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ECON305: Public Finance

Unit 1: Introduction to Public Finance and Tools of Analysis   This unit will begin with an introduction to the tools of analysis that will be used throughout the course.  Most of the models we will use in this course will be extensions of the supply and demand models you learned in your introductory microeconomics courses, which will allow you to evaluate the effects of tax and subsidy policies.  These policies change the relative costs of different activities for the individual decision-makers.  By using rational-choice assumptions—i.e. by assuming that individuals know what they prefer and, given a choice, will choose the happier path—we can graphically illustrate the effects of policy change.  Additionally, you will learn how economists use assumptions about optimality to “add up” individual benefits and costs such that they reflect social benefits and costs. While economists debate the appropriateness of certain assumptions, experience using a given set of tools will help you consider how changes in assumptions might affect the outcome of the analysis. After this quick refresher, this unit will go on to introduce major arguments for and against government fiscal intervention.

From an economic perspective, what is considered “good” government fiscal intervention?  Many economists believe that public goods and externalities exist as market failures and that the government should therefore use fiscal policy to affect the outcome in the marketplace.  Public goods are products or services that economists think are not likely to be provided in ideal quantities because individuals are not motivated to produce them.  If you ask an economist, “What is a public good?”, he or she will invariably respond: “National security.”  In this unit, we will consider the problem of national security, acknowledging that in order for individuals in society to be able to conduct their affairs and accumulate capital, they need assurances that the rule set they are operating under is somewhat stable.  How shall mechanisms for ensuring this space, such as a large military, be provided?  In this unit, we will learn how economists define a “public good” so that we can consider whether the particular subsidies from Unit 3.2 meet this definition.  Does national security meet this definition?

We will also take a look at how the dynamics of voting may fail to overcome the public goods problem when individual voters have different valuations for the public good before studying tax systems (such as the Lindahl tax) that seek to overcome this problem.  Finally, we will consider examples in which private persons have provided public goods despite the existing theory of public goods, which would incline us to believe that these goods do not exist until they are provided by a governmental unit that has the power to tax.  Consider how people provided public goods before the advent of modern governments: if free-rider problems are pervasive, how do public-goods-providing governments ever get started?

We will conduct a similar investigation into the issue of externalities.  Arthur Pigou, an English economist whose career and influence bridged the late 19th century and early 20th century, proposed a system of taxation that would internalize externalities by taxing behaviors such that the private value would equal the social value.  His model was widely accepted, until a challenge in 1960 from Ronald Coase demonstrated that Pigou’s model was only a special case. Ronald Coase won the Nobel Prize for refuting the efficiency of Pigou’s system and, in doing so, opened up a wholly new way of considering conflicts of interest.  This unit will take a look at Coase’s theorem and his insight into the difficulty of assigning rights—which often precede our legal understanding of externalities.  We will conclude by considering the possibility of government failure as an externality.

1.1 Tools of Analysis   1.1.1 Consumer Surplus, Producer Surplus, and Profit   - Lecture: Tutor2u’s “Consumer and Producer Surplus” Link: Tutor2u’s “Consumer and Producer Surplus” (Adobe Flash)
 
Instructions: Please open and review this presentation in its entirety.
 
Terms of Use: Please respect the copyright and terms of use displayed on the web pages above.

1.1.2 Pareto Principle   - Reading: Preston McAfee’s Introduction to Economic Analysis: “5.2.8 Edgeworth Box.” Link: Preston McAfee’s Introduction to Economic Analysis: “5.2.8 Edgeworth Box” (PDF)
 
Also available in:
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Instructions: Please open the link above to access the reading.  This reading is on pages 187-194 of Preston McAfee’s textbook and will explain the significance of the Edgeworth Box and how and why it relates to Public Finance.
                       
Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

1.2 Public Goods as a Definition and as a Theory   - Lecture: Tutor2u’s “Public Goods” Link: Tutor2u’s “Public Goods” (Adobe Flash)
 
Instructions: Please review this presentation in its entirety.
 
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1.2.1 Definition of a Public Good   - Reading: Preston McAfee’s Introduction to Economic Analysis: “6.4: Public Goods” and Randall G. Holcombe’s “A Theory of the Theory of Public Goods” Link: Preston McAfee’s Introduction to Economic Analysis: “6.4: Public Goods” (PDF) and Randall G. Holcombe’s “A Theory of the Theory of Public Goods” (PDF)
 
Also available in: (Preston McAfee)
Microsoft Word Document (Zip File)
 
Instructions: When reading the McAfee document, pay particular attention to the definition of a 'Samuelsonian Public Good'.  This reading is covered by pages 232-233 of Preston McAfee's textbook.
For the Holcombe reading, please click on the second link above to access the PDF file.  When it loads, the referenced reading is in volume 10, number 1. 
 
Terms of Use: The article above, McAfee’s “Public Goods,” is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here

 Terms of Use: The article above, Holcombe’s “A Theory of the Theory
of Public Goods,” is licensed under a [Creative Commons Attribution
3.0 United States
License](http://creativecommons.org/licenses/by/3.0/us/).  It is
attributed to the [Ludwig von Mises Institute](http://mises.org/). 
The original version can be found
[here](http://mises.org/periodical.aspx?Id=5&volume=Vol.%2010%20Num.%201).

1.2.2 Free Rider Problem, Median Voter, and Taxation Solution   - Reading: Preston McAfee’s Introduction to Economic Analysis: “6.4.2: Free Riders” and “6.4.3 Provision with Taxation” Link: Preston McAfee’s Introduction to Economic Analysis: “6.4.2: Free Riders” and “6.4.3 Provision with Taxation” (PDF)
 
Also available in:
Microsoft Word Document (Zip File)
 
Instructions: This reading is on pages 233-236 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/). 
 
Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

1.2.3 Tiebout Theory   - Reading: Preston McAfee’s Introduction to Economic Analysis: “6.4.4: Local Public Goods” Link: Preston McAfee’s Introduction to Economic Analysis: “6.4.4: Local Public Goods” (PDF)
 
Also available in:
Microsoft Word Document (Zip File)
 
Instructions: This reading is on pages 236-238 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/). 
 
Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

1.3 Externalities and Market Failure   1.3.1 Externalities as Market Failure   - Lecture: Tutor2u’s “Positive Externalities” and “Negative Externalities” Link: Tutor2u’s “Positive Externalities” (Adobe Flash) and “Negative Externalities” (Adobe Flash)
 
Instructions: Please read through and review both of these presentations, paying particular attention to the graphical representation of externalities.
 
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1.3.2 Pigouvian Taxes   - Reading: Preston McAfee’s Introduction to Economic Analysis: “6.3.2 Pigouvian Taxes” Link: Preston McAfee’s Introduction to Economic Analysis: “6.3.2 Pigouvian Taxes” (PDF)
 
Also available in:
Microsoft Word Document (Zip File)
 
Instructions: This reading is on pages 223-226 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/).
 
Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.

1.3.3 Coase’s Theorem and Insight   - Reading: Preston McAfee’s Introduction to Economic Analysis: “6.3.5 Coasian Bargaining” Link: Preston McAfee’s Introduction to Economic Analysis: “6.3.5 Coasian Bargaining” (PDF)
 
Also available in:
Microsoft Word Document (Zip File)
 
Instructions: This reading is on pages 226-227 of Preston McAfee’s textbook, which is publicly available under a creative commons license on the author’s website (www.mcafee.cc/Introecon/). 
 
Terms of Use: The article above is released under a Creative Commons Attribution-Non Commercial-Share-Alike License 3.0.  You can find the original version of this article here.