MICROECONOMICS

Topic 9
Public Goods and Taxes

Public Goods and Taxes

Introduction
The Different Kinds of Goods
The Use of Common Resources
Externalities
Taxes

The best things in life are free. . .

Most goods in our economy are allocated in
markets.
For these goods, prices are the signals that
guide the decisions of buyers and sellers.

The best things in life are free. . .

When goods are available free of charge, the
market forces that normally allocate resources
in our economy are absent.

The best things in life are free. . .

When a good does not have a price attached
to it, private markets cannot ensure that the
good is produced and consumed in the proper
amounts.

The best things in life are free. . .

In such cases, government policy can
potentially remedy the market failure that
results and raise economic well-being.

The Different Kinds of Goods

The various goods in our economy may be
grouped by excludability and rivalness.

The Different Kinds of Goods

Excludability
Property of a good

Refers to the possibility to prevent someone

from enjoying the benefits of it.

Rivalry in consumption
Property of a good
Refers to goods, services or resources if its
use by one person decreases the quantity
available for someone else.
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Excludability:
Nonexcludable if it is virtually impossible to
prevent someone from benefiting from it.
Fish in ocean
radio program
national defense
street light
air quality
Maintenance of dams and main canal in irrigation
system.

1
Four types of goods
Rival in consumption?

Yes

Yes
Excludable?

No

No

Private goods

Natural monopolies

- Ice-cream cones
- Clothing
- Congested toll roads

- Fire protection
- Cable TV
- Uncongested toll roads

Common resources

Public goods

- Fish in the ocean

- The environment
- Congested nontoll roads

- Tornado system
- National defense
- Uncongested nontoll roads

Goods can be grouped into four categories according to two characteristics:

(1) A good is excludable if people can be prevented from using it.
(2) A good is rival in consumption if one persons use of the good diminishes other
peoples use of it.
This diagram gives examples of goods in each category.

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The Different Kinds of Goods

Types of goods
Private goods
Excludable & Rival in consumption

Public goods
Not excludable & Not rival in consumption

Common resources
Rival in consumption & Not excludable

Natural monopoly
Excludable & Not rival in consumption
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The Different Kinds of Goods

Private goods: Rival and excludable.
apple
my garden
my office

Public goods: Nonrival and nonexcludable.

national defense
law and order
street lights

The Different Kinds of Goods

Common resources: Rival and nonexcludable.
ocean fish
earths atmosphere

Natural monopolies: Nonrival but excludable.

Uncongested bridge
Uncongested cable TV
Uncongested internet
Uncongested electricity or phone grid

Common Resources
Common resources
Not excludable
Rival in consumption

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The Free-Rider Problem

A free-rider is a person who receives the
benefit of a good but avoids paying for it.

The Free-Rider Problem

Since people cannot be excluded from
enjoying the benefits of a public good,
individuals may withhold paying for the good
hoping that others will pay for it.
The free-rider problem prevents private
markets from supplying public goods.

Solution to the Free-Rider Problem

The government should provide the good if its
total benefits exceed the costs.
The government can make everyone better off
by providing the good and paying for it with
tax revenue.

Externalities
Goods that are not excludable and, therefore,
are available to everyone free of charge.
Externalities arise because something of
value has no price attached to it.
People receive benefits without having to
compensate anyone for the use of scarce
resources.

Externalities
Externality:
a cost or benefit that arises from production and falls
on someone other than the producer; or
A cost or benefit that arises from consumption and
falls on someone other than the consumer

Externalities
Four (4) types of externalities:
Negative production externalities
Positive production externalities
Negative consumption externalities
Positive consumption externalities

Externalities
Negative production externality:
Those people who lives near the KLIA, Sepang share
a negative production externality from the noise of air
planes taking off from the international airport.
Logging and clearing of forests destroy the habitat of
wildlife and influence the amount of the carbon
dioxide in the atmostphere, which has a long term
effect on temperature.
Also includes water pollution and air pollution.

Externalities
Positive production externality:
Your neighbor is a good gardener who keep his
garden beautiful, everyone that sees the garden
gets pleasure from it.
A composer composed a beautiful song, he enjoys
the royalty and we enjoy listen to the music.

Externalities
Negative consumption externality:
Smoking in a confined space such as restaurant,
airlines creates unpleasant fumes for other people
(non-smoking) and pose a health risk.
Fun-seeking partygoers attend noisy party post
external cost on sleep-seeking neighbors.

Externalities
Positive consumption externality:
Flu medication generates positive consumption
externality. How?
When you get a flu medication to cure your
running nose, you not only treat your problem, but
also prevent your neighbor/friends from getting it
(from you).

Externalities
Externality creates inefficiency due to:
Property rights your lazy neighbor ignore your
complaint about his untidy lawn.
To enjoy different types of goods/services producers
produced all kinds of products/services and ignore the
pollution creates from the activity.

Taxation and Government

For government to provide goods and services such
as national defense, social security, national parks,
etc. it must have money.
The Government raises money several ways including
user fees and taxes.
User Fees are fees paid by those that use the good or
service: it is a price.
Taxes may be paid by everyone or only those that use
a good or service: who pays depends on the type of
tax.

Taxes
Tax
Tax is a compulsory contribution by individual/firm to
government
Comprises regular and periodical payments
Involves penalty for non-payment
Types of tax revenue:
Direct taxes (companies income tax, individuals
income tax, petroleum income tax, property gain
tax)
Indirect taxes (export duties, import duties, sales
tax, service tax)

Types of Tax Revenue

Income tax -Generally the tax is imposed on net
profits from business, net gains, and other income.
Capital gains tax - Capital gain is generally gain on
sale of capital assets, i.e., those assets not held for sale
in the ordinary course of business. Capital assets
include personal assets
Corporate tax - Corporate tax refers to income,
capital, net worth, or other taxes imposed on
corporations.

Types of Tax Revenue

Taxes on goods and services:
Value added tax (Goods and Services Tax) - A
value added tax (VAT), also known as Goods and
Services Tax (G.S.T), applies the equivalent of a sales
tax to every operation that creates value.
Sales taxes - Sales taxes are levied when a
commodity is sold to its final consumer. Retail
organizations contend that such taxes discourage
retail sales.

Types of Tax Revenue

Excises - Excise taxes are based on the quantity, not
the value, of product purchased.
Tariff - An import or export tariff (also called customs
duty or impost) is a charge for the movement of goods
through a political border.

Other Types of Tax Revenue

License fees - Occupational taxes or license fees may
be imposed on businesses or individuals engaged in
certain businesses. Many jurisdictions impose a tax on
vehicles.
Quick Rent
Road tax

Types of Tax Rates

An important feature of tax systems is the percentage of
the tax burden as it relates to income or consumption.
The terms progressive, regressive, and proportional are
used to describe the way the rate progresses from low
to high, from high to low, or proportionally.
The terms describe a distribution effect, which can be
applied to any type of tax system (income or
consumption) that meets the definition.

Types of Tax Rates

A progressive tax is a tax imposed so that the effective
tax rate increases as the amount to which the rate is
applied increases.
The opposite of a progressive tax is a regressive tax,
where the effective tax rate decreases as the amount to
which the rate is applied increases. This effect is
commonly produced where means testing is used to
withdraw tax allowances or state benefits.

Types of Tax Rates

In between is a proportional tax, where the effective
tax rate is fixed, while the amount to which the rate is
applied increases.
A lump-sum tax is a tax that is a fixed amount, no
matter the change in circumstance of the taxed entity.
This in actuality is a regressive tax as in actuality those
with lover income must use higher percentage of their
income than those with higher income and therefore
the effect of the tax reduces as a function of income.

The End
Good Luck in your Final Examination!