Public economics ''(or economics of the public sector)'' is the study of government policy through the lens of

economic efficiency In microeconomics, economic efficiency, depending on the context, is usually one of the following two related concepts: * Allocative or Pareto efficiency: any changes made to assist one person would harm another. * Productive efficiency: no addi ...

and

equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the diff ...

. Public economics builds on the theory of

welfare economics Welfare economics is a branch of economics that uses microeconomic techniques to evaluate well-being (welfare) at the aggregate (economy-wide) level. Attempting to apply the principles of welfare economics gives rise to the field of public ec ...

and is ultimately used as a tool to improve

social welfare Welfare, or commonly social welfare, is a type of government support intended to ensure that members of a society can meet basic human needs such as food and shelter. Social security may either be synonymous with welfare, or refer specifical ...

. Welfare can be defined in terms of well-being, prosperity, and overall state of being. Public economics provides a framework for thinking about whether or not the government should participate in economic markets and if so to what extent it should do so.

Microeconomic theory Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics foc ...

is utilized to assess whether the private market is likely to provide efficient outcomes in the absence of governmental interference; this study involves the analysis of government

taxation A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, o ...

and

expenditures An expense is an item requiring an outflow of money, or any form of fortune in general, to another person or group as payment for an item, service, or other category of costs. For a tenant, rent is an expense. For students or parents, tuition is ...

. This subject encompasses a host of topics notably

market failure In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value. Market failures can be viewed as scenarios where indiv ...

s such as,

public goods In economics, a public good (also referred to as a social good or collective good)Oakland, W. H. (1987). Theory of public goods. In Handbook of public economics (Vol. 2, pp. 485-535). Elsevier. is a good that is both non-excludable and non-riv ...

externalities In economics, an externality or external cost is an indirect cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity. Externalities can be considered as unpriced goods involved in either c ...

and

Imperfect Competition In economics, imperfect competition refers to a situation where the characteristics of an economic market do not fulfil all the necessary conditions of a perfectly competitive market. Imperfect competition will cause market inefficiency when it hap ...

, and the creation and implementation of government policy. Broad methods and topics include: * the theory and application of

public finance Public finance is the study of the role of the government in the economy. It is the branch of economics that assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the other to achiev ...

* Analysis and

design A design is a plan or specification for the construction of an object or system or for the implementation of an activity or process or the result of that plan or specification in the form of a prototype, product, or process. The verb ''to design' ...

public policy Public policy is an institutionalized proposal or a decided set of elements like laws, regulations, guidelines, and actions to solve or address relevant and real-world problems, guided by a conception and often implemented by programs. Public ...

* distributional effects of taxation and government expenditures * analysis of

and

government failure Government failure, in the context of public economics, is an economic inefficiency caused by a government intervention, if the inefficiency would not exist in a true free market. The costs of the government intervention are greater than the ben ...

. Emphasis is on analytical and scientific methods and normative-ethical analysis, as distinguished from

ideology An ideology is a set of beliefs or philosophies attributed to a person or group of persons, especially those held for reasons that are not purely epistemic, in which "practical elements are as prominent as theoretical ones." Formerly applied pri ...

. Examples of topics covered are

tax incidence In economics, tax incidence or tax burden is the effect of a particular tax on the distribution of economic welfare. Economists distinguish between the entities who ultimately bear the tax burden and those on whom tax is initially imposed. The ta ...

optimal tax Optimal tax theory or the theory of optimal taxation is the study of designing and implementing a tax that maximises a social welfare function subject to economic constraints. The social welfare function used is typically a function of individual ...

ation, and the theory of

.•

Agnar Sandmo Agnar Sandmo (9 January 1938 – 31 August 2019) was a Norwegian economist at the Norwegian School of Economics (NHH). He made a series of important contributions in the study of disparities, redistribution, insurance arrangements and tax system ...

, 2008."public goods," ''The New Palgrave Dictionary of Economics'', 2nd Edition
Abstract.
br />   • Serge-Christophe Kolm, 1987. "public economics," ''The New Palgrave: A Dictionary of Economics'', v. 3, pp. 1047-48.
   • Anthony B. Atkinson and Joseph E. Stiglitz, 1980. ''Lectures in Public Economics'', McGraw-Hill, pp. vii-xi.
   •

Mancur Olson Mançur Lloyd Olson Jr. (; January 22, 1932 – February 19, 1998) was an American economist and political scientist who taught at the University of Maryland, College Park. His most influential contributions were in institutional economics, and ...

, 1971, 2nd ed.''The Logic of Collective Action: Public Goods and the Theory of Groups'', Harvard University Press,
Description
and chapter-previews links, pp
ix x.
/ref>

Subject range

The Journal of Economic Literature (JEL) classification codes are one way categorizing the range of economics subjects. There, Public Economics, one of 19 primary classifications, has 8 categories. They are listed below with JEL-code links to corresponding available article-preview links of

The New Palgrave Dictionary of Economics ''The New Palgrave Dictionary of Economics'' (2018), 3rd ed., is a twenty-volume reference work on economics published by Palgrave Macmillan. It contains around 3,000 entries, including many classic essays from the original Inglis Palgrave Dictio ...

Online (2008) and with similar footnote links for each respective ''sub''category if available:
JEL: H (all)
– Public Economics
JEL: H0
– General
JEL: H1
– Structure and Scope of Government
JEL: H2
–

Taxation A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, o ...

Subsidies A subsidy or government incentive is a form of financial aid or support extended to an economic sector (business, or individual) generally with the aim of promoting economic and social policy. Although commonly extended from the government, the ter ...

, and

Revenue In accounting, revenue is the total amount of income generated by the sale of goods and services related to the primary operations of the business. Commercial revenue may also be referred to as sales or as turnover. Some companies receive rev ...

JEL: H3
– Fiscal Policies and Behavior of Economic Agents
JEL: H4
– Publicly Provided Goods
JEL: H5
– National Government Expenditures and Related Policies
JEL: H6
– National Budget, Deficit, and Debt
JEL: H7
– State and Local Government; Intergovernmental Relations
JEL: H8
– Miscellaneous Issues.

Market failures

The role of government in providing efficient and equitable markets is largely underpinned by addressing market failures that may arise. Public Economics focuses on when and to what degree the government should intervene in the economy to address market failures. Some examples of government intervention are providing pure public goods such as defense, regulating negative externalities such as

pollution Pollution is the introduction of contaminants into the natural environment that cause adverse change. Pollution can take the form of any substance (solid, liquid, or gas) or energy (such as radioactivity, heat, sound, or light). Pollutants, th ...

and addressing imperfect market conditions such as

asymmetric information In contract theory and economics, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. Information asymmetry creates an imbalance of power in transactions, which can ...

Public goods

Pure public goods, or collective consumption goods, exhibit two properties; non-rivalry and non-excludability. Something is non-rivaled if one person's consumption of it does not deprive another person, (to a point) a firework display is non-rivaled - since one person watching a firework display does not prevent another person from doing so. Something is non-excludable if its use cannot be limited to a certain group of people. Again, since one cannot prevent people from viewing a firework display it is non-excludable. Due to these constraints, one of few examples of a "pure public good" is national defense - it is both non-rivalry and non-excludable. Another example, of a pure public good is knowledge. Consider a book. The book itself can be destroyed and thus is excludable. However, the knowledge obtained from the book is far more difficult to destroy and is non-rivalrous and non-excludable. In reality, not all public goods can be classed as 'pure' and most display some degree of excludability and rivalrous. These are known as Impure public goods. To visualize the public good's characteristic of non-excludability, it would be the inability to build a fence, barrier or wall that would block the good from consumption. In the modern era, digital replication allows several goods to be non-rivalry; since, people from all over the world can access it if you have access to the internet and a device. Due to the two unique properties that public goods exhibit, being non-rivalrous & non-excludable, it is unlikely that without intervention markets will produce the efficient amount. It therefore, the role of government to regulate the production of public goods so as to create an efficient market equilibrium.

Externalities

Externalities arise when consumption by individuals or production by firms affect the utility or production function of other individuals or firms. Positive externalities are education, public health and others while examples of negative externalities are air pollution,

noise pollution Noise pollution, also known as environmental noise or sound pollution, is the propagation of noise with ranging impacts on the activity of human or animal life, most of them are harmful to a degree. The source of outdoor noise worldwide is mai ...

, non-vaccination and more. Pigou describes as

positive externalities In economics, an externality or external cost is an indirect cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity. Externalities can be considered as unpriced goods involved in either c ...

, examples such as resources invested in private parks that improve the surrounding air, and scientific research from which discoveries of high practical utility often grow. Alternatively, he describes

negative externalities In economics, an externality or external cost is an indirect cost or benefit to an uninvolved third party that arises as an effect of another party's (or parties') activity. Externalities can be considered as unpriced goods involved in either co ...

, such as the factory that destroys a great part of the amenities of neighboring sites. The role of government is to address the negative external effects and societal

deadweight loss In economics, deadweight loss is the difference in production and consumption of any given product or service including government tax. The presence of deadweight loss is most commonly identified when the quantity produced ''relative'' to the amoun ...

created from inefficient markets

Imperfect competition

Imperfect competition In economics, imperfect competition refers to a situation where the characteristics of an economic market do not fulfil all the necessary conditions of a perfectly competitive market. Imperfect competition will cause market inefficiency when it hap ...

within markets can take many forms and will often depend on the barriers to entry, firms profit and production objectives and the nature of the product and respective market. Imperfect competition will lead to a social cost and it is the role of government to minimize this cost. Some notable imperfections include: # Companies sell differentiated products # There are barriers to exit and entry # Suboptimal output and pricing In its essence, the role of government is to address the issues that arise from these market failures and decide the optimal degree of intervention necessary.

Taxation

Diamond–Mirrlees efficiency theorem

In 1971,

Peter A. Diamond Peter Arthur Diamond (born , 1940) is an American economist known for his analysis of U.S. Social Security policy and his work as an advisor to the Advisory Council on Social Security in the late 1980s and 1990s. He was awarded the Nobel Memoria ...

and James A. Mirrlees published a seminal paper that showed that even when

lump-sum tax A lump-sum tax is a special way of taxation, based on a fixed amount, rather than on the real circumstance of the taxed entity.

ation is not available, production efficiency is still desirable. This finding is known as the Diamond–Mirrlees efficiency theorem, and it is widely credited with having modernized Ramsey's analysis by considering the problem of

income distribution In economics, income distribution covers how a country's total GDP is distributed amongst its population. Economic theory and economic policy have long seen income and its distribution as a central concern. Unequal distribution of income causes ec ...

with the problem of raising revenue.

Joseph E. Stiglitz Joseph Eugene Stiglitz (; born February 9, 1943) is an American New Keynesian economist, a public policy analyst, and a full professor at Columbia University. He is a recipient of the Nobel Memorial Prize in Economic Sciences (2001) and the ...

and

Partha Dasgupta Sir Partha Sarathi Dasgupta (born on 17 November 1942), is an Indian-British economist who is the Frank Ramsey Professor Emeritus of Economics at the University of Cambridge, United Kingdom and Fellow of St John's College, Cambridge. Personal ...

(1971) have criticized this theorem as not being robust on the grounds that production efficiency will not necessarily be desirable if certain tax instruments cannot be used.

Pigouvian taxes

One of the achievements for which the great English economist

A.C. Pigou Arthur Cecil Pigou (; 18 November 1877 – 7 March 1959) was an English economist. As a teacher and builder of the School of Economics at the University of Cambridge, he trained and influenced many Cambridge economists who went on to take chair ...

is known, was his work on the divergences between

marginal Marginal may refer to: * ''Marginal'' (album), the third album of the Belgian rock band Dead Man Ray, released in 2001 * ''Marginal'' (manga) * '' El Marginal'', Argentine TV series * Marginal seat or marginal constituency or marginal, in polit ...

private costs and marginal

social costs Social cost in neoclassical economics is the sum of the private costs resulting from a transaction and the costs imposed on the consumers as a consequence of being exposed to the transaction for which they are not compensated or charged. In other w ...

(

). In his book, ''The Economics of Welfare'' (1932), Pigou describes how these divergences come about:

...one person A, in the course of rendering some service, for which payment is made, to a second person B, incidentally also renders services or disservices to other persons (not producers of like services), of such a sort that payment cannot be extracted from the benefited parties or compensation enforced on behalf of the injured parties (Pigou p. 183).

In particular, Pigou is known for his advocacy of what are known as corrective taxes, or

Pigouvian taxes A Pigouvian tax (also spelled Pigovian tax) is a tax on any market activity that generates negative externalities (i.e., external costs incurred by the producer that are not included in the market price). The tax is normally set by the governmen ...

It is plain that divergences between private and social net product of the kinds we have so far been considering cannot, like divergences due to tenancy laws, be mitigated by a modification of the contractual relation between any two contracting parties, because the divergence arises out of a service or disservice to persons other than the contracting parties. It is, however, possible for the State, if it so chooses, to remove the divergence in any field by "extraordinary encouragements" or "extraordinary restraints" upon investments in that field. The most obvious forms which these encouragements and restraints may assume are, of course, those of bounties and taxes (Pigou p. 192).

Pigou suggested that the market failure of externalities can be overcome by the introduction of taxes. The government can intervene in the market, using an emission tax for example to create a more efficient outcome; this Pigouvian tax is the optimal policy prescription for any aggregate, negative externality. In 1960, the economist Ronald H. Coase proposed an alternative scheme whereby negative externalities are dealt with through the appropriate assignment of

property rights The right to property, or the right to own property (cf. ownership) is often classified as a human right for natural persons regarding their possessions. A general recognition of a right to private property is found more rarely and is typically h ...

. This result is known as the

Coase theorem In law and economics, the Coase theorem () describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that if trade in an externality is possible and there are sufficiently low tra ...

Cost–benefit analysis

While the origins of cost–benefit analysis can be traced back to Jules Dupuit's classic article "On the Measurement of the Utility of Public Works" (1844), much of the subsequent scholarly development occurred in the United States and arose from the challenges of water-resource development. In 1950, the U.S. Federal Interagency River Basin Committee's Subcommittee on Benefits and Costs published a report entitled, ''Proposed Practices for Economic Analysis of River Basin Projects'' (also known as the ''Green Book''), which became noteworthy for bringing in the language of welfare economics. In 1958,

Otto Eckstein Otto Eckstein (August 1, 1927 – March 22, 1984) was a German-American economist. He was a key developer and proponent of the theory of core inflation , which proposed that in determining accurate metrics of long run inflation, the transitory pri ...

published ''Water-Resource Development: The Economics of Project Evaluation'', and Roland McKean published his ''Efficiency in Government Through Systems Analysis: With Emphasis on Water Resources Development''. The latter book is also considered a classic in the field of

operations research Operations research ( en-GB, operational research) (U.S. Air Force Specialty Code: Operations Analysis), often shortened to the initialism OR, is a discipline that deals with the development and application of analytical methods to improve decis ...

. In subsequent years, several other important works appeared:

Jack Hirshleifer Jack Hirshleifer (August 26, 1925 – July 26, 2005) was an American economist and long-time professor at the University of California, Los Angeles. He received a B.S. from Harvard University in 1945 and a Ph.D. in 1950. He worked at the RAND Co ...

, James DeHaven, and Jerome W. Milliman published a volume entitled ''Water Supply: Economics, Technology, and Policy'' (1960); and a group of Harvard scholars including

Robert Dorfman Robert Dorfman (27 October 1916 – 24 June 2002) was professor of political economy at Harvard University. Dorfman made great contributions to the fields of economics, statistics, group testing and in the process of coding theory. His pape ...

, Stephen Marglin, and others published ''Design of Water-Resource Systems: New Techniques for Relating Economic Objectives, Engineering Analysis, and Governmental Planning'' (1962).Introduction to Benefit-Cost Analysis
/ref>

Notes

References

* Atkinson, Anthony B., and

, 1980. ''Lectures in Public Economics'', McGraw-Hill * Auerbach, Alan J., and Martin S. Feldstein, ed. ''Handbook of Public Economics''. Elsevier. : 1985, v. 1
Description
an
preview.
: 1987, v. 2

: 2002. v. 3
Description.
: 2007. v. 4
Description.
* Barr, Nicholas, 2004. ''Economics of the Welfare State'', 4th ed., Oxford University Press. * Buchanan, James M.,

967 Year 967 ( CMLXVII) was a common year starting on Tuesday (link will display the full calendar) of the Julian calendar. Events By place Europe * Spring – Emperor Otto I (the Great) calls for a council at Rome, to present the ne ...

1987. ''Public Finance in Democratic Process: Fiscal Institutions and Individual Choice'', UNC Press
Description
scrollabl
preview
an
back cover.
* _____ and Musgrave, Richard A., 1999. ''Public Finance and Public Choice: Two Contrasting Visions of the State. MIT Press
Description
and scrollable previe
links.
* Coase, Ronald. "

The Problem of Social Cost "The Problem of Social Cost" (1960) by Ronald Coase, then a faculty member at the University of Virginia, is an article dealing with the economic problem of externalities. It draws from a number of English legal cases and statutes to illustrate Co ...

" ''Journal of Law and Economics'' Vol. 3 (Oct. 1960) 1-44 * Diamond, Peter A. and James A. Mirrlees. "Optimal Taxation and Public Production I: Production Efficiency" ''The American Economic Review'' Vol. 61 No. 1 (Mar. 1971) 8-27 * Diamond, Peter A. and James A. Mirrlees. "Optimal Taxation and Public Production II: Tax Rules" ''The American Economic Review'' Vol. 61 No. 3 (Jun. 1971) 261-278 * Drèze Jacques H., 1995. "Forty Years of Public Economics: A Personal Perspective," ''Journal of Economic Perspectives'', 9(2), pp
111-130.
* Dupuit, Jules. "On the Measurement of the Utility of Public Works" in ''Readings in Welfare Economics'', ed. Kenneth J. Arrow and Tibor Scitovsky (1969) * Haveman, Robert 1976. ''The Economics of the Public Sector''. * Kolm, Serge-Christophe, 1987. "public economics," '' The New Palgrave: A Dictionary of Economics'', v. 3, pp. 1047–55. * Feldstein, Martin S., and Robert P. Inman, ed., 1977. ''The Economics of Public Services''. Palgrave Macmillan. * Musgrave, Richard A., 1959. ''The Theory of Public Finance: A Study in Public Economy'', McGraw-Hill. 1st-page reviews of J.M. Buchanan

& C.S. Shoup

* _____ and Alan T. Peacock, ed., 9581994. ''Classics in the Theory of Public Finance'', Palgrave Macmillan
Description
an
contents.
* Laffont, Jean-Jacques, 1988. ''Fundamentals of Public Economics'', MIT Press
Description.
* Myles, Gareth D., 1995. ''Public Economics'', Cambridge
Description
and scroll to chapter-preview
links.
* Oates, Wallace E., 1972. ''Fiscal Federalism'', Harcourt Brace Jovanovich, Inc. * Pigou, A.C. "Divergences Between Marginal Social Net Product and Marginal Private Net Product" in ''The Economics of Welfare'', A.C. Pigou (1932) * Ramsey, Frank P. "A Contribution to the Theory of Taxation" in ''Classics in the Theory of Public Finance'', ed. R.A. Musgrave and A.T. Peacock (1958) * Stigler, George J. and Paul A. Samuelson, 1963. "A Dialogue on the Proper Economic Role of the State." ''Selected Papers'', No.7. Chicago: University of Chicago Graduate School of Business. * Starrett, David A., 1988. ''Foundations of Public Economics'', Cambridge
Description.
Scroll to chapter-previe
links.
* Stiglitz, Joseph E., 1994
'Rethinking the Economic Role of the State: Publicly Provided Private Goods'
Unpublished. * _____, 1998. "The Role of Government in the Contemporary World," in Vito Tanzi and Ke-Young Chu, ''Income Distribution and High-Quality Growth'', pp
211-54.
* _____, 2000. ''Economics of the Public Sector'', 3rd ed., Norton. * Tinbergen, Jan, 1958. ''On the Theory of Economic Policy''.

External links

Journal of Public Economics

{{Authority control Public economics,