1、Lecture on Local Government and Public Goods,Based on Chapter 19 in Urban Economics by Arthur OSullivan, 5th edition Adapted and summarized by Austin Troy, University of Vermont,What is the role of government?,Stabilization: monetary and fiscal policy used to control unemployment and inflation Redis
2、tribution: Taxation and transfers used to remedy inequities Resource allocation: makes production decisions either directly (e.g. through municipal utility) or indirectly (e.g. through subsidies or taxes on allocations). See Musgrave and Musgrave (1980),Local Government,Does not have the responsibil
3、ity of fiscal stabilization for obvious reasons Does not have redistributive role because of mobility of citizens. Poor will immigrate and rich will emigrate to other city Both of these roles are better filled by national government Local government primarily fills third role,When does local governm
4、ent intervene in resource allocation?,Provides goods produced under natural monopoly conditions Provides goods that generate positive externalities Provides public goods,Externalities,Represent a “market failure” Where one person or firms consumption of a good creates benefits or costs for others In
5、dividual makes a personally efficient decision (I.e. consumes until MB=MC) but externality causes there to be a social cost or benefit that is not considered; socially inefficient Causes divergence between private and social benefits and/or costs The cost or benefit is not “internalized” by producer
6、,Positive Externalities (e.g.education),Marginal social benefit,Marginal private benefit,Marginal cost,E,E*,Subsidy amt,E=how much market would provide E*=socially optimal amount,Negative Externalities (e.g. pollution),Marginal social benefit,Marginal private benefit,Marginal social cost,P,P*,P=poll
7、ution produced in private market P*=optimal pollution amount K=amount of externality,Marginal private cost,K,Natural Monopoly,Where production of a good subject to large scale economics: that is, very big fixed costs, so those costs dont get paid off until the scale of operation gets very large Natu
8、ral monopolies have decline average costs throughout their range of production Private firms would underprovide service because high scale economies mean that average cost marginal cost Marginal cost pricing means operates at loss City must step in and make up deficit,Natural Monopoly in Bus Service
9、,Demand= Marginal social Benefit,LRAC,LRMC,Quantity,deficit,S S*= optimum,P,P*,MR,Government sets this price,Natural monopoly,In absence of regulation, firm produces S and receives a price of P Problem is that firm producing at optimal point (S*) will lose money because D curve shows people not will
10、ing to pay that much But there is a social cost to not having enough bus service, so to get residents to buy the socially optimal amount, P must be lower than market price; locality subsidize this difference If set at P*, then socially optimal amount of S* is demanded. Because falls below Av Cost, g
11、overnment must make up the difference, equal to rectangle,Why Marginal Pricing?,If profit = TR-TC, then want to produce where distance between two is maximized, which is where the slopes, or marginal values are the same,P,Q,TR,TC,p,Marginal and Average Price,Normally looks like this: MC gets bigger
12、than AC,P,Q,MC,AC,Public Goods Provision,Local governments provide goods that the market cannot provide either because they cannot price it, charge for it, or exclude,Public Good Characteristics,Nonrivalrous: can be consumed by many at once, such as clean air Pure local public is were MC of addition
13、al user=0; does not decrease others utility Semi-rivalrous: where is non-rivalrous at small amounts or at certain times but not at others E.g. streets may be non-rivalrous at certain times of day but not others,Public Good Characteristics,Nonexcludable: impossible/impractical to exclude any from con
14、suming Examples: Defense, air waves, other examples? Hard to charge for the service Cant tell who is willing to pay and who is not, who is benefiting and who not Some are non-excludable by choice, because alternative would be inequitable Examples fire service,Pure and Partial Public Goods,A common s
15、ituation is that goods are non-rival at smaller usage levels, but rivalrous at large usage levels Example: with a park, an additional households use does not diminish anyones enjoyment, until you reach carrying capacity C at which point each marginal user does impose additional costs,Local Public Go
16、ods,These are public goods where the benefit is confined to a contained geographic area, like a city. Ideally, the size of jurisdictions would be determined by the level of “localness” of the public goods being provided The more extensive the benefits, the larger the jurisdiction needed to internali
17、ze those,Why provide certain public goods at the local level?,Wallace Oates (1972) proposed three criteria: Diversity of Demand: “one size fits all” vs. local diversity of preferences Externalities/spillovers: are external effects locally contained or do they spill over? Scale economies: higher leve
18、ls of government can leverage bigger scale economies The test for local provision of a public good is whether 1 outweighs 2 and 3,Tradeoff 1: Scale Economies v. Diversity of Demand,Assume 1 public good (library service) and two municipalities in metro area High Demand in city H and low in L No exter
19、nalities/spillovers between towns Scale economies: regional library can produce unit “literary services” cheaper than local library Identical services in towns,Who should make library allocation?,If towns merge and form metro government, pool resources to build bigger library system, then good news
20、is that cost/ unit service is lower, but bad news is that L is paying for more library service than they want and H is getting less library services/person than it had before. Only efficient to merge if savings due to scale economies are large relative to losses in efficiency from the uniformity of
21、service provision,Empirical Results,Moderate scale economies in things like sewer and water provision, because capital intensive Police, fire and schools, have scale economies (gains to scale) occurring until about 100,000 people, at which point fewer gains to consolidation Some areas have regional
22、government entities that provide services with large scale economies,Tradeoff 2: Externalities vs. Demand Diversity,Where service creates positive externalities that spill over into other jurisdictions, it will be underprovided, because they consider the costs but, not all the benefits Inefficiency
23、occurs because boundaries of jurisdiction is too small to contain benefits,Example: Water pollution,Town X in the Champlain Valley will underprovide stormwater management services (unless mandated) because benefits are realized by all Lake Champlain users, and they only consider local benefits,Examp
24、le: Parks Provision,Cities will tend to underprovide parks, because only consider benefits to local residents, when their parks could potentially be important resource for people regionally However, if a regional government takes over and DD is high, there will be too many parks for certain types of
25、 people and too few for others,Diversity of Demand and Spillovers,Town S: small parks,Town M: medium parks,Town L: large parks,MLB(s),MSB(s),MLB(m),MSB(m),MLB(l),MSB(l),S S*,M M*,L L*,If externalities small, S will be close to S*, M close to M*, etc. Then, municipal decisions are efficient. This is
26、reinforced if DD is very large and S* is far from M* etc.,Tradeoffs in level of PG provision: summary,If DD is large relative to scale economies or spillovers, local is better If spillovers or scale economies are large relative to DD, then regional is better In previous slide, gaps between individua
27、l demanders are greater than gaps between MSB and MLB, so local provider is better,Examples,Which category do these services fall into and why? Flood control Structural fire protection Wildfire protection Air quality University system Highway patrol,How much of a public good should a city provide?,P
28、ark example: how big to make it? Assumptions: decisions made by majority rule, three-person city, no congestion, no spillover benefits Efficient amount: where MB of additional acre equals MC To get MB we add up everyones demand curves, which represent WTP,How big should park be?,Marginal social bene
29、fit= MB1+MB2+MB3,MB1,MB2,MB3,MC,70 acres,$60,Cost/acre,Here WTP MC of additional acre,Here WTP MC of additional acre,MB curves for three citizens,Ideal amount is 70 acres,Methods for determining the amount of local public good,Benefits taxation: ideal, but impractical Median voter: practical and com
30、mon, but inefficient Household mobility and sorting: practical and efficient under some conditions, but not necessarily equitable. Well talk about this after Spring Break,Benefit taxation,Tax people on their WTP for the optimum size of the good (e.g. park) ; the greater the WTP, the greater the tax
31、This will yield optimum amount of the park, even if population is heterogeneous Impractical because must know shape of everyones demand curves and because there is no incentive for taxpayers with high WTP to reveal that willingness,Median Voter Approach,Assuming there is no interjurisdictional mobil
32、ity Often such decisions made through vote Will efficient size be chosen? No, not when charged by benefits taxation This is because the Q will be chosen where the median voters private MB= marginal private cost, or tax MC= $60/acre so each citizen pays $20/acre,Park provision under voting,Marginal s
33、ocial benefit= MB1+MB2+MB3,MB1,MB2,MB3,Marginal social cost,70 acres,$60,Cost/acre,$20,Marginal private cost,10,55,115,Median voter rule,In election between 115 and 55 acres, 55 would win because person 3 and person 2 would vote for it. In election between 10 and 55, 55 would win because person 1 an
34、d person 2 would vote for it. Where spending level vs. service is being voted on the median voters desired outcome gets the most votes. Inefficient because everyone pays equally, but some want it more than others The magnitude of persons 1 and 2s preferences dont matter because median will always wi
35、n,How do growth controls fit into this?,Growth controls are another way for controlling the amount of public services provided by a municipality and the average cost to residents It is also a way of preventing transfers of wealth from existing residents to new.,Inflation and Services,Imagine a commu
36、nity of 100 people and $10,000 repayment cost for municipal facilities= $100/household Now another 100 move into town; without inflation, all are equal. But with inflation, the nominal cost of the new infrastructure goes up to $20,000 for the same amount, which equals $200 per new resident. But that
37、 new burden must be shared equally, so everyone pays $150. Old residents are worse off Because new residents pay less than marginal cost, too many move to municipality and resource is congested Problem: no transparent means for charging marginal cost Old way (and Prop 13 in CA): limit reassessments
38、on houses of long-time residents; only reassess for transfer.,From Fischel chap 15,Inflation and services,Strong motivation for growth controls when inflation The big question is: do the additional nominal costs of new development outweigh the benefits of increased economies of scale in service prov
39、ision? Keep in mind that this only applies to fixed capital cost services, not variable cost items, like salaries of teachers Also, there are devices for recovering some additional costs from new residents, like exactions and impact fees Fischel: key goal is to eliminate fiscal incentive to exclude
40、by state aid to moving in of new people Reduce reliance on property tax to finance local services Unintended consequence of inclusionary zoning is it gives incentive for wholesale exclusion of all development. Perhaps then inclusionary zoning is a ruse by many communities to give appearance of complying with law while being able to exclude fully. How does Act 60 fit in?,From Fischel chap 15,
