Public FinanceInstructor: John Hartman

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

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

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

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

Textbook for this class

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

Office hours and review sessions Office: NH 2028 Office hours:

Mondays 10:30-11:30 am Wednesdays 9:30-10:30 am

I plan on conducting one review session before each test Time and location to be announced

Tests

Three tests, as of now scheduled for: Monday, April 28 (in lecture) Monday, May 19 (in lecture) Monday, June 8 (final, 4-6:30 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

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

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

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

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”

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

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

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

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

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

Unit 3

Health care and income redistribution Chapter 9: Problems of insurance in the health

care market Chapter 10: Government’s 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

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

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

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

Supply and Demand

Equilibrium: Q = 4, P = 6

Example of excess demand

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”

Factors of supply

Price: Higher price higher quantity demanded

Price of inputs Technology Weather

Shift in demand;movement along supply curve

Utility

Utility is used by economists to note a level of satisfaction

The higher the utility, the higher the satisfaction

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

Two goods and utility

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

Increasing utility U0

U1

U2

Budget constraints

We assume each person has wants that are above the resources available to her/him

Consumption must be made from resources available

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

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

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?

Substitution and income effects Income effect

E1 to Ec

Substitution effect Ec to E2

Note that budget lines to calculate income effect are parallel

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

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

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

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

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”

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

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

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”

What views do people have?

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

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

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

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

Determining what is “good”

What is “good” to one person may be viewed as bad as others

Let’s 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

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

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

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

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

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

Some ground rules at the end of lecture I will always try to be done by 3:15 pm In return, I expect your attention until the final

slide If you must leave early:

Please do so no later than 3:05 pm Sit near an exit Leave quickly and quietly

Example of final slide

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