC MBPRIVATE MBMarginal analysisTo find efficient level of fireworks, set PUBLIC MB = MC50 – 2Q = 10Q = 20Summary: Public goodsPublic goods are goods that are nonrival and nonexcludablePrivate provision of public goods leads to a quantity provided that is below the optimal quantityVertical summation of PRIVATE MBs determines PUBLIC MBUseful in determining optimal quantity of public goodGovernment failureGovernments often fail the MB/MC test on a public scaleThree methods for political gainPork barrel legislationPrice supportsRent seekingGovernments in a democracyWe vote in an indirect democracyWe elect people to represent usUS House of RepresentativesUS SenateVarious state and local electionsWe elect these people with the hope that they serve our interests, especially with market failuresPork barrel legislationConsider the US Congress435 members of the House of RepresentativesEach member of the House is interested in satisfying the people living in her/his districtEach member of the House may decide to try to pass legislation that is beneficial to her/his home district, even though people in other districts pay taxes to pay for the projectPork barrel legislationCongress members in the House have 2-year termsThey often act in a way to get re-electedBringing spending projects to their home districts are usually helpful in getting re-electedPork barrel legislationWill other Congress members stop pork barrel practices?Not if they want their own pork policies passedWhen politicians agree to pass each other’s pork policies, this is known as logrollingPrice supportsAnother issue related to government failure involves price supportsFirms try to influence politicians in order to increase profits for their businessesProposals often have big gains to a few and small losses to manyExample: Agricultural subsidiesThese proposals very often lead to lower efficiencyPrice supportsWhy do price-support measures pass when efficiency is lowered?Those that lose are often unaware of the programExample: The US has had programs to keep the price of peanuts artificially highFinding out information of all governments programs is costly (Recall Ch. 13)Most voters will not find out about government programs that are not in their best interestRent-seekingSometimes, a government determines a single winner for a contractExample: One firm is chosen to establish a type of beneficial technologyMany firms will often spend a substantial amount of money to gain the contractThese efforts are unproductive to society; this is known as rent-seekingSee Example 16.6 (p. 462) for the classic example of auctioning a $20 billWays to lessengovernment failureCampaign reform lawsRestrict spending and corporate influenceMore informed votersCost-benefit criteria for government spendingSummary: Government failureGovernments can step in to correct market failuresGovernments can also make decisions that lower efficiencyPork barrel legislationPrice supportsRent-seekingTaxationTaxes are the most important source for government revenueIncomePropertyCorporateHow much is enough?Governments can continue to charge more taxes to get more revenue, right?No: If taxes were 100%, people would have no incentive to workWhat is the largest amount of tax revenue that can be generated?How much is enough?The tax-revenue relationship was