7/31/2019 Public Finance, Chapter 2

http://slidepdf.com/reader/full/public-finance-chapter-2 1/5

Chapter 2

Introduction to

Public Finance

Prepared and Taught by

Lecturer: YIN SOKHENG, Master in Finance

Public Finance Defined

2 Instructed by YIN SOKHENG, Master in Finance

• Public finance is about the taxing and spendingactivities of the government.

• Public Finance analyzes the implication of suchincome and expenditure activities on theallocation of resources and distribution of income as well as overall stability of theeconomy.

• Focus is on microeconomic functions of government – polices that affect overallunemployment or price levels are left for macroeconomics.

• Public sector decisions impact private sector decisions in many ways both large and small.

3 Instructed by YIN SOKHENG, Master in Finance

Public Finance: Subject Matters

7/31/2019 Public Finance, Chapter 2

http://slidepdf.com/reader/full/public-finance-chapter-2 2/5

The Role of Government

The govt. should be established to operate apolice force and a court system to protect private

property and make a free market possible.

– Providing the economy with a legal structure – Maintaining competition – Redistribution of income – Supplies public goods – Promoting growth and stability

4 Instructed by YIN SOKHENG, Master in Finance

Why the free market usuallyworks well for consumers

• The Free Market generates just the right quantityfor consumers. – Productive efficiency: When producers minimize the

cost of producing a product of a given quantity.

– Allocative efficiency: When producers allocate theoptimal quantity of resources to the production of goods X versus goods Y.

5 Instructed by YIN SOKHENG, Master in Finance

Figure 2.1 Supply and Demand

6 Instructed by YIN SOKHENG, Master in Finance

P

$12

$10

$8

90 100 110

D (MB)

S (MC)

Q

7/31/2019 Public Finance, Chapter 2

http://slidepdf.com/reader/full/public-finance-chapter-2 3/5

Taxes, Subsidies, Regulation, and Inefficiency

• Any govt. intervention that changes the quantitycauses an inefficiency (allocative inefficiency) – a reduction in society’s welfare.

• A tax imposed by the govt. causes a decrease inthe quantity below the optimal quantity. – Figure 2.2 shows the effect of a $4 per unit tax levied

on producers. – Figure 2.3 shows the effect of a $4 per unit tax levied

on consumers.

7 Instructed by YIN SOKHENG, Master in Finance

Figure 2.2 A Tax on Producers

8 Instructed by YIN SOKHENG, Master in Finance

P

$12

$10

$8

90 100

D

S

S’

$14

T= $4

T= $4

Q

Figure 2.3 A Tax on Consumers

9 Instructed by YIN SOKHENG, Master in Finance

P

$12

$10

$8

90 100

D

S

$6

T= $4

T= $4

D’ Q

7/31/2019 Public Finance, Chapter 2

http://slidepdf.com/reader/full/public-finance-chapter-2 4/5

Figure 2.4 Inefficiency from the Tax

10 Instructed by YIN SOKHENG, Master in Finance

P

$12

$8

90 100

MB

MC

T= $4D

Q

B

A

Figure 2.5 A Subsidy to Producers

11 Instructed by YIN SOKHENG, Master in Finance

P

$12

$10

$8

100 110

D

S

Q

S= $4

S= $4

S’

$6

Figure 2.6 A Subsidy to Consumers

12 Instructed by YIN SOKHENG, Master in Finance

P

$12

$10

$8

100

D

S

S= $4

S= $4

D’

Q110

$14

7/31/2019 Public Finance, Chapter 2

http://slidepdf.com/reader/full/public-finance-chapter-2 5/5

Figure 2.7 Inefficiency from the Subsidy

13 Instructed by YIN SOKHENG, Master in Finance

P

$12

$8

100

MB

MC

S= $4

Q110

D

B

A

Taxes and Government Spending

14 Instructed by YIN SOKHENG, Master in Finance

Surplus or Deficit Budgeting

= Govt. taxes – Govt. spending