BEPP 2010: Public Finance and Public Policy

Vocab for this class

Public Finance

Study of the role of the government in the economy

Four Questions of Public Finance

1. When should the government intervene in the economy?

2. How might the government intervene?

3. What is the effect of those interventions on economic outcomes?

4. Why do governments choose to intervene in the way that they do?

Market Failures

problems that cause a market economy to deliver an outcome that does not maximize efficiency

Redistribution

Shifting of resources from some groups in society to others in order to promote economic equity and address inequalities.

Direct Effects

Effects of government interventions that would be prediced if individuals did not change their behavior in response to the interventions

Indirect effects

Effects of government interventions that arise only because individuals change their behavior in response to the interventions

Political economy

The theory of how the political process produces decisions that affect individuals and the economy

Public Good

Goods for which investment of any one individual benefits everyone in a larger group

Social insurance programs

Government provision of insurance against adverse events to address failures in the private insurance marketW

Welfare economics

The study of the determinants of well-being, or welfare, in societyD

Demand Curves

Curve showing the quantity of a good demanded by individuals at each priceTh

Theoretical tools

Set of tools designed to understand the mechanics behind economic decision makingEm

Empirical tools

Set of tools designed to analyze data and answer questions raised by theoretical analysis

Utility functions

Mathematical function representing an individual’s set of preferences, which translates into their well-being from different consumption bundles into units that can be compared in order to determine choiceC

Constrained utility maximization

Maximizing well-being (utility) of an individual, subject to their resources (budget constraint)Mo

Models

Mathematical or graphical representations of realityIn

Indifference curve

Graphical representation of all bundles of goods (combinations) that make na individual equally well off (same level of utility), and thus, individuals are indifferent as to which bundle they consume

Marginal utility

Additional increment to utility from consuming an additional unit of a good

Marginal Rate of substitution

The rate at which a consumer is willing to trade one good for another

The MRS is the slope of the indifference curve; the rate at which the consumer will trade the good on the vertical axis for the good on the horizontal axisBu

Budget constraint

Mathematical representation of all the combinations of goods an individual can afford to buy if she spends her entire income

Opportunity cost

The cost of any purchase is the next best alternative use of that money, or the forgone opportunityMa

Marginal Analysis

The consideration of the costs and benefits of an additional unit of consumption or production

Substitution effect

A relative rise in the price of a good will always cause an individual to choose less of that good

Income effect

A rise in the price of a good will typically cause an individual to choose less of all goods because her income can purchase less than before

Demand curve

Shows the quantity of a good demanded by individuals at each priceSu

Supply Curve

Shows the quantity supplied of a good or service at each market priceMa

Marginal Cost

The incremental cost to a firm of producing one more unit of a good

Profit

The difference between a firm’s revenues and costs, maximized when marginal revenues equal marginal costs

Market

The arena in which demanders and suppliers interact

Market equilibrium

The combination of price and quantity that satisfies both demand and supply, determined by the interactions of the supply and demand curves

Social effiency

The net gains to society from all trades that are made in a particular market, consisting of consumer and producer surplus

Consumer surplus

The beneift that consumers derive from consuming a good, above and byeond the price they paid for the good

Producer surplus

The benefit that producers derive from selling a good, above and byeond the cost of producing that goodTot

Total social surplus

Total surplus received by consumers and producers in a marketF

First Fundamental Theorem of Welfare Economics

The competitive equilibrium, where supply equals demand, maximizes social efficiencyDe

Deadweight loss

The reduction in social efficiency from preventing trades for which benefits exceed costsSo

Social welfare

The level of well-being in society

Second Fundamental Theorem of Welfare Economics

Society can attain any efficient outcome by suitably redistributing resources among individuals and then allowing them to freely tradeER

Equity efficiency trade off

The choice society must make between the total size of the economic pie and its distribution among individuals

Social welfare function (SWF)

Function that combines the utility functions of all individuals into an overall social utility functionCom

Commodity egalitarianism

All that matters is that individuals have a basic level of need for goos such as housing or medical care met, and after this is met, income distribution doesn’t matter

Equality of opportunity

Individuals have equal opportunities for success but not focus on the outcomes of choices made