Public Finance Instructor: John Hartman

1. Public FinanceInstructor: John Hartman Today: An introduction to Econ 130 A review of microeconomics Introduction to public finance

2. Before we begin… • Remember that this is a small class  Ask questions if things are not clear • The syllabus is posted online  See http://econ.ucsb.edu/~hartman/ • For most of you, attendance is important if you want to get a good grade

3. Before we begin… • I expect you to know the following tools • Calculus • Derivatives, integrals, partial derivatives • Microeconomics • Econ 1, Econ 100A or 104A, Econ 100B or 104B • Macroeconomics (although not as important for public finance) • Econ 2, Econ 101 or 105 • If you are lacking on any of these skills, please make sure you are comfortable with these skills by next week

4. Structure of learning • Expected time to spend on this class • 3 hours per unit per week • 12 hours per week total • Format of learning • Read first • Lecture • Do problems on your own • Solve problems in class and review sessions

5. Textbook for this class • Rosen/Gayer • Public Finance, 8th edition • Published by McGraw-Hill/Irwin

6. Office hours and review sessions • Office: NH 2028 • Office hours: • Mondays 10:30-11:30 am • Wednesdays 9:30-10:30 am • I plan on conducting one review session before each test • Time and location to be announced

7. Tests • Three tests, as of now scheduled for: • Monday, April 28 (in lecture) • Monday, May 19 (in lecture) • Monday, June 8 (final, 4-6:30 pm) • Some problems on tests will be similar to what we cover in practice problems • Some questions will require you to learn material and think your way through

8. Lecture slides • I will post a subset of lecture slides on-line • Usually posted 2 days to a week before lecture • Tables and figures from your textbook will often not be posted • On-line slides are not meant to be a replacement to lecture

9. Grading • If you do not miss a test: • Two best tests count 40% each • Lowest test counts 20% • Exception: If your best test is the final, the final will count 60% and the other two tests count 20% each • If you do miss a test, check the syllabus for details

10. Grading • Typical upper division Econ field class curve • 20-25% A+, A, or A- • 30-35% B+, B, or B- • 25-30% C+, C, or C- • Remaining students: D+, D, D-, or F • However, I will reward the class if you score well as a group

11. More on this class • Early on, I will lecture the entire time • Later on many lectures will be about 55-60 minutes, followed by problem solving • Some classes will be devoted to a single topic • Some classes will consist of two to four “mini-lectures”

12. Problems • Each week, I will post a few problems • The following week, I will solve some of the problems at the end of each lecture, as time permits • I will also solve some problems at each review session

13. Today • An introduction to Econ 130 • What will we cover over the next 10 weeks? • A brief review of Microeconomics (read Appendix) • Supply, demand, and equilibrium • Utility • Budget constraints • Substitution and income effects • Consumer and producer surplus • Introduction to public finance: Begin Chapter 1

14. An introduction to Econ 130 • This class covers four “units,” each with three to five lectures • Unit 1: Introduction and Microeconomic tools • Unit 2: Public goods, externalities, and government • Unit 3: Health care and income redistribution • Includes guest lecture by Ted Bergstrom • Tentative topic: Bone marrow as a public good • Unit 4: Primary and secondary effects of taxes

15. Unit 1 (begins today) • Introduction and Microeconomic tools • Appendix: Microeconomics review and marginal analysis • Chapter 1: Introduction to public finance and government • Chapter 2: Empirical tools • Chapter 3: Economic theory tools • Chapter 8: Cost-benefit tools

16. Unit 2 • Public goods, externalities, and government • Chapter 4: Public goods • Chapter 5: Externalities • Chapter 6: Government and political economy • Chapter 7: Government spending on education

17. Unit 3 • Health care and income redistribution • Chapter 9: Problems of insurance in the health care market • Chapter 10: Government’s role in health care • Chapter 11: The structure of Social Security; stresses caused by the baby boom generation • Chapter 12: Conceptual issues of income redistribution • Chapter 13: Programs for the poor

18. Unit 4 • Primary and secondary effects of taxes • Chapters 14 and 15, and parts of Chapter 16: Taxation, income distribution, and efficiency • Parts of Chapters 17-21: Taxation on the national level • Personal taxes • Corporate taxes • Deficit finance • Tax reform • Chapter 22: Taxation on a state and local level

19. Microeconomics review • Some topics you should already know • We will assume standard cases • If you need review on these topics, look in the Rosen/Gayer (“R/G”) appendix, or books that you used in introductory or intermediate microeconomics classes

20. Supply, demand, and equilibrium • In equilibrium, the supply and demand curves intersect • When quantity supplied is higher than quantity demanded, there is a push for prices to go down • Excess supply • When quantity supplied is lower than quantity demanded, there is a push for prices to go up • Excess demand

21. Supply and Demand

22. Equilibrium: Q = 4, P = 6

23. Example of excess demand

24. Factors of demand • Price: Higher price  lower quantity demanded • Income: Most goods are normal • Normal goods: Higher income means higher demand • Price of related goods (complements, substitutes) • “Tastes and preferences”

25. Factors of supply • Price: Higher price  higher quantity demanded • Price of inputs • Technology • Weather

26. Shift in demand;movement along supply curve

27. Utility • Utility is used by economists to note a level of satisfaction • The higher the utility, the higher the satisfaction

28. Bananas and utility • Notice this example, where the utility level is a function of the number of bananas consumed • Common unit of utility is called a “util” • Typically assume non-satiation

29. An indifference curve that is further from the origin has higher utility U2 > U1 > U0 Two goods and utility U2 Increasing utility U1 U0

30. Budget constraints • We assume each person has wants that are above the resources available to her/him • Consumption must be made from resources available

31. Budget constraints with no money • Becky has a given number of hours per day • Feasible bundles: t, v, w, x, y, z • Point t does not use up her time allotment • Point u is infeasible

32. Budget constraints with no trade • If there is no trade: • Becky chooses production to maximize her utility • This occurs where budget constraint is tangent to an indifference curve • Point E1 E1

33. Substitution and income effects • When the price of a good changes, two things happen • Income effect: How much does quantity change due to lower income? • Substitution effect: How much does quantity change due to change in relative prices?

34. Income effect E1 to Ec Substitution effect Ec to E2 Note that budget lines to calculate income effect are parallel Substitution and income effects

35. Consumer surplus • Height of triangle is ($6 – $3), or $3. • Length of triangle is (6 – 0), or 6 • Area of triangle is one-half times length times height • CS = $9 The area of this triangle is a good approximation of CS

36. Producer surplus • When P = 25 per unit, shaded area is approximate producer surplus • Area is a triangle, one-half times length times height • 0.5  10  25 = 125

37. Summary: Microeconomics review • Many microeconomic tools are needed to do public finance • Some of the tools that we will use are based on supply, demand, utility, and budget constraints

38. Introduction to public finance • This class is meant to cover public finance to students that have no direct background in the topic • Some knowledge on public goods and externalities is useful, but not required • Two topics will be covered in this “mini-lecture” • What is studied in a public finance class? • What kinds of views do people have about public finance? • Government will be addressed more in later lectures • Size of government will be covered in the next lecture • Growth of government will be covered in week 4

39. Public finance • Public finance, as defined by R/G (p. 2) • “The field of economics that analyzes government taxation and spending policies” • Public finance, as described by Former Czech Prime Minister Vaclav Klaus (From R/G, p. 2) • “Public finance is nothing else than a sophisticated discussion of the relationship between the individual and the state”

40. Public finance • We will study topics in which many argue that government intervention is justified • Public goods and markets with externalities • Subsidized education • Health care, Social Security, and income redistribution

41. Public finance and taxes • Many programs require tax money to operate • We will study how the governments on the local, state, and national level operate • Personal income tax • Reaction to labor/leisure choices • Corporate taxes • Deficit financing • Potential reforms to the current tax structure

42. Public _____ • There are at least two other terms that mean the same thing as public finance • Public sector economics • Public economics • Although I may use the three terms interchangeably to mean the same thing, I will usually use the term “public finance”

43. What views do people have? • Different people have different views about public finance • Organic view of government • Mechanistic view of government

44. Organic view of government • Government treats an entire society as a natural organism • Each individual is part of the organism • The government is the heart • Although individual goals differ, some goals are naturally needed for the societal organism

45. Mechanistic view of government • Government is needed for individuals to pursue their individual goals • “Invisible hand” (Adam Smith) • Efficient markets under certain sets of conditions • Property rights and lack of violence needed to have efficient markets • How much government beyond this is debatable • Libertarian: Small government • Social democrats: Larger government needed

46. What this class does • Some analysis is done on a society-wide scale • Social costs and benefits • Cost-benefit analysis on a nationwide scale • Other topics talk about individual analysis • Voting theory • Individual reaction to taxes and credits on labor

47. Determining what is “good” • What is “good” to one person may be viewed as bad as others • Let’s do an activity to illustrate this • Everyone starts by standing up • I will show a statement • Stay standing if you agree with the statement • Sit down if you disagree with the statement • There is no “right” answer to any question • Time to stand up

48. Statements 1-3 • I believe that reckless driving should be stopped through government actions (such as the use of police) • I think that government should build and maintain roads and highways • I believe that each baby needs to be securely buckled into a car seat while riding in a car, to be enforced by the government

49. Statements 4-6 • I believe that each person in a moving car needs a seat belt on, to be enforced by the government • I believe each driver needs liability insurance, to be enforced by the government • I believe the government has a right to regulate when each person can use the roads, and the route they take, in order to control traffic patterns

50. Statements 7-9 • I believe that the government has a right to prevent pilots of commercial aircraft from using a cell phone while actively flying • I believe that the government has a right to prevent drivers of cars from using a cell phone while driving • I believe that the government should charge a 90% tax rate on all income I earn in my lifetime