Economics ME326 Economics of Public Finance Second Term 2018/2019

University of BenhaFaculty of Commerce English Section Dept. of Economics Economics ME326Economics of Public Finance Second Term 2018/2019 Dr. Walaa Wageh DiabPhD in Economics MSc. in Economics. MSc. in Euro Mediterranean Studies.

Dr. Walaa Wageh Diab

The outcomes of Lecture 1 To know: • Why study public finance? • Economic rationale for the government Intervention • The Four Questions of Public Finance Dr. Walaa Wageh Diab

Why study Public Finance? 1. When should government intervene in economy? 2. How can the government intervene? 3. What is the effect of intervention on economic outcomes? 4. Why do governments choose to intervene in a particular way? Dr. Walaa Wageh Diab

Why study Public Finance? • What is Public Finance? • Public: General people • Finance: Resources Public finance: Resources of the masses, how they are collected and utilized. The discipline of public finance describes and analyses government services, subsidies, welfare payments and the methods by which the expenditures to these ends are covered through taxation, borrowing, foreign aid and the creation of money. Dr. Walaa Wageh Diab

Why study Public Finance? • What is Public Finance? What is the Role of Government? • To maintain and improve the welfare of the people. • To protect the people from harm. • To provide the institutions that allow market to function (e.g. protection of property rights). • To provide the essential goods and services that markets fail to adequately provide Ideology ? Dr. Walaa Wageh Diab

Why study Public Finance? • What is Public Finance? It is the branch of economics which assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the other to achieve desirable effects and avoid undesirable ones Dr. Walaa Wageh Diab

Why study Public Finance? • What is Public Finance? • The study of how governments collect and spend money and real resources • How do governments collect/spend money? Positive analysis • How should governments collect/spend money? Normative analysis Dr. Walaa Wageh Diab

Why study Public Finance? • What is Public Finance? • Positive Economics is a stream of economics that : • Focuses on the description "What is", quantification and explanation of economic developments, expectations and associated phenomena. • Relies on objective data analysis, relevant facts and associated figures. • Attempts to establish any cause-and-effect relationships or behavioral associations which can help ascertain and test the development of economics theories. Dr. Walaa Wageh Diab

Why study Public Finance? • What is Public Finance? Positive Economics For example, consider the following statement: "Though historical data indicates boost in spending if government cuts tax rates to half, the current budget constraints may not allow room for reducing tax rates." It attempts to convey a clear fact citing historical data that can be verified for the stated claim. Such statements can be defined, tested or rejected, and edited depending on the extent and availability of the evidence and form a part of positive economics. Dr. Walaa Wageh Diab

Why study Public Finance? • What is Public Finance? • Normative Economics is a stream of economics that : • Focuses on the ideological, opinion-oriented, prescriptive, value judgments and "what should be” For example, a statement like “Government should cut tax rates to increase disposable income and boost spending” may sound great, but it is far from being a fact, it lacks precise figures and concrete details about cause-and-effect, and it is confined to being desirable and subjective. Dr. Walaa Wageh Diab

Key Differences between Positive and Normative Economics • Positive economics is objective attempt to convey a reality, while normative economics is subjective and value based. • A positive statement is fact based that connects cause and effects, and it can be verified against evidences or historical instances and can be approved or disapproved. A normative statement are generalized recommendations, so it is usually based on an opinion and remains a value judgment that originates from personal perspectives, feelings, or opinions involved in the decision making process. • Positive economic statements usually contain keywords like “are” and “is”, while normative economic statements typically contain keywords such as "should" and "ought." Dr. Walaa Wageh Diab

What is Public Finance? • Public finance is about the taxing and spending activities of the government. Also known as “public sector economics” or “public economics.” • It refers to the income and outgo of the governments in the pursuit of national objectives. • It involves the inflow of financial resources in the form of taxes and other revenues, and the outflow of such resources in the form of expenditure to finance goods and services. Dr. Walaa Wageh Diab

Public Finance as Art • Art is application of knowledge for achieving definite objectives. Fiscal Policy which is an important instrument of public finance makes use of the knowledge of government’s revenue and expenditure to achieve the objectives of full employment, economic development and equality. Price stability etc. • To achieve the goal of economic equality taxes are levied which are likely to be opposed. Therefore it is important to plan their timing and volume. The process of levying tax is therefore an art. Study of Public finance is helpful in solving many practical problems. Public finance is therefore an art also. Dr. Walaa Wageh Diab

The Four Questions of Public Finance When Should the Government Intervene in the Economy? Market Failures Redistribution • Market Failure Problem that causes the market economy to deliver an outcome that does not maximize efficiency. • Market failure is the result of an inefficient market condition Economic Rationale Dr. Walaa Wageh Diab

The Four Questions of Public Finance When Should the Government Intervene in the Economy? Market Failures Redistribution • Markets are efficient because, when in equilibrium, they are allocated efficiently • The socially optimal amount of output will be produced: Marginal Social Benefit will equal Marginal Social Cost Economic Rationale Dr. Walaa Wageh Diab

The Four Questions of Public Finance When Should the Government Intervene in the Economy? • Markets are NOT always efficient. There are several circumstances under which resources will be mis-allocated by the free market. In other words, either too much of a good will be produced or not enough will be produced by the free market. Examples of market failures include: • Negative Externalities of Production and Consumption • Positive Externalities of Production and Consumption • Lack of Public Goods • Common Access Resources • Asymmetric Information • Abuse of Monopoly Power Market Failures Dr. Walaa Wageh Diab

The Four Questions of Public Finance When Should the Government Intervene in the Economy? In economics, an externality is the cost or benefit that affects a party who did not choose to incur that cost or benefit • Economists often urge governments to adopt policies that will "internalize" an externality, so that costs and benefits will affect mainly parties who choose to incur them. Market Failures Dr. Walaa Wageh Diab

Negative-Externalities For example, manufacturing activities that cause air pollution impose health and clean-up costs on the whole society, whereas the neighbors of individuals who choose to fire-proof their homes may benefit from a reduced risk of a fire spreading to their own houses. If external costs exist, such as pollution, the producer may choose to produce more of the product than would be produced if the producer were required to pay all associated environmental costs. Market Failures Dr. Walaa Wageh Diab

Positive-Externalities if there are external benefits, such as in public safety, less of the good may be produced than would be the case if the producer were to receive payment for the external benefits to others. For the purpose of these statements, overall cost and benefit to society is defined as the sum of the imputed monetary value of benefits and costs to all parties involved. Market Failures Dr. Walaa Wageh Diab

The Four Questions of Public Finance When Should the Government Intervene in the Economy? Market Failures Redistribution • Redistribution: The shifting of resources from some groups in society to others. Economic Rationale Dr. Walaa Wageh Diab

The Four Questions of Public Finance When Should the Government Intervene in the Economy? Market Failures Redistribution Income distribution : Some forms of government expenditure are specifically intended to transfer income from some groups to others. For example, governments sometimes transfer income to people that have suffered a loss due to natural disaster. Likewise, public pension programs transfer wealth from the young to the old. Redistribution Dr. Walaa Wageh Diab

The Four Questions of Public Finance When Should the Government Intervene in the Economy? Market Failures Redistribution Other forms of government expenditure which represent purchases of goods and services also have the effect of changing the income distribution. For example, engaging in a war may transfer wealth to certain sectors of society. Public education transfers wealth to families with children in these schools. Public road construction transfers wealth from people that do not use the roads to those people that do (and to those that build the roads). Dr. Walaa Wageh Diab

The Four Questions of Public Finance How Might the Government Intervene? Tax , Subsidize Private Sale , Purchase • One way that the government can try to address failures in the private market is to use the price mechanism, whereby government policy is used to change the price of a good in one of two ways: • 1. Throughtaxes, which raise the price for private sales or purchases of goods that are overproduced, or • 2. Throughsubsidies, which lower the price for private sales or purchases of goods that are underproduced. Dr. Walaa Wageh Diab

The Four Questions of Public Finance How Might the Government Intervene? Restrict or Mandate Private Sale or Purchase • The government can directly restrict the private sale or purchase of goods that are overproduced, or mandate the private purchase of goods that are underproduced and force individuals to buy that good. Public Provision The Government can provide the good directly, in order to potentially attain the level of consumption that maximizes social welfare. Public Financing of Private Provision Governments may want to influence the level of consumption but may not want to directly involve themselves in the provision of a good. Dr. Walaa Wageh Diab

The Four Questions of Public Finance What Are the Effects of Alternative Interventions? Direct Effects The effects of government interventions that would be predicted if individuals did not change their behavior in response to the interventions. Indirect Effects The effects of government interventions that arise only because individuals change their behavior in response to the interventions. Dr. Walaa Wageh Diab

The Four Questions of Public Finance Why do governments choose to intervene in a particular way? Why Do Governments Do What They Do? • political economy The theory • of how the political process produces decisions that affect individuals and the economy. Dr. Walaa Wageh Diab

Conclusion • It is clear that the government plays a central role in the lives of all of us. • It is also clear that there is ongoing disagreement about whether that role should expand, stay the same, or contract. (Continuous Debate). • The facts and arguments raised in this Lecture provide a backdrop for thinking about the set of public finance issues that we will explore later on in the rest of our course. Dr. Walaa Wageh Diab

Economics ME326 Economics of Public Finance Second Term 2018/2019