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Summary: book " Public Finance ", Rosen and Gayer, Lecture
(s) Chapters 3 to 6, 8, 12, 14, 15, 16, 18, 20, 22
Public Finance (Rijksuniversiteit Groningen)
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Public finance summary
Chapter 3 – Tools of normative analysis
welfare economics: the branch of economic theory concerned with the social desirability of alternative
economic states
basic concepts: 1) efficiency ° can we improve overall welfare?
2) equity ° is it fair?
pareto efficiency: nobody can be made better off without making someone worse off
pareto improvement: a reallocation of resources that makes at least one person better off without
making anyone else worse off
contract curve: the locus of all Pareto efficient points
production possibilities curve: a graph that shows the maximum quantity of one output that can be
produced, given the amount of the other output
marginal rate of transformation (MRT): the rate at which the economy can transform one good into
another good; it is the absolute value of the slope of the production possibilities frontier
marginal cost: the incremental cost of producing one more unit of output
utility possibilities curve: a graph showing the maximum amount of one person’s utility given each level
of utility attained by the other person
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Pareto-efficient allocation of resources if:
- perfect competition
- identical prices
- no market power
- existence of markets
- everything can be traded
1
st
Pareto efficiency condition : MRS
adam
= MRS
eve
2
nd
Pareto efficiency condition : MRS
af
= MRT
af
With well-functioning markets, prices reflect both:
- relative costs of production (MRT), and
- relative attractiveness of goods (MRS)
social welfare function: a function reflecting society’s views on how the utilities of its members affect
the well-being of society as a whole
asymmetric information: a situation in which one party engaged in an economic transaction has better
information about the good or service traded than the other party
externality: a cost or benefit that occurs when the activity of one entity directly affects the welfare of
another in a way that is outside the market mechanism
merit good: a commodity that ought to be provided even if people do not demand it (operas, concerts)
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Correct market failures:
- firms have market power
- firms set their own prices (P > MC)
- a market does not exist, because of:
- asymmetric information
- lack of property rights
- public goods
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Chapter 4 – Public goods
A pure public good has both these properties:
- consumption is non-rival
> cost of use by additional person is zero
> use by one person does not prohibit use by someone else
- consumption is non-excludable
> everyone consumes it
> everyone consumes the same quantity
> whether you want to or not
°