Public Economics Introduction

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Public Economics

broder definition

Public economics (or economics of the public sector) is the study of government policy through the lens of economic efficiency and equity. At its most basic level, public economics provides a framework for thinking about whether or not the government should participate in economics markets and to what extent its role should be. In order to do so, microeconomic theory is utilized to assess whether the private market is likely to provide efficient outcomes in the absence of governmental interference. Inherently, this study involves the analysis of government taxation and expenditures. This subject encompasses a host of topics including market failures, externalities, and the creation and implementation of government policy. Public economics builds on the theory of welfare economics and is ultimately used as a tool to improve social welfare.

Broad methods and topics include:

  • the theory and application of public finance
  • analysis and design of public policy
  • distributional effects of taxation and government expenditures
  • analysis of market failure and government failure.

Emphasis is on analytical and scientific methods and normative-ethical analysis, as distinguished from ideology. Examples of topics covered are tax incidence optimal taxation and the theory of public goods

What is Public Economics?
Public economics focuses on answering two types of questions

  1. How do government policies a搂ect the economy?
  2. How should policies be designed to maximize welfare?

  • Motivation 1: Practical Relevance

    • Interest in improving economic welfare -> interest in public economics
    • Almost every economic intervention occurs through government policy
      • Price intervention: taxes, welfare, social insurance, public goods
      • Regulation: min wages, FDA regulations (25% of products consumed),zoning, labor laws, min education laws, environment
      • Government directly employs one sixth of U.S. workforce
    • Contentious debate on the appropriate role of government in society
    • Stakes are extremely large because of broad scope of policies

  • Motivation 2: Academic Interest

    • Macro, development, labor, and corporate 脰nance questions often ultimately motivated by a public economics question
    • Natural to combine public 脰nance with another field
    • Understanding public 脰nance can help ensure that you work on relevant topics

  • Motivation 3: Methodology

    • Public economics is at the frontier of a methodological transformation in applied microeconomics
    • Data-driven approach to answering important policy questions
      • Combines a broad set of skills: applied theory, applied econometrics, simulation methods
      • Useful skill set for many applied 脰elds in economics

  • Theme 1: Connecting Theory to Data

    • Modern public economics tightly integrates theory with empirical evidence to derive quantitative predictions about policy ||

    • Taditional approach: theoretical models and numerical simulations

    • Recent work derives robust formulas that can be implemented using well-identified empirical estimates

  • Theme 2: Quasi-Experimental Empirical Methods

  • Theme 3: “Big Data”

    • so-called pre-existing Survey Data and Administrative Data
  • Theme 4: Behavioral Models

Administrative data

refers to information collected primarily for administrative (not research) purposes. This type of data is collected by government departments and other organisations for the purposes of registration, transaction and record keeping, usually during the delivery of a service.

Event Study Designs

  • Event studies are a powerful research design when treatments are staggered in time across individuals
  • Use a group of treated individuals as counterfactuals for each other to account for time series trends

  • Good for identifying sharp, short-run e§ects but not longer-term impacts

  • Methodology

    1. Define “event time” as calendar time minus date of treatment for each treated obs.
    2. Plot means/medians, etc. of outcome variable by event time

Social Insurance

definition

  • Transfers based on events such as unemployment, disability, or age
  • Contrasts with welfare: means-tested transfers
  • SI is the biggest and most rapidly growing part of government expenditure today

MAIN QUESTION

  1. Why have social (as opposed to private, or any) insurance?
  2. What type of SI system maximizes social welfare?

Tradeoff between two forces

  • Benefits — reducing risk (áuctuations in consumption)
  • Distortion — changes in incentives for workers and firms -> ineficient behavior and DWL

Also will generate new distortions as you fix the problem you set out to solve -> second-best solution.

Identify optimal policy by combining theoretical models of social insurance with empirical evidence on program effects

first question: Why have social insurance

  • Motivation for insurance: reduction in risk for risk-averse individuals
    • Unemp Ins: risk of involuntary unemployment
    • Workersícomp and DI: risk of injuries/disabilities
    • Social Security annuity: risk of living too long

But why is government intervention needed to provide this insurance? Possible sources of market failure here:

  1. Informational problems (adverse selection)
  2. Individual optimization failures (myopia/improper planning)
  3. Macroeconomic shocks

Adverse Selection

reference: Rothschild and Stiglitz (1976); see MWG Ch. 13 for a good review

Main result: can lead to market failure where no equilibrium supports
provision of insurance