week1 - I. THE ROLE OF GOVERNMENT IN A MARKET ECONOMY A....

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1 I. THE ROLE OF GOVERNMENT IN A MARKET ECONOMY A. What is public finance. 1. Private markets produce efficient outcomes, under certain conditions. 2. The role of the public sector (i.e., government) in a market economy: a. Create environment in which markets can function. b. Respond when markets fail. B. Positive versus normative analysis 1. Positive analysis. a. Describes economy or market outcome: price is P 0 and quantity is Q 0 (in figure 1). b. Empirical evidence is often lacking. 2. Normative analysis. a. Describes what should happen: price should be P 0 and quantity should be Q 0 . b. Often just conjecture, since may not know impact of policies for years and counterfactuals don’t exist. C. Focus of public finance: government spending, taxes, and regulation D. View of government and society affect opinion of government intervention. Figure 1 0 20 40 60 80 100 120 140 0 20 40 60 80 100 120 140 Q P Q 0 P 0 D S
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2 II. TOOLS OF ANALYSIS: WELFARE ECONOMICS A. Role of welfare economics. 1. Use economic models to describes social desirability of alternative outcomes. 2 Distinguish circumstances in which markets perform well from those in which they fail. B. Model of consumer choice. 1. Consumer has choice between 2 goods, X and Y. 2. Quantity consumed measured on axes. 3. Utility measured by indifference curves. a. Represent combinations of two goods that provide constant levels of utility. b. Diminishing marginal rate of substitution. c. Utility increases as move away from origin. d. The marginal rate of substitution: i. The rate an individual is willing to trade one good for another. ii. Slope of indifference curve equals marginal rate of substitution. 4. Budget constrains amount each consumer can purchase. a. All income (I) must be spent on 2 goods, so I = P X X + P Y Y. b. Consumers are price takers – P
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week1 - I. THE ROLE OF GOVERNMENT IN A MARKET ECONOMY A....

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