Public Policy I

Master's in International Development & Public Policy

T2, Fall 2022-23
 Public Policy I:
team and resources

Instructor:
Paulo Pamplona Côrte-Real ppc@novasbe.pt
OH: Tuesday 5.30pm
Grader:
Frederica Mendonça frederica.mendonca@novasbe.pt

Textbook
• Jonathan Gruber, Public Finance and Public Policy, Worth Publishers

Moodle Enrollment Key: publicpolicy*

 Public Policy I:
grading

Group assignment (Nov 8th – 15th) 10%

Individual assignment (Nov 24th – Dec 4th) 20%

Class participation 10%

Final Exam 60%

Dec 13th, 11am
 Public Policy I:
syllabus

should you pay more tuition?

should the government provide health insurance?

should workfare be preferred to welfare?

 Public Policy I:
syllabus

predict what agents will do: positive

‘should’ statements: normative

 Public Policy I:
syllabus
Disagreements resolved by evidence
Descriptive

predict what agents will do: positive

‘should’ statements: normative

Prescriptive
Disagreements not resolved by evidence
 Public Policy I:
syllabus
If an agent is told she will have to pay more for public
lighting according to how much she states she
benefits from it, she will tend to report a lower
valuation.
Efficiency is good.
If taxes are higher, people will look for ways to evade
them.
If you don’t like risk, you will tend to buy insurance.
When splitting a cake, it is important to ensure no
waste.
Public Policy I:
syllabus
Public Policy I:
syllabus

what’s optimal?

optimality criteria:

efficiency

fairness?
 Public Policy I:
syllabus
1. Introduction: the goals of government intervention (Ch 1)
2. Efficiency and fairness criteria (Ch 2)
3. Externalities (Ch 5-6)
4. Public Goods(Ch 7)
5. Collective decision-making (Ch 9)
6. Mixed Goods (Ch 11)
7. Social Insurance and applications: Social Security,
Unemployment Insurance, Poverty-Alleviation Programs,
Health (Ch 12-15, 17)
8. Taxation (Ch 19-20)
 government intervention in a market economy
main objectives

When Should the Government Intervene in the

Economy?
• Economics generally presumes that markets deliver
efficient outcomes, so why should government do
anything?
• Primary motive for government intervention when
efficiency is the concern is therefore “market failure”.
• Market failure: economics typically defines this as the
failure of the market economy to deliver an efficient
outcome.
government intervention in a market economy
main objectives

When Should the Government Intervene in the

Economy?

• Even if the market is well-functioning, an efficient

outcome is not necessarily socially desirable.
• Redistribution is a second reason for government
intervention.
• Redistribution: The shifting of resources from some
groups in society to others.
 government intervention in a market economy
main tools

How Might Governments Intervene?

• Tax or Subsidize Private Sale or Purchase

o Use the price mechanism, changing the price of a
good to encourage or discourage use.
• Taxes raise the price for private sales or purchases of
goods that are overproduced.
• Subsidies lower the price for private sales or purchases
of goods that are under-produced.
 government intervention in a market economy
main tools

How Might Governments Intervene?

• Restrict or Mandate Private Sale or Purchase

o Quotas restrict private sale of goods that are
overproduced.
o Mandates require private purchase of goods that
are under-produced.
• Public Provision
o The government can provide the good directly.
• Public Financing of Private Provision
o Governments pays, private companies produce.
 government intervention in a market economy
effects

What Are the Effects of Alternative Interventions?

Interventions have direct and indirect effects.
•Direct effects: The effects that would be predicted if
individuals did not change their behavior in response to
the interventions.
o With 49 million uninsured, providing universal
health insurance covers 49 million people.
•Indirect effects: The effects that arise only because
individuals change their behavior in response to the
interventions.
o If people drop private coverage, many more
people may end up covered by the public plan.
government intervention in a market economy
challenges
Why Do Governments Do What They Do?
• Governments do not always choose efficient or socially
desirable outcomes.
• Political economy: The theory of how the political
process produces decisions that affect individuals and
the economy.
 efficiency and fairness
Pareto efficiency

What is efficiency?

• Pareto efficiency: it is not possible to improve the welfare of

one agent without reducing the welfare of another agent.
• Pareto improvement: change that makes one agent better off
without making any other agent worse off.

• promotion of efficiency requires:

– identification and study of market failure
– identification of motives for public corrective action
(issues of information, avaliable instruments and
motivation)
 efficiency and fairness
Pareto efficiency
Examples

Representatives from three neighboring regions (X, Y, and Z) are

faced with three possibilities of improving the quality of life of their
co-citizens: building a bridge from X to Y (option B), building a new
cultural center in X (option C), and building new sport facilities
(option S). Their preferences are given by:

X Y Z
1 C B B
2 B S C
3 S C S

Find the Pareto optimal choices and indicate a change that

constitutes a Pareto improvement
 efficiency and fairness
Pareto efficiency

examples
Three students share the
same room and
therefore need to wake
up at the same time.
Their utility levels as a
function of wake-up time
are represented in the
graph.
Identify a change in wake-
up time that is a Pareto
improvement. Are there
Pareto-optimal wake-up
times?
 efficiency and fairness
Pareto efficiency

Equilibrium: Graphical Representation

 efficiency and fairness
Pareto efficiency

Social Efficiency

• Social efficiency represents the net gains to society

from all trades that are made in a market, and it
consists of the sum of two components: consumer and
producer surplus. Also called total social surplus.
• Consumer surplus: The benefit that consumers derive
from consuming a good, above and beyond the price
they paid for the good.
• Producer surplus: The benefit that producers derive
from selling a good, above and beyond the cost of
producing that good.
 efficiency and fairness
Pareto efficiency

Consumer Surplus: Graphical Representation

• Consumer surplus is the area under the demand curve

since demand = willingness to pay.
 efficiency and fairness
Pareto efficiency
Producer Surplus: Graphical Representation

• Producer surplus is the area above the supply

curve since supply = marginal cost.
 efficiency and fairness
Pareto efficiency

Social Surplus: Graphical Representation

 efficiency and fairness
Pareto efficiency

Competitive Equilibrium Maximizes Social Efficiency

• First fundamental theorem of welfare economics: The

competitive equilibrium, where supply equals demand,
maximizes social efficiency.
• Deadweight loss: The reduction in social efficiency
from preventing trades for which benefits exceed costs.
• Quick hint: Deadweight loss is a triangle that points
toward the equilibrium price and grows away from it.
 redistribution and fairness
equilibrium and social welfare
From Social Efficiency to Social Welfare: The Role
of Equity
• Social welfare: The level of well-being in society.
o Determined by both how much gets produced, and
how it is distributed.
• Second fundamental theorem of welfare economics:
Society can attain any efficient outcome by suitably
redistributing resources among individuals and then
allowing them to freely trade.
o Difficult in practice to redistribute like this.
• Equity–efficiency trade-off: The choice society must
make between the total size of the economic pie and
its distribution among individuals.
 efficiency
equilibrium and social welfare
Example: finding a Utility Possibility Frontier
uB
1

uB

1 uA
 efficiency
equilibrium and social welfare
Example: finding a Utility Possibility Frontier
uB
1

uB

1 uA
 redistribution and fairness
equilibrium and social welfare

uB

T
S

uA
 redistribution and fairness
utility-based fairness criteria
Bergson-Samuelson Social Welfare Functions
functions that combine utility functions of all individuals into na
overall social utility function (interpersonal comparison of utilities)

• utilitarianism (Bentham):
Max W=Σui(yi)
Harsanyi: Max W=Σpiui(yi) - total ignorance: pi=1/N

• Rawls: original position, veil of ignorance

- Maximin rule: Max min {u1(y1), u2(y2), ..., uI(yI)}
maximize utility of agent with lowest welfare; extreme degree
of risk aversion (only information on worst possible outcome is
considered)
 redistribution and fairness
utility-based fairness criteria
Example: Utilitarian uA = xA
uB = xB
uB
Max uA + uB
1 s.t. uA = 1- uB

uA = 1- uB
Isowelfare Curves
All points on the UPF
are optimal

UPF

1 uA
 redistribution and fairness
utility-based fairness criteria
Example: Utilitarian uA = xA
uB = √xB
uB
Max uA + uB
1 Isowelfare Curves s.t. uB = 1- uA2

uA = ½
and uB = ¾

UPF

1 uA
 redistribution and fairness
utility-based fairness criteria
Example: Rawls uA = xA
uB = xB
uB
Max min{uA , uB }
1 uA = uB s.t. uA = 1- uB

uA = uB = 1/2

1 uA
 redistribution and fairness
utility-based fairness criteria
Example: Rawls uA = xA
uB = √xB
uB
Max min{uA , uB }
1 uA = uB s.t. uB = 1- uA2

uA = uB = (√5-1)/2

UPF

1 uA
 redistribution and fairness
utility-based fairness criteria

Social welfare functions may reflect different possible equity

criteria, always based on utility levels.
Two difficult issues in applications of social welfare functions:

- interpersonal utility comparisons: cardinal vs. ordinal

information and comparability
- equity vs. efficiency – if there are no lump-sum transfers,
distortionary intervention creates deadweight loss
 redistribution and fairness
preference-based fairness criteria

• no-domination:
no agent should receive more of all goods than another.
• no-envy:
no agent should prefer another agent’s allocation to her own
i.e. the allocation is envy-free.
• equal-division lower bound:
all agents should prefer their allocation to equal division of
resources.
• egalitarian-equivalence:
there should be a common reference bundle such that all
agents are indifferent between their allocation and that
bundle (that need not be feasible).
 redistribution and fairness
resource-based fairness criteria

Welfarism? Utilities vs. resources

– Rawls’s A Theory of Justice primary social goods: rights
and liberties, opportunities and powers, income and
wealth, social bases of self-respect.
– Sen’s Equality of What? functionings (“midfare”, between
goods and welfare): what goods do to people - escape
morbidity, adequate nourishment, mobility, self-respect,
take part in community life, be happy.
– Dworkin’s What is equality? Equality of resources requires
distinction between circumstances and tastes/ambitions:
use transferable resources only to compensate for
different circumstancial resources.
 redistribution and fairness
circumstances

• Gender data gap:

– UN Women report estimates
• unpaid childcare services represents 20% of US GDP;
• unpaid care and domestic work in Mexico was 21% (“higher than
manufacturing, commerce, real estate, mining, construction and
transportation and storage”)
– in Australia, estimate that unpaid childcare represents
“almost three times the financial and insurance services
industry”;
– implications on choice of full-time vs. part-time jobs,
elasticity of labor supply, pension entitlement, devaluing
of care work, gender poverty gap; and inequality.
 redistribution and fairness
circumstances

• Gender inequality and public policy

– where to cut expenditure in a time of crisis?
– where to create jobs?
– development efforts?
– retirement plans?
– tax policy?
– how to deal with inequality?
 redistribution and fairness
circumstances
• Ethnic or ‘racial’ origin, national origin
– The case of Portugal

Labor Portuguese average African origin

Manual unskilled labor (2011) 13% 37%

Average wage in manual €603 €499
unskilled labor (2011)
Unemployment rate (2011) 13% 30%

(Oliveira and Gomes, 2014)

 redistribution and fairness
circumstances
• Ethnic or ‘racial’ origin, national origin
– The case of Portugal

Education Portuguese average African origin

Retention rates (1st cycle) 5% 16%

Retention rates (2nd cycle) 11% 28%
Retention rates (3rd cycle) 15% 32%
Retention rates (Secondary 20% 50%
education)
Redirection to vocational 43% 78%
education (Secondary)
(Seabra et al., 2016)