Public economics ''(or economics of the

public sector The public sector, also called the state sector, is the part of the economy composed of both public services and public enterprises. Public sectors include the public goods and governmental services such as the military, law enforcement, pu ...

)'' 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 addit ...

and equity. Public economics builds on the theory of

welfare economics Welfare economics is a field of economics that applies microeconomic techniques to evaluate the overall well-being (welfare) of a society. The principles of welfare economics are often used to inform public economics, which focuses on the ...

and is ultimately used as a tool to improve

social welfare Welfare spending 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 specifically to social insurance p ...

. 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 economics that studies the behavior of individuals and Theory of the firm, firms in making decisions regarding the allocation of scarcity, scarce resources and the interactions among these individuals and firms. M ...

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 and expenditures. 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.Paul Krugman and Robin Wells Krugman, Robin Wells (2006 ...

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 goods, commodity, product or service that ...

, externalities 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 causes market inefficiencies, resulting in ...

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

public finance Public finance refers to the monetary resources available to governments and also to the study of finance within government and role of the government in the economy. Within academic settings, public finance is a widely studied subject in man ...

* Analysis and

design A design is the concept or proposal for an object, process, or system. The word ''design'' refers to something that is or has been intentionally created by a thinking agent, and is sometimes used to refer to the inherent nature of something ...

public policy Public policy is an institutionalized proposal or a Group decision-making, decided set of elements like laws, regulations, guidelines, and actions to Problem solving, solve or address relevant and problematic social issues, guided by a conceptio ...

* distributional effects of taxation and government expenditures * analysis of

and

government failure In public choice, a government failure is a counterpart to a market failure in which government regulatory action creates economic inefficiency. A government failure occurs if the costs of an intervention outweigh its benefits. Government failu ...

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

ideology An ideology is a set of beliefs or values attributed to a person or group of persons, especially those held for reasons that are not purely about belief in certain knowledge, in which "practical elements are as prominent as theoretical ones". Form ...

. 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 the tax is initially imposed. Th ...

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 individuals ...

ation, and the theory of

.• Agnar Sandmo, 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, 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 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,

Subsidies A subsidy, subvention or government incentive is a type of government expenditure for individuals and households, as well as businesses with the aim of stabilizing the economy. It ensures that individuals and households are viable by having acce ...

, and

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

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 harm. Pollution can take the form of any substance (solid, liquid, or gas) or energy (such as radioactivity, heat, sound, or light). Pollutants, the component ...

and addressing imperfect market conditions such as asymmetric information.

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, or sound pollution, is the propagation of noise or sound with potential harmful effects on humans and animals. The source of outdoor noise worldwide is mainly caused by machines, transport and propagation systems.Senate Publi ...

, non-vaccination and more. Pigou describes as positive externalities, 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, 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 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 causes market inefficiencies, resulting in ...

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 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 e ...

with the problem of raising revenue. Joseph E. Stiglitz and Partha Dasgupta (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 is known, was his work on the divergences between marginal private costs and marginal social costs ( externalities). 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:

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 Possession (law), possessions. A general recognition of a right to private property is found more rarely ...

. This result is known as the Coase theorem.

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 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 () (U.S. Air Force Specialty Code: Operations Analysis), often shortened to the initialism OR, is a branch of applied mathematics that deals with the development and application of analytical methods to improve management and ...

. In subsequent years, several other important works appeared: Jack Hirshleifer, 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, Stephen Marglin, and others published ''Design of Water-Resource Systems: New Techniques for Relating Economic Objectives, Engineering Analysis, and Governmental Planning'' (1962).

Individual Preferences for Public Goods

Public economics involves collective decision making, which can be difficult as individuals in society have different views, including on how much should be spent on public goods. Richer individuals prefer to spend more on both public and private goods than individuals with lower incomes.Stiglitz, Joseph E., Rosengard, Jay K.. (2015). ''Economics of the Public Sector'' (Ed. 4th). New York: W.W. Norton & Company, Inc.. While both rich and poorer citizens pay the same price for private goods, individuals with higher incomes must pay a relatively higher cost when it comes to

. We can calculate this additional expenditure as the tax price; “the additional amount an individual must pay when government expenditures increase by one dollar”. With a higher tax price wealthier individuals will desire a lower expenditure on public goods.

Aggregating Preferences

An important part of collective decision making in a

democracy Democracy (from , ''dēmos'' 'people' and ''kratos'' 'rule') is a form of government in which political power is vested in the people or the population of a state. Under a minimalist definition of democracy, rulers are elected through competitiv ...

, and thus public economics, is aggregating preferences of all individuals in society. To aggregate preferences, however, the decision-making body (i.e. the government) must first ascertain the preferences of the citizens. We can call this process preference revelation, and in terms of public economics, the objective is to determine the “desired level of public goods of each individual”. This can be a very difficult process in practice. In most democratic countries, citizens vote for representatives that best emulate their preferences. This process can be perverted in a number of ways including

lobbying Lobbying is a form of advocacy, which lawfully attempts to directly influence legislators or government officials, such as regulatory agency, regulatory agencies or judiciary. Lobbying involves direct, face-to-face contact and is carried out by va ...

, media biases, political advertising, and

special interest group A special interest group (SIG) is a community within a larger organization with a shared interest in advancing a specific area of knowledge, learning or technology where members cooperate to effect or to produce solutions within their particular f ...

s. Another aspect of this public choice paradigm was identified by

Anthony Downs James Anthony Downs (November 21, 1930October 2, 2021) was an American economist specializing in public policy and public administration. His research focuses included political choice theory, rent control, affordable housing, and transportatio ...

in 1957, when he wrote that “parties formulate policies to win elections, rather than win

election An election is a formal group decision-making process whereby a population chooses an individual or multiple individuals to hold Public administration, public office. Elections have been the usual mechanism by which modern representative d ...

s to formulate policies”. The argument is that

political parties A political party is an organization that coordinates candidates to compete in a particular area's elections. It is common for the members of a party to hold similar ideas about politics, and parties may promote specific ideological or p ...

and candidates are motivated primarily by self-interest, and “the income, prestige and power which come from being in office". This can sometimes lead to difficult outcomes and can make it harder to properly aggregate the preferences of the population and can potentially lead to the favouring of the welfare of government officials as opposed to public welfare. Social Choice Theory

Social choice theory Social choice theory is a branch of welfare economics that extends the Decision theory, theory of rational choice to collective decision-making. Social choice studies the behavior of different mathematical procedures (social welfare function, soc ...

in economics studies how groups end up making decisions as opposed to individuals. One of the central components of social choice theory is that government actions result from individuals acting out of rational self-interest within the confines of the “rules of the game”. In this sense, the constitution of a given country is a significant factor in what actions a government can take (i.e. limits on deficit spending). One of the pioneers in this field was the American economist James Buchanan, who emphasized the role of the constitution in setting out the rules of the game. The idea is that without restraints in place, there will be natural incentives for the majority to redistribute income in away from the minority in their favour. There is also the threat of special interest groups influencing elected representatives to act in their favour, at the expense of the public interest, and without appropriate rules in place these temptations will naturally be capitalized on.

Notes

References

* Atkinson, Anthony B., and Joseph E. Stiglitz, 1980. ''Lectures in Public Economics'', McGraw-Hill * Auerbach, Alan J., and Martin S. Feldstein, ed. ''Handbook of Public Economics''. Elsevier. : 1985, v. 1
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: 1987, v. 2

: 2002. v. 3
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: 2007. v. 4
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* Barr, Nicholas, 2004. ''Economics of the Welfare State'', 4th ed., Oxford University Press. * Buchanan, James M., 9671987. ''Public Finance in Democratic Process: Fiscal Institutions and Individual Choice'', UNC Press
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an
back cover.
* _____ and Musgrave, Richard A., 1999. ''Public Finance and Public Choice: Two Contrasting Visions of the State''. MIT Press
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* Coase, Ronald. " The Problem of Social Cost" ''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.,

958 Year 958 (Roman numerals, CMLVIII) was a common year starting on Friday of the Julian calendar. Events By place Byzantine Empire * October / November – Battle of Raban: The Byzantine Empire, Byzantines under John I Tzimiskes, Jo ...

1994. ''Classics in the Theory of Public Finance'', Palgrave Macmillan
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* Laffont, Jean-Jacques, 1988. ''Fundamentals of Public Economics'', MIT Press
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* Myles, Gareth D., 1995. ''Public Economics'', Cambridge
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* 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
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* 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,