Chapter 7 Supply of State and Local Goods and Services

Production function

Shows the maximum amount of output that can be produced with a given set of inputs.

Inputs of government production

Labor (L), Capital (K), and Materials/Supplies (X).

Production function formula

Q = q(L, K, X)

Example production function

Q = 3L^0.6 K^0.3 X^0.1

Cost of production formula

Cost = wL + rK + pX

w (in cost function)

Wage or price of labor.

r (in cost function)

Rental price of capital.

p (in cost function)

Price of materials and supplies.

Government expenditures

The total cost of producing directly produced output.

Three ways to measure government output

Expenditures, directly produced output, and consumer outcomes/results.

Expenditures measure of output

The amount of money spent on inputs to produce government services.

Direct output

The quantity of services produced by the government (example

Consumer outcomes

The final results experienced by citizens from government services (example

Consumer output function

A function showing how directly produced output becomes results for consumers.

Consumer output function formula

G = g(Q, X, N, E)

G in consumer output function

Consumer outcome or result.

Q in consumer output function

Government produced output.

X in consumer output function

Private goods purchased by individuals.

N in consumer output function

Population served.

E in consumer output function

Environmental and community characteristics.

Benchmarking

Evaluating government programs by comparing performance results across jurisdictions.

Why expenditures may not equal benefits

Technology differences, input price differences, community characteristics, and private consumption.

Major component of state and local government costs

Labor costs.

State and local worker compensation

Wages are usually slightly lower than private sector but benefits are higher.

Productivity

The amount of output produced per unit of input.

Productivity increases

Can offset increases in input prices and prevent costs from rising.

Baumol hypothesis (cost disease)

Productivity increases in some sectors raise wages throughout the economy, increasing costs in sectors where productivity does not improve.

Why Baumol hypothesis affects government services

Many public services rely heavily on labor and cannot easily increase productivity.

Examples of services affected by Baumol hypothesis

Education, public safety, and the arts.

Effect of rising costs with inelastic demand

Costs increase while consumption falls only slightly, so total spending rises.

Elastic demand

Quantity demanded changes a lot when price changes.

Inelastic demand

Quantity demanded changes only a little when price changes.

Evidence about demand for public services

Demand for state and local services is generally inelastic.

Ways governments can reduce cost pressures

Increase productivity or use privatization.

Privatization

Contracting private firms to provide services normally produced by the government.

Examples of technology improving productivity in public services

Police databases, radar guns, red light cameras, and electronic monitoring.

Tax and expenditure limits

Legal restrictions on government taxes or spending.

Property tax rate limit

A maximum property tax rate governments are allowed to charge.

Revenue (levy) limit

A restriction on how much total tax revenue can increase.

Expenditure limit

A restriction on how much government spending can increase.

Supermajority requirement

A rule requiring more than a simple majority vote to raise taxes.

Purpose of tax and expenditure limits

Reduce taxes/spending, increase political control, change revenue sources, or shift fiscal roles between state and local governments.

Monopoly bureaucrat model

The idea that government officials may push for larger budgets than voters actually want.

Free-lunch perception

Voters believe taxes can be reduced without reducing services.

Head-in-the-sand perception

Voters believe they receive little benefit from government services.

Optimist perception

Voters believe spending cuts will affect others but not themselves.