财政学教程第5版

Copyright©2010WorthPublishers1.1

TheFourQuestionsofPublicFinance1.2

WhyStudyPublicFinance?FactsonGovernmentintheUnitedStatesandAroundtheWorld1.3WhyStudyPublicFinanceNow?PolicyDebatesoverSocialSecurity,HealthCare,andEducation1.4ConclusionWhyStudyPublicFinance?1HeatherLueaandDanSacksPREPAREDBYIntroduction:TheAffordableCareAct1.1OnMarch23,2010,PresidentBarackObamasignedintolawthePatientProtectionandAffordableCareAct,commonlyknownastheACA.UndertheACA,thegovernmentwasprojectedtospendnearly$1trilliononpublichealthinsuranceandsubsidiestoprivatehealthinsurancecoveragebetween2010and2019.Thisspendingwouldbeoffsetbyspendingreductionsonexistingpublicinsuranceprogramsandnewtaxesonthemedicalsectorandthewealthy.AsaresultoftheACA,insurancecompaniescannolongerdiscriminateagainstsickpatients,andindividualswhocanaffordhealthinsurancemustpurchaseitorpayapenalty.Inaddition,dozensofnewinitiativesarebeingundertakeninanattempttocontrolrunawayhealthcarespendingintheUnitedStatesIntroduction:TheAffordableCareAct1.1Despiteitspassage,theACAcontinuestobedebatedferociouslyinCongress,inthestates,andincampaignsatalllevelsofgovernment.Supportersarguethatthebillcorrectsfailedinsurancemarkets,reducestheeconomicburdenontheuninsured,andmovestocontrolhealthcarecostsinthelongrun.OpponentsofthelegislationviewedtheACAasanunwarrantedexpansionofgovernmentpowerintothehealthcaresector—andanenormousexpansionofgovernmentspendingatatimeofrecorddeficits.Thecontroversiesovertheproperroleofthegovernmentindealingwithhealthcarecoverageandcostsraisethefundamentalquestionsaddressedbythebranchofeconomicsknownaspublicfinance.TheFourQuestionsofPublicFinance1.1Publicfinance:Thestudyoftheroleofthegovernmentintheeconomy.Fourquestionsofpublicfinance:

When

shouldthegovernmentinterveneintheeconomy?How

mightthegovernmentintervene?What

istheeffectofthoseinterventionsoneconomicoutcomes?Why

dogovernmentschoosetointerveneinthewaythattheydo?WhenShouldtheGovernmentInterveneintheEconomy?1.1Economicsgenerallypresumesthatmarketsdeliverefficientoutcomes,sowhyshouldgovernmentdoanything?Primarymotiveforgovernmentinterventionisthereforemarketfailure.Marketfailure:Aproblemthatcausesthemarketeconomytodeliveranoutcomethatdoesnotmaximizeefficiency(discussedinChapter2).1.1Measlesvaccinewasintroducedin1963,andmeaslescaseshadbecomerelativelyrareintheUnitedStatesbythe1980s.1989−1991:Hugeresurgenceinmeasles.Thisoutbreakresultedfromverylowimmunizationratesamongdisadvantagedinner-cityyouths.Unimmunizedchildrenimposedanegativeexternalityonotherchildren.APPLICATION:ModernMeaslesEpidemicThefederalgovernmentrespondedtothishealthcrisisintheearly1990s:Encouragedparentstoimmunizetheirchildren.Paidforthevaccinesforlow-incomefamilies.Impressiveresults:Immunizationrates

neverhigherthan70%priortooutbreak.Roseto90%by1995.Governmentinterventionclearlyreducedthisnegativeexternality,discussedinChapters5and6.1.1APPLICATION:ModernMeaslesEpidemicIn2014,therewere644cases.LargestoutbreakinDisneyland.Thereasonwastherefusalofalargenumberofparentstoimmunizetheirchildrenduetonowdiscredited“link”betweenvaccinationsandautism.The“anti-vaccine”movementhastakenroot,resultinginlargepocketsofnonimmunizedchildreninsomeareas.Doesgovernmentpolicyneedtogofurtherandrequirechildrentobevaccinated?1.1APPLICATION:ModernMeaslesEpidemicWhenShouldtheGovernmentInterveneintheEconomy?1.1Evenifthemarketiswell-functioning,anefficientoutcomeisnotnecessarilysociallydesirable.Redistributionisasecondreasonforgovernmentintervention.Redistribution:Theshiftingofresourcesfromsomegroupsinsocietytoothers.1.1TaxorSubsidizePrivateSaleorPurchase

Usethepricemechanism,changingthepriceofagoodtoencourageordiscourageuse.Taxesraisethepriceforprivatesalesorpurchasesofgoodsthatareoverproduced.Subsidieslowerthepriceforprivatesalesorpurchasesofgoodsthatareunderproduced.HowMighttheGovernmentIntervene?1.1RestrictorMandatePrivateSaleorPurchaseQuotasrestrictprivatesaleofgoodsthatareoverproduced.Mandatesrequireprivatepurchaseofgoodsthatareunderproduced.PublicProvisionThegovernmentcanprovidethegooddirectly.PublicFinancingofPrivateProvisionGovernmentspays;privatecompaniesproduce.HowMighttheGovernmentIntervene?Interventionshavedirectandindirecteffects.Directeffects:Theeffectsofgovernmentinterventionsthatwouldbepredictedifindividualsdidnotchangetheirbehaviorinresponsetotheirinterventions.With49millionuninsured,providinguniversalhealthinsurancecovers49millionpeople.Indirecteffects:Theeffectsofgovernmentinterventionthatariseonlybecauseindividualschangetheirbehaviorinresponsetotheinterventions.Ifpeopledropprivatecoverage,manymorepeoplemayendupcoveredbythepublicplan.1.1WhatAretheEffectsofAlternativeInterventions?Governmentsdonotalwayschooseefficientorsociallydesirableoutcomes.Governmentsfaceenormouschallengesinfiguringoutwhatthepublicwantsandhowtochoosepoliciesthatmatchthosewants.Politicaleconomy:Thetheoryofhowthepoliticalprocessproducesdecisionsthataffectindividualsandtheeconomy,discussedinChapter9.1.1WhyDoGovernmentsDoWhatTheyDo?Thegovernmentisahugepartoftheeconomy:Governmentspendingrepresentsalargesectoroftheeconomy,intheUnitedStatesandaroundtheworld.Thisspendingisfinancedwithtaxesorwithdebt,andtheseaffecteveryfacetoftheeconomy.Manysectorsoftheeconomyarealsodirectlyaffectedbyregulation.1.2WhyStudyPublicFinance?Themethodsandresultsderivedfromempiricaleconomicsarecentraltothedevelopmentofpublicpolicyatalllevelsofgovernment.TheCongressionalBudgetOffice(CBO)“scores”policyproposalsbyestimatingtheirbudgetimplications.CBOscoringusesthetheoreticalandempiricaltoolsofpublicfinance.CBOscorescandeterminethefateoflegislation.1.1APPLICATION:TheCBO:GovernmentScorekeepers1.2TheSizeandGrowthofGovernment:FederalSpendingasaPercentofGDP,1930−2014In1930,thefederalgovernment’sactivityaccountedforonlyabout3.4%ofGDP.Fromthe1950sthroughthepresent,thesizeofgovernmenthasaveragedaround20%ofGDP,althoughitgrowsduringrecessions.1.2TheSizeandGrowthofGovernment:TotalGovernmentSpendingAcrossDevelopedNations,1960−2015In1960,theUnitedStateswassquarelyinlinewiththeaverageoftheOECDintermsofthegovernmentspendingshareofGDP.GovernmentgrowthwasmuchfasterinotherOECDnationsinthe1960sand1970s.AllhavenowsurpassedtheUnitedStates.DecentralizationAkeyfeatureofgovernmentsisthedegreeofcentralizationacrosslocalandnationalgovernmentunits.Centralization:Theextenttowhichspendingisconcentratedathigher(federal)levelsorlower(stateandlocal)levels.IntheUnitedStates,stateandlocalspendingisaboutone-thirdoftotalgovernmentspending.1.2Federalvs.State/LocalGovernmentSpending,20141.2ThefederalgovernmentprovidesthemajorityofgovernmentspendingintheUnitedStates,butothergovernmentspendingisquitelargeaswell,amountingtoroughlyone-thirdoftotalgovernmentspending,andover110%ofGDP.Spending,Taxes,Deficits,andDebts1.2Governmentspendinganditsinflowsaretaxrevenues.Ifrevenuesexceedspending,thereisabudgetsurplus.Ifrevenuesfallshortofspending,thereisabudgetdeficit.Eachdollarofgovernmentdeficitaddstothestockofgovernmentdebt.Thatis,thedeficitmeasurestheyear-to-yearshortfallofrevenuesrelativetospending.Thedebtmeasurestheaccumulationofpastdeficitsovertime.Thisgovernmentdebtmustbefinancedbyborrowingfromeithercitizensofone’sownlocalornationalarea,orbyborrowingfromcitizensofotherareasorothernations.Spending,Taxes,Deficits,andDebts:FederalRevenuesandExpenditures,1930−20141.2WiththeexceptionofanenormousincreaseinspendingunmatchedbyincreasedtaxationduringWorldWarII(1941–1945),thefederalgovernment’sbudgetwasclosetobalanceduntilthelate1960s.Spending,Taxes,Deficits,andDebts:FederalSurplus/Deficit,1930−20141.2Fromthemid-1970sthroughthemid-1990s,therewasarelativelylargedeficit,whichshrankdramaticallyinthe1990s.TheUnitedStateswasbackindeficitbytheearlytwenty-firstcentury,withthedeficitbecomingverylargeinthelate2000s.Spending,Taxes,Deficits,andDebts:FederalDebt,1930−20141.2ThestockofdebtrosesharplyinWorldWarII,thenfellsteadilyuntillargedeficitscausedittoriseinthe1980s.Thedebthasrisenconsiderablysince,withabriefpauseinthemid-tolate-1990s,andnowisover103%ofGDP.1.2Spending,Taxes,Deficits,andDebts:DebtLevelofOECDNationsin2014TheUnitedStateshashigherdebtlevelsthanmostothercomparablenations,butitsloadremainswellbelowothers.1.2Spending,Taxes,Deficits,andDebts:StateandLocalGovernmentReceipts,Expenditures,andSurplus,1947−2014Unlikethefederalgovernment,stateandlocalgovernment’sbudgetsaretypicallyinsurplus:thereisverylittledeficitoverallacrossthestateandlocalgovernmentsinanyyear.DistributionofSpendingPublicgoods:Goodsforwhichtheinvestmentofanyoneindividualbenefitseveryoneinalargergroup,discussedinChapter9.Example:DefensespendingSocialinsuranceprograms:Governmentprovisionofinsuranceagainstadverseeventstoaddressfailuresintheprivateinsurancemarket,discussedinChapter13.Example:HealthinsuranceOvertime,spendinghasshifteddramaticallytowardsocialinsurance,especiallyhealthinsurance.1.2DistributionofFederalSpending,1960and20141.2In1960,nearlyhalfoffederalgovernmentspendingwasonnationaldefense.Today,however,defensespendinghasfallentolessthanone-fifthofthefederalbudget.TheSocialSecurityprogramisthesinglelargestgovernmentprogramintheUnitedStatestoday.DistributionofState/LocalSpending,1960and20141.2Education,welfare,andpublicsafetyforalmost40%ofstateandlocalgovernmentspending.Themajordevelopmenthasbeentheparallelgrowthinhealthcarespendingandthereductionineducationspending.DistributionofRevenueSourcesIndividualincometax:AtaxleviedontheincomeofU.S.residents.Corporatetaxrevenues:ThefundsraisedbytaxingtheincomesofbusinessesintheUnitedStates.Payrolltaxes:Thetaxesonworkerearningsthatfundsocialinsuranceprograms.Themajorshiftovertimeatthefederallevelhasbeentherapidshrinkingofcorporatetaxrevenues.Thedecreaseinrevenuefromthesetaxeshasbeenlargelyreplacedbythegrowthofrevenuefrompayrolltaxes.1.21.2DistributionofFederalRevenueSources,1960and2014Corporatetaxrevenuesonceprovidedalmost25%offederalgovernmentrevenue,theynowprovideonlyabout15%.Payrolltaxeshavegrownfromasixthoffederalrevenuestowelloverathird.1.2DistributionofState/LocalRevenueSources,1960and2014Overthepast40years,thesubstantialdropinrevenuefrompropertytaxeshasbeenmadeupbyrisingfederalgrantsandincometaxes.RegulatoryRoleoftheGovernmentThegovernmentregulatesawiderangeofeconomicandsocialactivities:TheFoodandDrugAdministration(FDA):food,cosmetics,drugs,andmedicaldevices.TheOccupationalSafetyandHealthAdministration(OSHA):workplacesafety.TheFederalCommunicationsCommission(FCC):radio,television,wire,satellite,andcable.TheEnvironmentalProtectionAgency(EPA):pollutionofair,water,andfoodsupplies.1.2Manyheatedpolicydebatesconcerntheimpactofmajorpublicprograms:TheroleofSocialSecurity,healthcare,andeducationareallcontentioussubjects.“Liberal”and“Conservative”positionsholddifferingviewsonhowtoapproachthesemajorpolicyissues.WhyStudyPublicFinanceNow?PolicyDebatesover

SocialSecurity,HealthCare,andEducation1.3SocialSecurityisthesinglelargestgovernmentexpenditureprogram.Thefinancingstructureofthisprogramisbasicallythattoday’syoungworkerspaytheretirementbenefitsoftoday’sold.Asthepopulationages,itisincreasinglydifficulttofund.Liberalsarguethatweshouldraisenecessaryresourcesthroughhigherpayrolltaxes.Conservativesarguethat,ratherthantransferfromyoungtoold,weshouldencouragepeopletosave.WhyStudyPublicFinanceNow?SocialSecurity1.3By2010,about50millionAmericanslackedanyhealthinsurance,about18%ofthenon-elderlyU.S.population.TheAffordableCareAct(ACA)expandedthegovernment’srolebyincreasingregulationofinsurancemarkets,mandatinginsurancecoverage,andintroducinglargenewsubsidiesforthepurchaseofhealthinsurance,discussedinChapter16.SupportersarguethattheACAcorrectsseriousmarketintheinsurancemarket.Opponentschargethatitrepresentsanenormous,expensive,unwarrantedexpansionofgovernmentpower.WhyStudyPublicFinanceNow?HealthCare1.3Thereisanenormousdissatisfactionwithourcurrenteducationalsystem.In2012,theUnitedStatesranked17thinreading,20thinscience,and27thinmathskillsinastudyof65countries.Willmorespendingimproveeducationaloutcomes?Ormightcompetitionamongschoolshelp?1.3WhyStudyPublicFinanceNow?EducationGovernmentplaysacentralroleinthelivesofallAmericans.Thereisongoingdisagreementaboutwhetherthatroleshouldexpand,staythesame,orcontract.Thefactsandargumentsraisedinthischapterprovideabackdropforthinkingaboutthesetofpublicfinanceissuesthatweexploreintheremainderofthisbook.1.4ConclusionCopyright©2010WorthPublishers2.1ConstrainedUtilityMaximization2.2

PuttingtheToolstoWork:TANFandLaborSupplyAmongSingleMothers2.3EquilibriumandSocialWelfare2.4WelfareImplicationsofBenefitReductions:TheTANFExampleContinued2.5ConclusionTheoreticalToolsofPublicFinance2HeatherLueaandDanSacksPREPAREDBY2Thischaptercoversthetheoreticaltoolsofpublicfinance.Theoreticaltools:Thesetoftoolsdesignedtounderstandthemechanicsbehindeconomicdecisionmaking.Empiricaltools:Thesetoftoolsdesignedtoanalyzedataandanswerquestionsraisedbytheoreticalanalysis.TheoreticalToolsofPublicFinance2Wecanillustratehowconsumersarepresumedtomakechoicesinfoursteps:First,wediscusshowtomodelpreferencesgraphically.Then,weshowhowtotakethisgraphicalmodelofpreferencesandrepresentitmathematicallywithautilityfunction.Next,wemodelthebudgetconstraintsthatindividualsface.Finally,weshowhowindividualsmaximizetheirutility(makethemselvesaswelloffaspossible)giventheirbudgetconstraints.Introduction:HowConsumersMakeChoices2.1Utilityfunction:Amathematicalfunctionrepresentinganindividual’ssetofpreferences,whichtranslatesherwell-beingfromdifferentconsumptionbundlesintounitsthatcanbecomparedinordertodeterminechoice.Constrainedutilitymaximization:Theprocessofmaximizingthewell-being(utility)ofanindividual,subjecttoherresources(budgetconstraint).Models:Mathematicalorgraphicalrepresentationsofreality.ConstrainedUtilityMaximizationIndifferencecurve:Agraphicalrepresentationofallbundlesofgoodsthatmakeanindividualequallywelloff.Becausethesebundleshaveequalutility,anindividualisindifferentastowhichbundleheconsumes.Indifferencecurveshavetwokeyproperties:1. Consumerspreferhigherindifferencecurves.2. Indifferencecurvesarealwaysdownwardsloping.2.1PreferencesandIndifferenceCurves2.1PreferencesandIndifferenceCurvesConsumerisindifferentbetweenAandB.CispreferredtoAorB.

PreferencesandIndifferenceCurvesConsumerisindifferentbetweenAandB.CispreferredtoAorB.2.1UtilityMappingofPreferences2.1

UtilityMappingofPreferences:Example2.1

2.1MarginalUtility

MarginalUtility:GraphicalRepresentation2.1Witheachadditionalmovieconsumed,utilityincreasesbutbyeversmalleramounts.2.1

MarginalRateofSubstitutionMarginalRateofSubstitution2.1AsAndreamovesdowntheindifferencecurve,gettingmoremoviesandfewercakes,themarginalutilityofcakesrises,andthemarginalutilityofmoviesfalls,loweringtheMRS.BudgetConstraints2.1

BudgetConstraints2.1Theslopeofthebudgetconstraintistherateatwhichshecantradecakesformoviesinthemarketplace,PM/PC=–8⁄16=–1⁄2.2.1

PuttingItAllTogether:ConstrainedChoice2.1

PuttingItAllTogether:ConstrainedChoice2.1PuttingItAllTogether:ConstrainedChoiceWheneveraconsumerisatapointwheretheindifferencecurveandthebudgetconstraintarenottangent,shecanmakeherselfbetteroffbymovingtoapointoftangency.2.1Maximizingutilitytellsushowmanygoodsapersonbuysatagivenprice.Whathappenswhenwechangetheprices?Substitutioneffect:Holdingutilityconstant,arelativeriseinthepriceofagoodwillalwayscauseanindividualtochooselessofthatgood.Incomeeffect:

Ariseinthepriceofagoodwilltypicallycauseanindividualtochooselessofallgoodsbecauseherincomecanpurchaselessthanbefore.TheEffectsofPriceChanges:SubstitutionandIncomeEffectsTheEffectsofPriceChanges:SubstitutionandIncomeEffects2.1Thesubstitutioneffectholdsutilityconstantbutchangestheincomewhilereflectingthechangeinrelativeprices.2.1Howdochangesinincomeaffectdemand?Normalgoods:Goodsforwhichdemandincreasesasincomerises.Inferiorgoods:Goodsforwhichdemandfallsasincomerises.TheEffectsofPriceChanges:SubstitutionandIncomeEffects2.1TheTANFprogramwascreatedin1996andprovidesamonthlysupportchecktofamilieswithincomesbelowathresholdlevelthatissetbyeachstate.SupposethatJoelleisasinglemotherwhospendsallofherearningsandTANFbenefitsonfoodforherselfandherchildren.Byworkingmorehours,shecanearnmoremoneyforfood,butshehaslesstimeathomewithherchildrenandforleisure.Shewouldprefertimeathometotimeatwork(leisureisanormalgood).Withthesepreferences,moreworkmakesJoelleworseoff,butitallowshertobuymorefood.HowdoesJoelledecideontheoptimalamountoflabortosupply?PuttingtheToolstoWork:TANFandLaborSupplyAmongSingleMothers2.1PuttingtheToolstoWork:TANFandLaborSupplyAmongSingleMothers:IdentifyingtheBudgetConstraintIfshetakesnoleisure,shecanhaveconsumptionof$20,000peryear;butifshetakes2,000hoursofleisure,herconsumptionfallsto0.Thisisrepresentedbythebudgetconstraintwithaslopeof–10,therelativepriceofleisureintermsoffoodconsumption.2.1PuttingtheToolstoWork:TANFandLaborSupplyAmongSingleMothers:IdentifyingtheBudgetConstraintPointDmarkstheendofthenewbudgetconstraintandprovidesanewoption:shecanhave2,000hoursofleisureand$5,000infoodconsumptionbecauseofthe$5,000TANFbenefitguarantee.PuttingtheToolstoWork:TANFandLaborSupplyAmongSingleMothers:EffectsofChangesinBenefitGuarantee2.1Foodconsumption(dollars)$20,0002,000Leisure(hours)ABCSlope=−10Slope=−510,0005,0001,000DFE6,0003,0001,400Iftheguaranteefallsto$3,000,thebudgetconstraint(AEF)doesn’tflattenuntilshetakesmorethan1,400hoursofleisure;now,with2,000hoursofleisure,herconsumptionisonly$3,000atpointF.2.1Foodconsumption(dollars)$20,0002,000Leisure(hours)10,0005,0001,0006,0003,0001,400HowLargeWilltheLaborSupplyResponseBe?AB(1,910hours,$5,450)(1,655hours,$4,725)Thesubstitutioneffectholdsutilityconstantbutchangesrelativeprices.2.1Thesizeoftheresponsedependson:Howmuchwasearnedbeforethebenefitchange.Thesizeoftheincomeandsubstitutioneffectsonherleisure/labordecision.Let’sconsidertwoindividuals:Individual2valuesleisuremorehighlyrelativetoconsumptionthanIndividual1does.TANFandLaborSupplyAmongSingleMothers:HowLargeWilltheLaborSupplyResponseBe?2.1WhentheTANFguaranteeis$5,000,theoptimalchoiceistotake1,910hoursofleisureandconsume$5,450(atpointA).Whentheguaranteefallsto$3,000,shereducesherleisureto1,655hours,andherconsumptionfallsto$4,725(atpointB).HowLargeWilltheLaborSupplyResponseBe?2.2Foodconsumption(dollars)$20,0002,000Leisure(hours)10,0005,0001,0006,0003,0001,400HowLargeWilltheLaborSupplyResponseBe?BA(2,000hours,$5,000)(2,000hours,$3,000)Becauseleisureisvaluedmorehighlyrelativetoconsumptionforthisindividual,shechooses2,000hoursofleisureregardlessoftheTANFguarantee.Thereductioninguaranteethereforelowersherconsumptionfrom$5,000(atpointA)to$3,000(atpointB).2.3Howdomarketsdeterminewhatgetsproduced?Dotheyproducetherightamount?Market:Thearenainwhichdemandersandsuppliersinteract.Marketequilibrium:Thecombinationofpriceandquantitythatsatisfiesbothdemandandsupply,determinedbytheinteractionofthesupplyanddemandcurves.Welfareeconomics:Thestudyofthedeterminantsofwell-being,orwelfare,insociety.EquilibriumandSocialWelfare2.3Howmuchofagooddopeoplewanttobuyatthemarketprice?Demandcurve:

Acurveshowingthequantityofagooddemandedbyindividualsateachprice.Obtainedbyfindingtheutility-maximizingbundleateachprice.DemandCurves2.3DemandCurvesTherelationshipbetweenthepriceandutilitymaximizingchoicescanbeusedtotraceoutthedemandcurveformovies,DM.2.3

ElasticityofDemandElasticitiesofdemand:Elasticitiesofdemandareoftennegative:Quantitydemandedfallsaspricerises.Elasticitiesofdemandaretypicallynotconstantalongademandcurve.Typically,achangeinthepriceofonegoodwillaffectdemandforothergoodsaswell.Theeffectofonegood’spricesonthedemandforanothergoodisthecross-priceelasticity.2.3ElasticityofDemandPerfectlyinelasticandperfectlyelasticdemand:Whentheelasticityofdemandiszero,thedemandcurveisperfectlyinelastic,inwhichcasethedemandcurveisvertical,andquantitydemanddoesnotchangewhenpricerises.Whentheelasticityofdemandisinfinite,thedemandcurveisperfectlyelastic,inwhichcasethedemandcurveishorizontal,andquantitydemandedchangesinfinitelyforevenaverysmallchangeinprice.2.3ElasticityofDemand2.3

SupplyCurvesProfitMaximization2.3Howdofirmsdecidehowmuchtoproduce?Marginalproductivity:Theimpactofaunitchangeinanyinput,holdingotherinputsconstant,onthefirm’soutput.Marginalcost:Theincrementalcosttoafirmofproducingonemoreunitofagood.Firmschoosequantitiestomaximizeprofits,thedifferencebetweenrevenuesandcosts.Profitismaximizedwhenmarketpriceequalsmarginalcost.Equilibrium2.3Toundertakewelfareanalysisweneedtoanalyzeatthemarketlevel:Thedemandsofeachindividualwhoisdemandinggoodsinthismarketisaddedtoobtainmarketdemand.Thesuppliesofeachfirmthatissupplyinggoodsinthemarketisaddedtogetmarketsupply.Themarket-levelsupplyanddemandcurvesinteracttodeterminethemarketequilibrium.Socialefficiencyismaximizedatthecompetitiveequilibrium.Equilibrium:GraphicalRepresentation2.3Equilibriumisthepriceandquantitypairthatwillsatisfybothdemandandsupply.SocialEfficiencySocialefficiencyrepresentsthenetgainstosocietyfromalltradesthataremadeinamarket,anditconsistsofthesumoftwocomponents:consumerandproducersurplus.Alsocalledtotalsocialsurplus.Consumersurplus:Thebenefitthatconsumersderivefromconsumingagood,aboveandbeyondthepricetheypaidforthegood.Producersurplus:Thebenefitthatproducersderivefromsellingagood,aboveandbeyondthecostofproducingthatgood.2.3ConsumerSurplus:GraphicalRepresentation2.3Consumersurplusistheareaunderthedemandcurveandaboveequilibriumprice.Demand=willingnesstopay.ProducerSurplus:GraphicalRepresentation2.3Producersurplusistheareaabovethesupplycurveandbelowequilibriumprice.Supply=marginalcost.SocialSurplus:GraphicalRepresentation2.3SocialsurplusforthismarketisthesumoftheshadedareasA+B+C+D+E.CompetitiveEquilibriumMaximizesSocialEfficiencyFirstFundamentalTheoremofWelfareEconomics:Thecompetitiveequilibrium,wheresupplyequalsdemand,maximizessocialefficiency.Deadweightloss:Thereductioninsocialefficiencyfrompreventingtradesforwhichbenefitsexceedcosts.Quickhint:Deadweightlossisatrianglethatpointstowardtheequilibriumpriceandgrowsawayfromit.2.3FromSocialEfficiencytoSocialWelfare:TheRoleofEquity2.3SecondFundamentalTheoremofWelfareEconomics:Societycanattainanyefficientoutcomebysuitablyredistributingresourcesamongindividualsandthenallowingthemtofreelytrade.Difficultinpracticetoredistributelikethis.Socialwelfare:Thelevelofwell-beinginsociety.Determinedbybothhowmuchgetsproducedandhowitisdistributed.Equity–efficiencytrade-off:Thechoicesocietymustmakebetweenthetotalsizeoftheeconomicpieanditsdistributionamongindividuals.SocialWelfareFunctions2.3

ChoosinganEquityCriterion2.3Socialwelfarefunctionsreflectdifferentpossibleequitycriter