Public sector economics

pse

What is a market? (L1)

a set of interactions between buyers and sellers + production is meant for exchange

What are the rules that govern exchange? (L1)

producers cannot charge consumers what they like + consumers cannot pay what they like -> we must find EQUILIBRIUM

What does Ostrom say about social capital? (Hardin vs Ostrom)

highlights the importance of human relationships and cooperation; traditional story is that humans are selfish -> overconsumption will lead to depletion of shared resources (the Commons); Hardin argued Commons/shared resources should be privatised -> divided into small sections and each person would look after their section; Ostrom disagreed, highlighting that communities can and do look after shared resources; Social capital helps solve collective problems — not just with natural resources, but in education, health, and governance too

What is social capital?

the value of human relationships, trust, and cooperation within a community

How do we evaluate economic performance? (L1)

efficiency (neo-classical take); equity; sustainability

What is Pareto efficiency? (L1)

Nobody can be better off without making someone worse off; allocation of resources is Pareto optimal if it is not possible to reallocate resources to make someone better off without making someone worse off; efficiency -> all allocations have taken place so that an additional exchange would make someone worse off; no waste

What is utility? (L1)

Sense of satisfaction after consuming goods

What are the 3 aspects of efficiency required for Pareto efficiency? (L1)

1. Exchange efficiency 2. Production efficiency 3. Production mix efficiency

What is exchange efficiency? (L1)

goods are distributed so nobody can be better off without making somebody worse off; utility is maximised; consumers get what they prefer

What is production efficiency? (L1)

when the economy can no longer produce additional amounts of a good without lowering the production level of another

What is production mix efficiency? (L1)

optimal combination of goods produced, considering consumer preferences + production technology; MRS = MRT; “rate at which consumers are willing to trade goods should match the rate at which producers can transform resources”

What is the MRS and MRT? (L1)

MRS = how much of one good a person is willing to give up to get more of another (same satisfaction); MRT = how much of one product must be given up in production to get more of another

What are the features of competitive markets? (L1)

large number of buyers/sellers; homogenous products; free entry/exit; perfect information; price takers

What is the First Fundamental Theorem of economics? (L1)

If the economy is competitive, it is Pareto efficient; do not care about redistribution

What is the Second Fundamental Theorem of economics? (L1)

Any Pareto efficient allocation can be reached by suitable redistribution of initial wealth and then letting competitive markets work freely; but taxes are distortionary; even with no market failure, free markets might generate inequality

What measures of progress do we use? (L1)

GDP, Gini index, etc.

Neo-classical economics outline (L2)

focuses on producers and consumers moving towards equilibrium; equilibrium is determined by interactions and self-interest; pursuing self-interest -> highest welfare in society -> laissez-faire must prevail; provides framework for markets under stable/predictable conditions

Evolutionary economics outline (L2)

emphasizes complexity, dynamism, innovation, adaptation, and irregular growth; Mazzucato: mission-oriented policies

Describe the supply-demand graph in equilibrium

demand slopes downward (price ↑ → demand ↓); supply slopes upward (price ↑ → supply ↑); equilibrium is where they intersect

Describe supply-demand graph in excess supply (surplus)

price set above equilibrium; quantity supplied > demand; lowering price increases demand back to equilibrium

Describe supply-demand graph in excess demand (shortage)

price is too low; raising price increases supply back to equilibrium

Law of diminishing marginal utility

Marginal utility = benefit/satisfaction from consuming one more unit; as consumption increases, additional satisfaction decreases

Profit maximisation in competitive markets

P = MR = MC (Price = marginal revenue = marginal cost)

Principal ideas of institutional economics (L2)

Market arrangements are socially embedded (legal, financial, social institutions, ideologies); critiques abstract competitive market models; arose as 20th-century institutions (trade unions, corporations, etc.) developed

Two thinkers in institutional economics? (L2)

Veblen; Galbraith

What does Veblen say? (L2)

Critiqued self-interest + utility maximisation; theory of leisure class; conspicuous consumption (showing class by what ppl consume); waste (inefficient use of resources to show status); consumer culture = dissatisfaction; businesses prioritise profit/control over efficiency

What does Galbraith say? (L2)

Capitalism is driven by technology/innovation; R&D is corporate/systematic, not random; big firms control innovation; innovation is planned/managed (like planned economies)

What is evolutionary economics? (L2)

economy = dynamic, evolving; path dependency (history matters, leads to lock-in e.g. QWERTY keyboard); complexity > simple models

Difference between institutional and evolutionary economics

Institutional: shaped by institutions, rules, norms; Evolutionary: driven by competition, innovation, adaptation; overlap exists (history matters in both)

What is Market Failure Theory (MFT)? (L2)

state intervention only needed when there is market failure

Innovation systems (Lundvall)

innovation systems are networks (e.g. universities); work only if synergised with entrepreneurial ecosystem

What does Mazzucato say? (L2)

Critiques MFT; state isn’t just a patcher; needs mission-oriented policies; “visible hand” development state creates competitive advantage; trial and error policies; entrepreneurial state takes risks (e.g. Solyndra, Tesla loans); states should secure benefits (royalties, shares)

How are goods classified? (L3)

Non-excludability (can’t exclude); Non-rivalry (one’s use doesn’t reduce availability)

Four types of goods

Public goods (non-rivalrous, non-excludable, e.g. army); Club goods (non-rivalrous, excludable, e.g. gyms, Netflix); Private goods (rivalrous, excludable, e.g. car, phone); Common pool resources (rivalrous, non-excludable, e.g. fisheries, commons)

Forms of market failures with public goods? (L3)

Underconsumption (exclusion inefficient for non-rival goods); Undersupply (no incentive to supply if no charge)

Why are public goods not provided?

Free rider problem; selfish individuals don’t cooperate; taxation forces contribution

Efficient provision of public goods (Samuelson Rule)

sum of individuals’ MRS = MRT; resources scarce so providing more public goods means giving up private goods; willingness to trade must equal production trade-off

How are public goods funded?

Govt collects taxes, reducing private purchasing power

Alternative insights on public goods/free rider problem

humans are social, cooperate often; altruism/emotions; reciprocity (tit-for-tat); fairness/inequity aversion; not fully integrated in mainstream econ

What is a publicly provided private good?

Goods with high marginal cost to supply more individuals (e.g. water, toll roads, healthcare, education); consumption rivalrous/excludable; risk of overconsumption if free

3 ways of rationing publicly provided private goods

1) Queueing (time not wealth; wastes time) 2) User fees (users pay; may cause underconsumption) 3) Uniform provision (everyone gets same standardised level, e.g. free primary school; ignores individual needs)

What is a transaction cost? (L3)

costs of exclusion in markets/public goods; e.g. checkout clerks, toll collectors; easy defn = costs of making economic exchange

When should govt intervene in public goods?

Neoclassical: only fix market failures; But Keynes/Polanyi: markets blind to social/env concerns; state should step in when individuals can’t

Global political system features + global public goods

features: anarchy (no world govt); uncertainty (Keohane); global public goods = non-rivalrous + non-excludable (e.g. climate stability, peace, disease eradication); benefits available to all regardless of provision

What are international regimes? (Krasner)

“sets of implicit/explicit principles, norms, rules, decision-making procedures around which actors’ expectations converge”; regimes structure cooperation

Free rider problem with regimes

even non-contributors benefit from global public goods

Supply side of regimes (global public goods)

Hegemonic Stability Theory (Kindleberger): one hegemon stabilises order, bears costs, sets rules; incentives = disproportionate benefits, power

Demand side of regimes (global public goods)

cooperation improves efficiency + reduces uncertainty; Coase Theorem: bargaining efficient if liability, info, and zero transaction costs exist; in reality → imperfect info, positive transaction costs, unclear liability

GATT case study

demand: coordination to avoid trade wars; supply: US hegemony post-WW2 anchoring trade order; articles: non-discrimination, reciprocity

What is an externality?

when a firm/individual affects others without affecting market price

Negative vs positive externalities

Negative: excessive production/consumption (e.g. pollution, antibiotic resistance); Positive: underproduction/consumption (e.g. vaccination, beehives aiding crops)

Private solutions to externalities

Internalising externalities; Legal system; Coase theorem

Internalising externalities example

large units internalise effects (e.g. neighbours improving/neglecting gardens)

What is the Coase theorem?

if property rights well-defined + bargaining costless → negotiations internalise externality → efficiency; doesn’t matter who gets rights, outcome efficient

Legal system as private solution

common law protects against injury incl. economic costs; courts implicitly assign property rights; govts as trustees (e.g. US vs BP oil spill 2010)

Limitations of Coase/private solutions

unclear property rights; high transaction costs; collective action/free rider issues; imperfect info; litigation costs; holdout problem

Public solutions to externalities

Taxes (Pigouvian), Subsidies, Marketable permits, Direct regulation

Pigouvian tax

tax = marginal external cost (MEC); increases price → reduces quantity; producer held responsible

Criticism of Pigouvian tax

info problem (difficult to measure social cost); enforcement costs; may reduce incentives for efficiency; blunt tool; political feasibility issues

Subsidies for externalities

subsidise pollution abatement; aim to equalise MSB with MPB; encourages firms to reduce pollution; but doesn’t fully solve inefficiency

Marketable permits

cap emissions, allocate/sell permits; firms trade permits; equilibrium where MC of abatement = permit price; problems: creates assets, bribes, locational issues

Direct regulation

command/control (input or performance-based); +certainty; -political interference, info problems, monitoring costs, regulatory capture, jurisdictional limits

Ostrom + polycentric governance

externalities can be managed without single authority; multiple decision-making centres (local→global) cooperate; example: Valencia irrigation system

Global commons

High seas (treaty); Outer space (Moon Agreement); Antarctica; Atmosphere

What is market power?

traditionally: ability to raise prices; now: control prices/market aspects

Sources of market power

resource control (diamonds); govt monopolies (patents); natural monopolies (utilities); mergers/acquisitions

Competitive firm vs monopolist

competitive: many producers, horizontal demand, price taker; monopoly: sole producer, downward demand, price maker

Profit maximisation in comp. vs monopoly

competitive: P=MR=MC; monopoly: P>MR=MC, produces less, charges more, deadweight loss

Monopoly + elasticity

more inelastic → bigger markup

Monopoly outline

monopoly = market failure; quantity low, price high, DWL; rents extracted; more inelastic → bigger markup; price discrimination possible

What is a monopsony?

one buyer; can set lower wages/quantity; inefficient allocation; workers lack options

Traditional vs intellectual monopolies

Traditional: profit via restricting output/raising prices; focus on tangible assets, integration; Intellectual: profit via data/control, often free services, focus on intangibles (data/algorithms); e.g. Amazon controls infrastructure, algorithms

What is an oligopoly + price fixing?

few firms dominate; collusion sets prices; harms consumers; prices interdependent

Example: Car makers collusion (AdBlue)

Daimler, BMW, VW, Porsche, Audi colluded on AdBlue tech limits; fined €875m (Daimler escaped by revealing)

Detecting cartels

evidence (docs, wiretaps); measure concentration (define market, HHI index)

What is HHI?

measure of market concentration; sum of squared market shares;

Solutions to monopolies/oligopolies

Antitrust laws; break-ups; block mergers; regulate behaviour (price caps, universal obligations); fines; nationalise; Chicago School “do nothing”

Chicago School on monopolies

monopolies not harmful, drive innovation/growth; perfect competition unrealistic; antitrust misused; network effects not bad; creative destruction is real competition

What is a tariff?

tax on imports; raises price of imports; benefits domestic producers, harms consumers; reduces total surplus

Trade deficit vs surplus

deficit = imports > exports; surplus = exports > imports

Balance of payments

records country’s transactions with world; divided into current account, capital account, financial account

Current account

imports/exports; credits = outflow of goods/services; debits = inflow

Capital account

one-off capital transfers (debt forgiveness, gifts); small share

Financial account

financial assets/liabilities; assets = outflow (investment abroad); liabilities = inflow (investment into home economy)

Key link between accounts

CA + capital account balance = financial account balance

Double entry balance

every transaction recorded twice (CA + FA); ensures BoP adds to zero

Trade models

1) Factor/Samuel-Stolper 2) Sector/Ricardo-Viner 3) New Trade Theory 4) New New Trade Theory

Factor/Samuel-Stolper model

long-term; factors mobile; abundant factor gains, scarce loses; leads to class conflict

Sector/Ricardo-Viner model

short-term; factors immobile; industry-based conflict; lobbying for protection/free trade

New Trade Theory

post-WW2; similar-similar trade; intra-industry trade; consumers love variety; monopolistic competition; reduces conflict

New New Trade Theory

1990s; only most productive firms trade; trade boosts productivity (weak exit, strong grow)

How are trade preferences aggregated?

affected by electoral systems, lobbying, PR vs Majoritarian; PR less protectionist; Majoritarian more protectionist

What is embedded liberalism? (Ruggie)

combines multilateral trade with domestic stability; prevents backlash; basis of postwar order (Bretton Woods, IMF, GATT)

Neoclassical vs Keynesian on unemployment

Neoclassical: wages adjust → full employment; Keynesian: wages sticky, cutting worsens unemployment (low demand)

Keynes’ solution to unemployment

govt fiscal spending stimulates demand + jobs; counter-cyclical policy (spend in downturn, tax in boom)

Timeline of Keynes’ influence

dominant post-WW2; declined in stagflation 1970s; revived post-2008 crisis

Aggregate demand/GDP formula

ZZ = C+I+G+(X-M); Equilibrium: Z=Y

Keynesian multiplier

initial spending → multiplied impact via repeated rounds of consumption

Money supply + interest rates

expand supply = lower rates; tighten = higher rates