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Lecture 2 Introduction to Public Finance ANDREEA STOIAN, PHD PROFESSOR OF FINANCE DEPARTMENT OF FINANCE AND CEFIMO BUCHAREST UNIVERSITY OF ECONOMIC STUDIES Why Study Public Finance? Role of the government in economy CANDIDATE 1 CANDIDATE 2 The role of the government is not to create wealth. The role of the government is to create an environment in which the entrepreneur is willing to take risk and to be able to get a return on the risk taken. oSet in motion programs that help people go to college, buy a new house, and build their wealth oPlans invest in people oInvesting more in public schools and expecting more in return The goal of Public Finance The study of the role of the government in the economy in order to proper understand it. Four questions of Public Finance WHEN should government intervene in the economy? HOW might the government intervene? WHAT is the effect of those interventions in the economy? WHY do governments choose to intervene in the way what they do? WHEN? MARKET FAILURE REDISTRIBUTION Problem that causes The shifting of resources the market economy to from some groups in deliver an outcome society to others that does not maximize efficiency Market failure Market failure (I) Individual needs Private goods Market Peoples’ needs Public goods Social needs Government Due to choices based on ‘individual rationality’ Government intervene in achieving the most efficient outcome for the society Should be the most efficient outcome for society when all individuals would make ‘collective decisions’ Market fails in delivering the most efficient outcome to society Competitive market equilibrium Market failure (II) By making collective decisions aiming at the ‘social welfare’ Supplementary reading: http://www.econlib.org/library/Buchanan/buchCv3c4.html#Ch. 4, Individual Rationality in Social Choice Redistribution Redistribution (I) Size Distribution EquityEfficiency trade off Thomas Piketty – Capital in the TwentyFirst Century The Regulatory Role of the Government Another critical role that government plays in all nations is that of regulating economic and social activities. Example of the regulatory role of the government in economic activities • Give an example! Example of the regulatory role of the government in social activities • Give an example! The Stabilization Role of the Government Intervene in the economy in order to stimulate/reduce the activity • Give an example! Smoothing the business cycle • Give an example! Prevent large disequilibrium • Give an example! HOW? Restricting or mandating Taxes and subsidies Government Public financing and private provision Public provision WHAT? Empirical public finance Direct Effects: that would be predicted if individuals did not change behaviour in response to the intervention Indirect Effects: that arise only because individuals change their behaviour in response to the interventions WHY? Normative • How should government intervene? • Question concerned with how things should be done Positive • Why do governments do what they do? • Question concerned with the things are the way they are Political economy • The theory of how the political process produces decisions that affect individuals and the economy • Government failures
