2023 Mdef 612 4

Public Expenditure Theory
The Role of Public Sector: Eciency and Equity

Concerns
Dr. Edward Asiedu
University of Ghana Business School,Department of Finance
May 20, 2023
Email: edasiedu@ug.edu.gh
Dr. Edward Asiedu MDEF 612: Public Sector Finance

Outline
1 Public Expenditure Theory


Public Expenditure Theory Public Expenditure Theory
Outline
1 Public Expenditure Theory


Session Overview
What distinguishes public goods, those goods which are

typically provided by governments, from privately provided
goods?
Why will private markets undersupply pure public goods?
What is the free rider problem?
Why do governments provide goods which are not pure public
goods? What determines an ecient supply of pure public
goods?
In what sense is ecient government a public good?

Public Goods and Publicly Provided Private Goods
The governments supplies a wide variety of goods; national

defense, education , police , re protection etc.


What are the economic properties of goods such as National
defense?


What are the economic properties of goods such as National
defense?
How are they dierent from goods and services that are
provided by private market such as ice cream?

Public Goods
What distinguish between private and pubic goods?

Public Goods

The rst question is, does the good have the property of rival
consumption?

Public Goods

consumption?
Rival Consumption means that if a good is used by one
person, it cannot be used by another.

Public Goods

consumption?
Rival Consumption means that if a good is used by one
person, it cannot be used by another.
By contrast, non-rival consumption refers to cases for which
one person's consumption does not detract from or prevent
another person's consumption

Public Goods continu. . .


What is the key property that distinguish between private and

pubic goods?


pubic goods?
The second question is the property of exclusion


pubic goods?
The second question is the property of exclusion
Is it possible to exclude any individual from the benets of
public good without incurring great costs?

Public Goods And Market Failures
There are instances where a product has one of the properties

and not the other


and not the other
For some goods, consumption is non-rival but exclusion is
possible, e.g., Cable TV


and not the other
For some goods, consumption is non-rival but exclusion is
possible, e.g., Cable TV
For some goods, consumption is rival but exclusion is
impossible, e.g., crowded city sidewalk)

Public Goods And Market Failures continu. . .
There are two basic forms of market failure associated with

public goods; Under consumption and undersupply


In the case of non-rival goods, exclusion is undesirable because
it results in under consumption


In the case of non-rival goods, exclusion is undesirable because
it results in under consumption
But with-out exclusion , there is the problem of undersupply

Paying For Public Goods
If exclusion is possible, even if consumption is non-rival,

governments often charge fees, called user fees


User fees are often thought of as an equitable way of raising
revenues


User fees are often thought of as an equitable way of raising
revenues
However, when consumption is non-rival ,user fees introduce
an ineciency

The Free Rider Problem
Many of the most important publicly provided goods-such as

health programs and national defense-have the property of
non-excludability ,making rationing by the price system
unfeasible


unfeasible
While national defense has the property of non-excludability
and zero marginal cost


unfeasible
While national defense has the property of non-excludability
and zero marginal cost
There are few goods which have the property of at least high
cost of exclusion.

Economists and the free rider problem

The reluctance of individuals to contribute voluntarily to
support the provision of public goods is referred to as the free
rider problem.


rider problem.
The free rider problem is a reection of an important incentive
problem that arises in the case of public goods.


rider problem.
The fundamental issue is that if the good is going to be
provided anyway, why should I pay?


rider problem.
What I would contribute would be negligible, and hardly alter
supply.


rider problem.
supply.
However if everyone reasons the same way, the good would not
be supplied.


rider problem.
supply.
However if everyone reasons the same way, the good would not
be supplied.
This is one of the arguments for government's to provide these
goods, because government has the power to compel people to
contribute (through taxes).
Publicly Provided Private Goods
Publicly provided goods for which there is a large marginal

cost associated with supplying additional individuals are
referred to as Publicly Provided Private Goods


Education is a publicly provided private good in a sense that- if
the number of students enrolled doubles, costs will roughly
double (assuming that quality, as reected in class size,
expenditures etc. are kept constant)


Education is a publicly provided private good in a sense that- if
the number of students enrolled doubles, costs will roughly
double (assuming that quality, as reected in class size,
expenditures etc. are kept constant)
One of the usual explanation given for public provision of
education is that the opportunities of the young should not
depend on the wealth of their parents.



Three Methods Of Rationing Publicly Provided Goods

Uniform Provision
Advantage:


Uniform Provision
Advantage:
Saves on transaction costs


Uniform Provision
Advantage:
Disadvantages


Uniform Provision
Advantage:
Disadvantages
Leads some to under-consume, others to overconsume


Uniform Provision
Advantage:
Disadvantages
High demanders may supplement public consumption


Uniform Provision
Advantage:
Disadvantages
Increasing total transactions costs


Uniform Provision
Advantage:
Disadvantages
User charges
Advantages:
Those who benet bear the costs


Uniform Provision
Advantage:
Disadvantages
User charges
Advantages:
Disadvantages
Results in under-consumption


Uniform Provision
Advantage:
Disadvantages
User charges
Advantages:
Disadvantages
Results in under-consumption
Administering pricing system adds transactions

Queuing

Queuing
Advantage:
Goods (like health care) allocated not necessarily on basis of
who is wealthiest

Queuing
Advantage:
who is wealthiest
Disadvantage

Queuing
Advantage:
who is wealthiest
Disadvantage
Time is wasted

Eciency Conditions for Public Goods

A central concern is how large the supply of public goods
should be


should be
Resource allocation should be pareto ecient(if no one can be
better o without someone else's becoming worse o.


should be
Public goods are eciently supplied when the sum of the
marginal rates of substitution (over all individuals) is equal to
the marginal rate of transformation.


should be
The marginal rate of substitution of private goods for public
goods tells how much of the private good each individual is
willing to give up to get one more unit of the public good.


should be
The marginal rate of substitution of private goods for public
goods tells how much of the private good each individual is
willing to give up to get one more unit of the public good.
Marginal rate of transformation tells us how much of the

private good must be given up to get one more unit of the
public good.




Demand Curves For Public Goods
Individuals do not buy public goods


However, we can ask how much they would demand the good
if they had to pay a given amount for each extra unit of the
public good.


public good.
This is not completely hypothetical question.


public good.
This is not completely hypothetical question.
We call the extra payment that an individual has to make for
each unit of the public good his tax price

Eciency Conditions For Public Goods

Limitations on income Redistribution and The ecient

Supply of Public Goods
Governments usually evaluate projects by asking who benets
from the program?


from the program?
Benets to the poor is given more weights than the benets to
the rich


from the program?
the rich
Yet previous analysis suggested that one should simply add up
the marginal rates of substitution


from the program?
the rich
Which means that the amounts that each individual is willing
to pay at the margin for an increase in the public good,
treating the rich and the poor equally


from the program?
the rich
Which means that the amounts that each individual is willing
to pay at the margin for an increase in the public good,
treating the rich and the poor equally
how can these approaches be reconciled

Distortionary Taxation and the Ecient Supply of public

Goods
Revenue that is raise to nance public goods is through

distortionary taxes such as income tax

Distortionary Taxation and the Ecient Supply of public

Goods
Revenue that is raise to nance public goods is through

distortionary taxes such as income tax
The amount of private goods that individuals must give up to
get one more unit of public goods is greater than it would be if
the government could raise revenue in a way that did not entail
distortionary incentive eects that was not costly to administer

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Public Expenditure Theory

The Role of Public Sector: Eciency and Equity

May 20, 2023

Dr. Edward Asiedu MDEF 612: Public Sector Finance

1 Public Expenditure Theory

Dr. Edward Asiedu MDEF 612: Public Sector Finance

1 Public Expenditure Theory

Dr. Edward Asiedu MDEF 612: Public Sector Finance

What distinguishes public goods, those goods which are

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods and Publicly Provided Private Goods

The governments supplies a wide variety of goods; national

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods and Publicly Provided Private Goods

The governments supplies a wide variety of goods; national

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods and Publicly Provided Private Goods

The governments supplies a wide variety of goods; national

Dr. Edward Asiedu MDEF 612: Public Sector Finance

What distinguish between private and pubic goods?

Dr. Edward Asiedu MDEF 612: Public Sector Finance

What distinguish between private and pubic goods?

Dr. Edward Asiedu MDEF 612: Public Sector Finance

What distinguish between private and pubic goods?

Dr. Edward Asiedu MDEF 612: Public Sector Finance

What distinguish between private and pubic goods?

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods continu. . .

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods continu. . .

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods continu. . .

What is the key property that distinguish between private and

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods continu. . .

What is the key property that distinguish between private and

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods continu. . .

What is the key property that distinguish between private and

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods And Market Failures

There are instances where a product has one of the properties

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods And Market Failures

There are instances where a product has one of the properties

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods And Market Failures

There are instances where a product has one of the properties

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods And Market Failures continu. . .

There are two basic forms of market failure associated with

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods And Market Failures continu. . .

There are two basic forms of market failure associated with

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Public Goods And Market Failures continu. . .

There are two basic forms of market failure associated with

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Paying For Public Goods

If exclusion is possible, even if consumption is non-rival,

Dr. Edward Asiedu MDEF 612: Public Sector Finance

Paying For Public Goods

If exclusion is possible, even if consumption is non-rival,

The Role of Public Sector: Eciency and Equity

Eciency Conditions for Public Goods

Eciency Conditions for Public Goods

Eciency Conditions for Public Goods

Eciency Conditions for Public Goods