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ALL RIGHTS RESERVED. Instructors of classes adopting PUBLIC FINANCE: A CONTEMPORARY APPLICATION OF THEORY
TO POLICY, Seventh Edition by David N. Hyman as an assigned textbook may reproduce material from this publication for classroom
use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part
of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or
mechanical, including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage
and retrieval systems—without the written permission of the publisher.
Printed in the United States of America
ISBN 0-03-033652-X
Copyright © 2002 by Thomson Learning, Inc.
Positive and Normative
Economics
Positive Economics explains “what is”
without making judgments about the
appropriateness of “what is.”
Normative Economics: designed to
formulate recommendations on what
should be.
1.00 = P2 A D
MSB
Z
and Cost
TSB – TSC
0 Q*
Copyright © 2002 by Thomson Learning, Inc.
Loaves of Bread per Month
Conditions under which the
Market is Pareto Optimal
All productive resources are privately owned.
All transactions take place in markets and in each
separate market many competing sellers offer a
standardized product to many competing buyers.
Economic Power is dispersed in the sense that no
buyers or sellers alone can influence prices.
All relevant information is freely available to buyers
and sellers.
Resources are mobile and may be freely employed
in any enterprise.
Copyright © 2002 by Thomson Learning, Inc.
If These Conditions are Met
P = MPB = MSB
and
P = MPC = MSC
so
P = MSB = MSC
Taxes
Subsidies
MSB = P B
MSC
Cost (Dollars)
E
Loss in Net Benefits
MSCM A
D = MSB
MR
0 QM Q*
Copyright © 2002 by Thomson Learning, Inc.
Output per Month
Figure 2.3 Taxes and Efficiency
5 E
4 B
Demand = MSB
0 3 4
Billions of Message Units per Month
Copyright © 2002 by Thomson Learning, Inc.
Figure 2.4 Subsidies and Efficiency
Supply = MSC
Price (Dollars per Bushel)
5 A
E
4
3 C
Demand = MSB
0 Q* QS
Bushels of Wheat per Year
Copyright © 2002 by Thomson Learning, Inc.
Market Failure: A Preview of the
Basis for Government Activity
Government intervention may be warranted if there
is:
Monopoly power.
Effects of market transactions on third parties.
Lack of a market for a good where MSB>MSC
(i.e. a public good).
Incomplete information about goods being sold.
An unstable market.
Annual Well-Being of A UA
E1 Z
UA2
X E2
UA1
E3
0 UB1 UB2 UB
Copyright © 2002 by Thomson Learning, Inc.
Annual Well-Being of B
Positive Analysis Trade-off
Between Equity and Efficiency
When making choices about public policy
issues we are usually faced with the
inevitable situation that you make one person
worse off while making another better off.
(Taxes must be paid by some in order that
public goods can be purchased and these
benefits accrue to others.) Some economists
attempt to overcome this with the
Compensation Criteria.