This document provides an overview of a public economics course, including: 1) The main textbook and lecture slides are listed. Office hours and exam procedures are also outlined. 2) The four questions of public finance are introduced: when should government intervene, how might it intervene, what are the effects of interventions, and why do governments intervene as they do. 3) Facts about government spending, taxes, deficits, and debt in the US and Europe are presented to illustrate the size and role of government. 4) Current policy debates around social security, healthcare, and education funding are briefly discussed. 5) In conclusion, the central role of government around the world is established to provide context for

1. Public Economics
Carlo Fiorio
(Bocconi University)
Email: carlo.fiorio@unibocconi.it
Web Page: http://fiorio.economia.unimi.it/tea/biem/
Public Economics 1

2. Course information
Main textbook
• Gruber, J., (2010), Public Finance and Public Policy, Palgrave Macmillan, 3rd edition
(reference textbook)
• Optional textbooks
• Connolly, S. and A. Munro (1999), Economics of the public sector, Prentice Hall.
• Hindriks J. & G.D. Myles, (2006 ), Intermediate Public Economics, MIT Press.
• Tresch, R.W. , (2008), Public Sector Economics, Palgrave.
Lectures slides posted on:
• http://fiorio.economia.unimi.it/tea/biemf/
Office hours:
• Thursdays 10:30-12:30, at Econpubblica, 3rd floor, Office 3.B1.13 (or appointment
by email).
Prerequisites:
• Microeconomics and (some) Calculus
Exams procedures:
• Check the link on the course webpage, under ``Exam regulations''
Public Economics 2

3. 1.1 The Four Questions of
Public Finance
1.2 Why Study Public
Finance? Facts on
Why Study Government in the United
States and around the World
Public Finance? 1.3 Why Study Public
Finance Now? Policy Debates
over Social Security, Health
Care, and Education
1.4 Conclusion
FERNANDO QUIJANO AND SHELLY TEFFT
Public Economics 3

4. 1.1
The Four Questions of Public Finance
public finance The 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?
Public Economics 4

5. 1.1
The Four Questions of Public Finance
When Should the Government Intervene in the Economy?
Market Failures
market failure Problem that
causes the market economy to
deliver an outcome that does
not maximize efficiency.
Public Economics 5

6. 1.1
The Four Questions of Public Finance
 APPLICATION
The Measles Epidemic of 1989–1991
 After the measles vaccine was introduced in 1963, measles cases had
become relatively rare in the U.S. by the 1980s. Over the period from 1989
to 1991, however, there was a huge resurgence in measles.
 It is clear that this outbreak resulted from very low immunization rates
among disadvantaged inner-city youths:
 These unimmunized children were imposing a negative externality on
other children who had received their immunizations but for whom
immunization may have worn off.
 The federal government responded to this health crisis in the early 1990s:
 The government publicly encouraged parents to get their children
immunized.
 The government also paid for the vaccines for low-income families.
The result was impressive. Immunization rates, which had never been above
70% before the epidemic, rose to 90% by 1995. Government intervention
clearly reduced this negative externality.
Public Economics 6

7. 1.1
The Four Questions of Public Finance
When Should the Government Intervene in the Economy?
Redistribution
redistribution The shifting of
resources from some groups
in society to others.
Public Economics 7

8. 1.1
The Four Questions of Public Finance
How Might the Government Intervene?
Tax or Subsidize Private Sale or Purchase
One way that the government can try to address failures in the private
market is to use the price mechanism, whereby government policy is
used to change the price of a good in one of two ways:
1. Through taxes, which raise the price for private sales or
purchases of goods that are overproduced,
or
2. Through subsidies, which lower the price for private sales or
purchases of goods that are underproduced.
Public Economics 8

9. 1.1
The Four Questions of Public Finance
How Might the Government Intervene?
Restrict or Mandate Private Sale or Purchase
The government can directly restrict private sale or purchase of goods
that are overproduced, or mandate private purchase of goods that are
underproduced and force individuals to buy that good.
Public Provision
The government can provide the good directly, in order to potentially
attain the level of consumption that maximizes social welfare.
Public Financing of Private Provision
Governments may want to influence the level of consumption but may
not want to directly involve themselves in the provision of a good.
Public Economics 9

10. 1.1
The Four Questions of Public Finance
What Are the Effects of Alternative Interventions?
Direct Effects
direct effects The effects of
government interventions that
would be predicted if individuals
did not change their behavior in
response to the interventions.
Indirect Effects
indirect effects The effects of
government interventions that
arise only because individuals
change their behavior in
response to the interventions.
Public Economics 10

11. 1.1
The Four Questions of Public Finance
Why Do Governments Do What They Do?
political economy The theory of
how the political process
produces decisions that affect
individuals and the economy.
Public Economics 12

12. 1.2
Why Study Public Finance? Facts on Government in the
United States and around the World
The Size and Growth of Government
Public Economics 14

13. Size of the government sector in 2008
(Source: OECD in figures, 2009)
Public Economics 15

14. Size of the government sector in 2008
(Source: OECD in figures, 2009)
…continued
Public Economics 16

15. 1.2
Why Study Public Finance? Facts on Government in the
United States
Spending, Taxes,
Deficits, and Debts
Federal Revenues and
Expenditures, Surplus or Deficit,
and Debt, 1930–2008 • For most
of the twentieth century, except
for the World War II period,
federal government tax receipts
have kept pace with
expenditures. But expenditures
have exceeded receipts by
several percentage points of
GDP on average since the
1970s. The resulting federal
government debt (held by the
public) at the end of July 2011 is
was about 67% of GDP. Including
intragovernament debt the ratio
rises to 98%.
Source: Office of Management and Budget
(2008), Tables 1.2 and 7.1. (Debt figures for
1930–1939 come from the U.S. Department of
the Treasury’s Bureau of the Public Debt.)
Public Economics 18

16. 1.2
Why Study Public Finance? Facts on Government in the
United States
Spending, Taxes, Deficits, and Debts
Public Economics 19

17. 1.2
Where is the US Federal debt nowadays?
Public Economics 20

18. 1.2
Why Study Public Finance? Facts on Government in Europe
NET BORROWING (+)/LENDING (-) IN 2009
(as a percentage of GDP)
Source: Banca d’Italia, 2011
Public Economics 21

19. 1.2
Why Study Public Finance? Facts on Government in Europe
GROSS PUBLIC DEBT IN 2009
(as a percentage of GDP)
Source: Banca d’Italia, 2011
Public Economics 22

20. 1.2
Why Study Public Finance? Facts on Government in the
United States
Distribution of Spending
The Distribution of Federal
and State Expenditures,
1960 and 2007 • This figure
shows the changing
composition of federal and
state spending over time, as
a share of total spending. (a)
For the federal government,
defense spending has fallen
and Social Security and
health spending have risen.
(b) For the states, the
distribution has been more
constant, with a small decline
in education and welfare
spending and a rise in health
spending.
Source: Bureau of Economic Analysis,
NIPA Table 3.16.
Public Economics 23

21. 1.2
Why Study Public Finance? Facts on Government in the UK
Public Economics 24

22. 1.2
Why Study Public Finance? Facts on Government in the
United States and around the World
Distribution of Spending
public goods Goods for
which the 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 market.
Public Economics 25

23. 1.2
Why Study Public Finance? Facts on Government in the
United States and around the World
Distribution of Revenue Sources
The Distribution of Federal and
State Revenues, 1960 and 2008 •
This figure shows the changing
composition of federal and state
revenue sources over time, as a
share of total revenues. (a) At the
federal level, there has been a
large reduction in corporate and
excise tax revenues and a rise in
payroll tax revenues. (b) For the
states, there has been a decline in
property taxes and a rise in income
taxes and federal grants.
Source: Bureau of Economic Analysis, NIPA
Tables 3.2 and 3.3.
Public Economics 26

24. 1.2
Why Study Public Finance? Facts on Government in the
United States and around the World
Regulatory Role of the Government
•Another critical role the government plays in all nations is that of
regulating economic and social activities:
 The Food and Drug Administration (FDA) regulates the labeling and
safety of nearly all food products and bottled water, tests cosmetics to
ensure their safety, and approves drugs and medical devices to be sold
to the public.
 The Occupational Safety and Health Administration (OSHA) is
charged with regulating the workplace safety of the 135 million
Americans employed at 8.9 million job sites.
 The Federal Communications Commission (FCC) regulates interstate
and international communications by radio, television, wire, satellite,
and cable.
 The Environmental Protection Agency (EPA) is charged with
minimizing dangerous pollutants in the air, water, and food supplies.
Public Economics 27

25. 1.3
Why Study Public Finance Now? Policy Debates over
Social Security, Health Care, and Education
Social Security, health care, and education are each the subject of debate,
with both the “liberal” and “conservative” positions holding differing views
in their approach to these major policy issues.
Social Security
•Social Security is the single largest government expenditure program in most
Western countries. The financing structure of this program is basically that
today’s young workers pay the retirement benefits of today’s old.
Health Care
This is one of the most dynamic expenditure items in developed world. In
the US, before the Obama health care reform, there were 45 million
Americans without any health insurance, about 18% of the non-elderly
U.S. population. Projections suggest that health care will consume almost
half of US GDP within the next century.
Public Economics 28

26. 1.3
Why Study Public Finance Now? Policy Debates over
Social Security, Health Care, and Education
Education
•There is an increasing debate over
spending in educational educational
system, highlighted by the cross-
country test on students’ assessment
(OECD-PISA)
Public Economics 29

27. Historical trends in government
•Over the last century, time trend of government expenditures as percentage of GDP has
been upwards (Wagner's Law)
– Cyclical element: G=GDP rises in recessions and vice versa (why?).
• Gov't consumption has risen much more slowly than gov't expenditures as a whole,
nearly at in many countries in last 30 yrs.
• Social security spending has shown a much sharper upward trend in most countries.
• There are various reasons for the Wagner’s law:
– Fiscal illusion: voters are unable to comprehend the full implications for
taxation of expenditure rises, hence vote for high-spending governments. Gov't
manipulate complexity of tax-benefit system, hiding real costs.
– Interest groups, they act in their interest. Their power increased over time.
– Some goods, such as healthcare, are luxury goods.
– Urbanization and growth
– Baumol effect: relative price of labor-intensive services increases compared to
manufactured goods, because of the stronger rate of technological progress in
the latter. As demand for service is (about) inelastic, their share in national
output tend to rise.
– Changing sufrage
– Changing demographics (increasing pension burden)
Public Economics 30

28. Conclusion
•It is clear from the facts presented here that the government plays a central role in
the lives of all developed countries around the world (and not only those).
•It is also clear that there is ongoing disagreement about whether that role should
expand, stay the same, or contract.
•The facts and arguments raised in this chapter provide a backdrop for thinking
about the set of public finance issues that we explore in the remainder of this
course.
Public Economics 31