Public economics

Masha Pautrel, Associated professor, GRANEM University of Angers

masha.pautrel@univ-angers.fr
Introduction

 Public economics studies the government and how its policies

affect the economy. It considers how the choices of the
government are made and how they can improve or hinder
economic efficiency.
Public economics also investigates the extent to which it is
possible for the government to influence the distribution of
income and wealth and whether this is desirable.
Hindriks and Myles, Intermediate Public economics, 2000.
Introduction
How big is public sector ?
Introduction
Some economic bases

 Economics, what is about ?

 Production of goods and services : how much each firm, the
branch or the economy produces; how many people are
employed and which qualification, how much production lines,
tools,... are used.
 Consumption of goods and services : how much of each
goods an individual would buy; how much she spends and
how much she saves; how people's consumption is affected
by prices, income, advertising, fashion,..
 Economics is about a choice…
Introduction
Some economic bases

 We have to make a choice because of a scarcity of resources

 Natural resources : land and raw materials, but also the water, fishing
and even air, are limited.
 Manufactured resources : capital (factories, machines, transportation and
other equipment), all those inputs have to be produced in the first place.
The stock of capital is limited and the productivity of capital is limited by
state of technology.
 Human resources : labor. The labor forces if limited both in number and in
skills.
The time in this context is also limited : there are only 24 hours in a
day, people can not spend more than 24 hours per day to work (or to
consume).
Introduction
Some economic bases

The economics studies an allocation of scarce resources

in the “best way”
Introduction
Competitive market

 Two sides : supply and demand

 Some conditions :
 There are many firms and many individuals (consumers),
nobody is able to influence the market price, each firm and each
person is price taker. The individual' impact to the amount of
exchange is too small, so individual decisions don't modify the
market price… [Atomicity]
 Individuals and firms have a perfect information about the
quality, the availability of all goods and services and their prices.
 Any action of economic agent (individual of firm) have not a direct
influence to other individual of firm situation except through prices.
 Only buyer him self can use or take advantage from good or
service he bought.
 Introduction
Competitive market eqiulibrium
 The supply curve shows the Market clearing
greatest quantity firms are Price
willing to produce (to supply) for
each price. This curve has a
positive slop. S
 The demand curve shows the excess
greatest quantity individuals are P1
willing to buy (to consume) for
each price. A rising of price leads P*
to a fall of demand, the slop of
demand curve is usually negative. P2 shortage D
 An equilibrium (market clearing) is
a situation when supply matches
demand, leaving no shortage or
excess : a price for which demand Q*
Quantity
and supply quantities are equal.
 Introduction
Competitive market equilibrium

Pareto efficiency (optimality)

 Exchange efficiency : goods are distributed across individuals
such that it’s not possible to obtain a gain by an additional
exchange.
 Production efficiency : firms uses the production factors in the
best way, produce with the lowest cost and can’t obtain a gain
by replacing one production factor by another one.
 Efficiency in combination of produced goods : produced goods
and services match consumers’ preferences.

If a market mechanism is so great, does an economy need of a

Government ?
What is the relation of government policies with the economy ?
The course organisation

 Why the economy needs a public intervention ?

 What is (are) goal(s) of public intervention ?

 What are means of public intervention ?

 How evaluate the public intervention ?

Part 1. Reasons of public intervention

 Public goods

 Externalities

 Natural monopoly

 Demand of redistribution
 1.1. Public goods

 The great stink story (Krugman and Wells, 2009)

 Two reasons of public intervention :

Public  Sewage system: individual benefits from the system do not depend on
good how many individuals use it.
Common  Water in the Tamis : many people can consume whether or not they
ressource paid for it but whose consumption by each person reduces the amount
available to others.
 The capacity of the market to provide efficiently goods and
services depends on their characteristics, namely:
 Whether or not it is excludable
 Whether or not it is rival in consumption
1.1. Public goods

 A good is excludable if the supplier of

that good can prevent people who do
not pay from consuming it.
 When a good is nonexcludable, the
supplier cannot prevent consumption
by people who do not pay for it.
 A good is rival in consumption if the
same unit of the good cannont be
consumed by more than one person
at the same time.
 A good is nonrival in consumption if
more than one person can consume
the same unit of the good at the
same time.
 1.1. Public goods

 Public goods are non-excludable : no private firms willing to

produce those goods.
 Public goods are nonrival in consumption: one can use it even she
doesn’t pay. The demand is not rely with a price. [Free-rider
problem]

 May be a society could to make «a deal » where each member

will pay a part of provision of pubilc goods ?...

 Let’s play a game to explore this solution.

1.1 Public good game
(Holt and Laury, 1997, Pickhardt, 2005)
.
1.1 Public good game
.
CONCLUSION
 Even the social optimum is achieved when every player contribute to a
commont pot, it’s not consistent with individual preferences (strategies)
 How to obtain the social optimum ?
 The market has not a mechanisme to provide public goods. In a such
case we talk about market failures.
 The market needs an external force able to force individual contribution
to public goods –> a Governement.
1.1 Common resources
.

To avoid a tragedy of common a government action is needed

1.1 Under or over-consumed goods
. Could be provided privately

 Under-consumed goods  Over-consumed (addictive) goods

Medical care, insurance, education Alcohol, cigarettes, narcotics, …
or professionnal training  Over-consumption (or even
 The reason : imperfect consumption) not desirable for
information individual and for society
 because of negative effects:
Example :
Human health, additional costs for
Parents pay for their child school medical care, population protection
education but the benefit of it is not from anti-social behavior, …
immediate and is not their.
 Public intervention for reducing
Don’t send a child to school but to the consumption of such goods is
work mean an immediate benefit necessary
(child’s wage) for family.
Public intervention (compulsory
schooling)
1.1 CHECK YOUR UNDERSTANDING
.
1. Classify each of the following goods according to whether they
are excludable and whether ther are rival in consumption. What
kind of good is each ?
 Portable Foldable Solar Panel
 A Road
 Covid vaccine
 Netflix
 iPhone 14
 A New Technology

2. Why the market is not able to provide public goods ?

3. What is a free-riding problem ? Give some examples of free-
riding.
 1.2. Externalities

 A story about rain… (Krugman and

Wells, 2009)
 What are reasons of a such behavior ?
 Because pollutant emissions do not
affect the production of power plants.
 When individuals impose costs on or
provide benefits for others, but don’t
have an economic incentive to take
those costs or benefits into account,
economists say that externalities are
generated.
 What is the economics of this
phenomena ?
« For many polluters, acid rain is
someone else’s problem » (Krugman and
Wells, 2009).
Source:
https://www.lelivrescolaire.fr/page/16235122
 The economics of externalities
1.2
.  Optimal program of producer. Preliminaries
Each firm maximases its profit :
where is total revenue obtained from sold the outcome, is total cost for
production of outcome.
If a power plan produces a quantity of outcome (electricity), and sells it for a
price ,

For each level of production, , the total cost is the minimum cost in
production factors the firm has to pay. This is the objective function of a
technical optimal program of producer : to choose quantités of production
factors (usually Labor, , and Capital, ) to produce a given quantity of outcome
with minimum cost (expenditures).
If a wage rate is and an interest rate is , the total expenditure to production
factors is given by :
where expenditures to row meterials etc depending on quantity of the
outcome.
 The economics of externalities
1.2
.  Technical optimal program of producer:

where is a production function relying each factors combination with an

outcome quantity .
The first order conditions give a system :

The solution of this system , is the optimal combination of factors, depends on

the oucome quantity (as well as on wage and interest rate), and allows the
minimum of exenditure named Total Cost .
 The economics of externalities
1.2
.  Economic optimal program of producer :
The first order condition is given by :

is called Marginal Revenue (an additional revenue from sell to one more small unit)
When competitive economy (producers are price takers) .
is called Marginal Cost , an additional cost when the outcome is rising for a small
unit.
* Don’t confuse with Average Cost , a mean of cost by produced unit of outcome.
Finally the optimal quantity to produce is obtained from :
(if competitive economy)
* If it’s not a competitive economy,
* MC depends on
 The economics of externalities
1.2
.  What is pollution ? – a kind of « production » inherent of production.
If is a quantity of pollution (emissions), it depends positively on quantity of
outcome (with the same technology and same row materials, ceteris paribus)
 The pollution does not enter into producer program so the producer have no
incentive to reduce the pollution.
 How could he reduce the pollution ?
 Change the technology (production function) but same TR
 Buy less pollutant row materials (for example low-sulfur coal)

The firm has no incentive to reduce a level of pollution.

 The economics of externalities
1.2
.  What about fisherman ?
 An optimal decision of individual about quantity of goods and services to consume
follows the maximisation utility program under budget constraint.
 Assume that the individual utility depends on quantitty of recreative fishing and
consumption of other goods and services . The price of fishing is , the price of
other goods is , and the income of the individual is .
 The individual optimal program is :

The first order condition with the budget constraint give the optimal level of
recreative fishing the individual is willing to consume with this price system and his
income.
depends on quantity of the firm outcome affects negatively the quantity of fishing
and thus reduce the utility of fisherman. But the fisherman has non control to this
variable.
 Positive externalities.
1.2
.  Recall the definition of externalities : When individuals impose costs on or provide
benefits for others, but don’t have an economic incentive to take those costs or
benefits into account, economists say that externalities are generated
 An exemple of positive externalitites : a beekeeper with hives close to an orchard.
 Bees pollinate fruit trees Increase the yield of treesand the harvest
 Beekeeper is not conscious about this additional « activity » of her bees, while
orchard owner is.
 But even orchard owner would like more bees, he does not decide how much hives
the beekeeper should have close to his orchard.
1.2 The paper river game.
. (Hoyt et al., 1999)
1.2 Externalities. Different natures
.

 External costs of production (costs of firm B because of production of

firm A)
 External benefits of production (benefits of orchard owner because of
production of hives)
 External costs of consumption : when consumption of one individual
creates costs to other(s) (smell of barbecue party for neigbors)
 External benefits of consumption (snow clearing in front of my house,
flowers planting in front of my house,…)
1.2 Externalities.
. How much pollution should society allow ?

 “How much” decisions in economics always involve comparing the marginal

benefit from an additional unit of something with the marginal cost of that
additional unit. Here the question about whole society not one agent.
 The marginal social cost of pollution is the additional cost imposed on
society as a whole by an additional unit of pollution.
For example, acid rain damages fisheries, crops, and forests, and each additional ton of
sulfur dioxide released into the atmosphere increases the damage.
 The marginal social benefit of pollution—the additional benefit to society
from an additional unit of pollution.
What’s good about pollution? However, avoiding pollution requires using scarce resources
that could have been used to produce other goods and services.
 The optimal quantity of pollution—the quantity of pollution society would
choose if all its costs and benefits were fully accounted for.
1.2 Externalities.
. How much pollution should society allow ?
1.2 Externalities. Solutions of the
. problem

 Why we could solve the pollution problem ? Because the professor

decreed a payment to the Firm A (internalize the externality) - If
externalities are fully internalized, the outcome is efficient even without
government (Coase theorem)
 If two parts could negociate the solution ? – It depends on transaction
costs.
Beekeeper and orchard owner probably could but it’s not always possible.
Example : preservation of agricultural land in State New Jersey from real
estate promoters pressure. Agricultural lands generate many positive
externalities. A « negociation » was not possible, so the State of New
Jersey implemented a subsidy policy.
1.2 CHECK YOUR UNDERSTANDING
.
1. Wastewater runoff from large poultry farms adversely affects their
neighbors. Explain the following:
a) The nature of the external cost imposed
b) The outcome in the absence of government intervention or a
private deal
c) The socially optimal outcome
2. Give two examples for each notion:
a) Externe cost of production
b) Externe benefit of production
c) Externe cost of consumption
d) Externe benefit of consumption

Click
here
for
1.2 CHECK YOUR UNDERSTANDING
. 3. Suppose a company produces organic waste that increases the fertility of surrounding
farmland, thereby lowering farmers' costs. The following table shows the marginal cost
of the firm and the marginal benefit to the farmers.

a) In the absence of government intervention, Producti Price (€) Marginal Marginal Social
how much should the firm produce to on cost of the benefit to marginal
maximize its profit? (units) firm (€) the cost (€)
farmers(€)
b) Complete the SMc column
c) What is the socially optimal level of 1 20 16 6
2 20 15 5
production? 3 20 15 4
d) Determine the subsidy (in number of units) 4 20 16 3
that a government should give to the firm 5 20 17 2
6 20 18 2
to induce it to produce this quantity?
7 20 20 2
e) What would be the total cost to the 8 20 22 2
government? 9 20 24 2
10 20 27 1
f) If a new technology doubled the benefit Click here
farmers derive from the company's waste, for
then what would be the socially optimal answers
 1.3. Natural monopoly

 Optimal firm decision.

The first order condition (FOC) of this program : or ,

where marginal revenue, an additional revenue when the production
is rising infinitesimally; and marginal cost, an additional cost when
the production is rising infinitesimally.
In the competitve market (each firmis price taker) : the FOC

The supply curve of a firm coincides with its marginal cost curve (the
part of marginal cost curve above the minimum of average cost
curve).
1.3 A Monopoly and its optimal
decision.
 There is only one firm in the market and many consumers of the good
supplied by this firm - MONOPOLY
 Consumers are still price taker but the monopoly is not.
 The monopoly knows the demande curve : or
For example, for a linear demand , the inverse demand is ( are
parameters).
 The monopoly can not to choose both price and quantity, but only one
of them (quantity) and obtain an other one (price) from inverse demand
function.
 The profit of the monopoly is still
 The demand curve now coincides with average revenue :
 But the FOC is not the same anymore :
1.3 A Monopoly and its optimal decision.

FOC:

Monopoly profit
 Consequences of
the monopoly for
the economy
1. The monopoly put the price as
high as consumers are willing
to pay. A monopoly’s surplus
increase by diminishing a
consumers’ one.
2. There is a part of global
surplus in competitive market,
which is lost in monopoly’s
one : deadweight loss.
3. A deadweight loss is a loss of
social welfare. So with a
monopoly there is a loss of
efficiency.

1.3
1.3 Why a monopoly possible ?

 Many reasons…on of them :

 There are some technologies (some industries) where the average cost
decreases with rising of production : increasing returns to scale. It
means that one firm will produce some quantity with lass costs then
two or more firms.
 The optimal number of firms in a such industry, is one. This situation is
called natural monopoly.
Example : power plants, railroads,…
1.3 How to reduce a monopoly power ?

 Depends on whether or not the industry in question is a natural

monopoly.
 If it is not, other firms could start to produce in the same market
(example with mobile phone market). The government could also
broken up the monopoly (antitrust policy).
Standard Oil, founded by John D. Rockefeller in 1870. By 1878 Standard Oil
controlled almost all U.S. oil refining; but in 1911 a court order broke the
company into a number of smaller units.
 It it is a natural monopoly : one firm is the best efficient solution from
technological point of view. But it's still a monopoly and thereby causes
inefficiency : a consumer price too high and a deadweight loss for hole
economy. Only one way to reduce this inefficiency is a public
intervention.

 Two ways of public intervention are possible in this case : Public

Ownership and Public regulation
1.3 How to reduce a monopoly power ?

 Public regulation
1.3 CHECK YOUR UNDERSTANDING
.
1. What policy should the government adopt in the following case?
Explain.

Internet service in Anytown, OH, is provided by cable. Customers feel

they are being overcharged but the cable company claims it must
charge prices that let it recover the costs of laying cable.

2. True or false ? Explain your answer.

a) Society’s welfare is lower under monopoly because some

consumer surplus is transformed into profit for the
monopolist.

b) A monopolist causes inefficiency because there are

Click
here consumers who are willing to pay a price greater than or
for equal to marginal cost but less than the monopoly price.
1.3 CHECK YOUR UNDERSTANDING
.
3. The following figure represents an industry that was competitive but is
now in a monopoly situation. The cost and revenue curves are the same
in both situations.
Determine the optimal price and quantity in
a) a competitive situation.
b) a monopoly situation.
€ Cm = CmS Which areas represent :
c) consumer surplus in a competitive situation
1 2 d) consumer surplus in a monopoly situation
P3
3 4
5
e) the loss of consumer surplus when moving from competition to
P2
7
8
monopoly
6
P1
9 10 f) the surplus of producers in a situation of competition
RM = D
11
12 = BmS g) the surplus of producers in a monopoly situation
Q1 Q2 Q
h) the gain of producers when moving from competition to
Rm
monopoly
Click
i)The deadweight loss to the economy here
for
1.3 HOME WORK
.
 Give an example from your country of an industry in a situation of a
natural monopoly. Argue that it’s natural monopoly. What politics does
the Government adopt to reduce its monopoly power ?
1.4 1.4 Demand of redistribution
Textbook "Economics" of Joseph Stiglitz and Carl Walsh

 Even when the markets are efficient, the income of a part of the population is
too low to guarantee them an acceptable standard of living.

 On the market, individuals’ income dépend on their assets and their

productivity. Low educated individuals have low wage then low income.

 US example : GDP (wealth of the Nation) CUS$ 20,34 Trillion in 2021

75% of less wealthy households own less than 15% of total wealth

Mean wealth of 25% of less wealthy households was CUS$ 1100 in 2001 (GDP CUS$ 13,89
Trillion)

The highest earning 10% of the population receive 30% of total income while the lowest
earning 20% receive only 2%.

The richest 10% of households own 70% of the total wealth and the poorest 50% only 3%.
1.4 1.4 Demand of redistribution
Textbook "Economics" of Joseph Stiglitz and Carl Walsh

 Why give an attention to inequality ?

 High inequality is often related with a range of social and political issues, which in
turn, are often at the root of an unfavorable climate for investment:

Exemple : South-East Asian and Latin America countries

South-East Asian countries. Mean Annual Growth Rate over 20 last years 5% with
moderate level of inequality (Ginny coefficient 0,3-0,4)

Latin America countires. Mean Annual Growth Rate 3,5% with high level of inequality
(Ginny coefficient 0,45-0,55)

 Social justice of equity as moral « duty » of the society

 Market can not give answers, son the society need of a Governement to
redistribute the total income (a part) from reach to poor housholds.
1.4 1.4 Home work

 Find data about inequality in your country. What is the opinion of

society about inequality ? What are public politics of redistribution if
any exist ?
1.2 ANSWERS
. 1. Wastewater runoff from large poultry farms adversely affects their neighbors. Explain the
following:
a) The nature of the external cost imposed
The external cost is the pollution caused by the wastewater runoff, an uncompensated
cost imposed by the poultry farms on their neighbors.
b) The outcome in the absence of government intervention or a private deal
Since poultry farmers do not take the external cost of their actions into account when
making decisions about how much wastewater to generate, they will create more runoff
than is socially optimal in the absence of government intervention or a private deal.
They will produce runoff up to the point at which the marginal social benefit of an
additional unit of runoff is zero; however, their neighbors experience a high, positive
level of marginal social cost of runoff from this output level. So the quantity of
wastewater runoff is inefficient: reducing runoff by one unit would reduce total social
benefit by less than it would reduce total social cost.
c) The socially optimal outcome
At the socially optimal quantity of wastewater runoff, the marginal social benefit is
equal to the marginal social cost. This quantity is lower than the quantity of wastewater
1.2 ANSWERS
. 3. Suppose a company produces organic waste that increases the fertility of surrounding
farmland..
a) In the absence of government intervention,
how much should the firm produce to
maximize its profit? 7 units (when Productio
Productio Price
Price Marginal
Marginal Marginal
Marginal Social
Social
n
n (€)
(€) cost
cost of
of benefit
benefit to
to marginal
marginal
b) Complete the SMc column (see table) cost
(units)
(units) the
the the
the cost (€)
(€)
c) What is the socially optimal level of firm(€)
firm(€) farmers(€
farmers(€
production? ))
8 units (when 1 20 16 12 4
1 20 16 6 10
d) Determine the subsidy that a government 2
2 20
20 15
15 10
5 5
10
should give to the firm to induce it to 3
3 20
20 15
15 8
4 7
11
4
4 20
20 16
16 6
3 10
13
produce this quality? – 2 (social marginal
5
5 20
20 17
17 4
2 13
15
benefit) 6 20 18 4 14
6 20 18 2 16
e) What would be the total cost to the 7
7 20
20 20
20 4
2 16
18
government? - 8
8 20
20 22
22 4
2 18
20
9
9 20
20 24
24 4
2 20
22
f) If a new technology doubled…, the socially 10
10 20
20 27
27 12 25
26
optimal level of production? 9 units (when
1.3 ANSWERS
.
1. What policy should the government adopt in the following case? Explain. Internet service in
Anytown, OH, is provided by cable. Customers feel they are being overcharged but the cable
company claims it must charge prices that let it recover the costs of laying cable.

Cable Internet service is a natural monopoly. So the government should intervene only
if it believes that price exceeds average total cost, where average total cost is based
on the cost of laying the cable. In this case it should impose a price ceiling equal to
average total cost. Otherwise, it should do nothing.

2. True or false ? Explain your answer.

a) Society’s welfare is lower under monopoly because some consumer surplus is transformed
into profit for the monopolist.

False. The inefficiency arises from the fact that some of the consumer surplus is
transformed into deadweight loss, not that it is transformed into profit. (insert a
graph)
1.3 ANSWERS
.
3. True or false.
b) A monopolist causes inefficiency because there are consumers who are willing to pay a price
greater than or equal to marginal cost but less than the monopoly price.
True. If a monopolist sold to all customers who have a valuation greater than or equal
to marginal cost, all mutually beneficial transactions would occur and there would be
no deadweight loss.
1.3 ANSWERS
.
3. The following figure represents an industry that was competitive but is
now in a monopoly situation. The cost and revenue curves are the same
in both situations.
Determine the optimal price and quantity in
a) a competitive situation.
b) a monopoly situation.
€ Cm = CmS
Which areas represent :
c) consumer surplus in a competitive situation 1+2+3+4+5
1 2
P3
d) consumer surplus in a monopoly situation 1+2
3 4
5
P2
7
e) the loss of consumer surplus when moving from competition to
6 8
P1 monopoly 3+4+5
9 10

11
RM = D f) the surplus of producers in a situation of competition 6+7+8+9
12 = BmS

Q1 Q2 Q g) the surplus of producers in a monopoly situation 3+4+6+7+9

Rm
h) the gain of producers when moving from competition to monopoly
3+4-8
i)The deadweight loss to the economy 5+8