Public Finance Lecture Notes

okay so let&#39;s start off with what is public finance well public finance is what I call it because it&#39;s what I was raised to call it but it&#39;s also we know what it really is as public economics because what we&#39;re not going to be really talking about is the actual financing of government right we won&#39;t be talking about muni bonds and stuff like that we&#39;ll be talking about deficits and debt come on in we&#39;ll be talking my deficits and debt and stuff like that does I&#39;m do an entire lecture in fact we&#39;ll talk about government budgets we&#39;re not going to be talking about the muni bond market that&#39;s not going to happen so really when I call it public finance I mean public economics public economics is the study of the interaction or the role of government in the economy public finance seeks to answer three main questions the first is when is there a role for government when&#39;s your government intervene in the economy the second question is how might the government choose to intervene what are the different ways in which it could intervene in the economy it&#39;s different policy tools and the final question is of these alternative alternative interventions what are the potential effects of these different tools so what are the direct effects what are the indirect effects of these particular ways the government could intervene so let&#39;s talk on the first question when should the government intervene well there&#39;s two main reasons the government might choose to intervene the first being that there is some sense that there is a potential for redistribution that would be more optimal that somehow whatever the equilibrium in the economy is whatever the competitive equilibrium is is not achieving an allocation of resources that society is pleased with Society or like things divided up differently in that case the competitive equilibrium won&#39;t handle that on its own there are some special cases in which sort of the second fundamental theorem of welfare tells us that ah you know if we reallocate initial sort of resources the competitive equilibrium can then achieve any post equilibrium allocation of resources but that takes the frictionless transfer of assets between people and that&#39;s generally pretty hard to do right it&#39;s very hard to say hey mr. Buffett that&#39;s a fine billion dollars you have over there we&#39;re just going to give it to mat you know it&#39;s very it&#39;s not something society we typically Rabil to do we call this transfer has lump sum taxes and while there are theoretical possibility there in actuality pretty hard to actually achieve so in general if we want the outcome the equilibrium allocation of resources to be different we need we need to have something larger than the competitive competitive forces sort of intervening to redistribute resources the second reason we might see a role for government why government may have a role to play or potential to improve the equilibrium is in the case of market failures market failures just mean that the competitive equilibrium isn&#39;t achieving sort of maximum efficiency but there are sort of missing blind spots in in the competitive equilibrium that government could potentially fix what types of market failures am i talking about the first is simply externalities so the spillover of one person&#39;s of oh the so it&#39;s this case where one person&#39;s decisions spill over onto other people right or other actors in the economy there&#39;s a case of positive externalities like vaccinations right when I choose to get vaccinated against measles I actually make other people better off right people who have no real people aren&#39;t vaccinated or less likely to get measles if I&#39;m unlikely to get it because because I&#39;m vaccinated that&#39;s a positive externality it might be true that when I am well educated I work better with other people unless I&#39;m less sort of likely to commit crimes etc etc that all benefits my community members rights almost like there&#39;s a crime on them or I&#39;m a more pleasant person to be around so I could be a positive externality of education but they&#39;re also negative externalities right the classic example being a paper mill that&#39;s upstream from say a fishing village as the paper mill decides to perhaps dump you know say dioxin or something into the stream because that&#39;s the most cost effective way for it to dispose of the dioxin right it&#39;s making a decision based on its profit function its objective but what does that have a spill over it has spill over onto the fisherman downstream because their productivity Falls for every hour they spend fishing they catch fewer healthy fish right because the water is polluted that&#39;s a negative externality the paper mill is exerting on the fisherman a second there&#39;s the there&#39;s a market failure if there are public goods a public good is simply a good that is non-rival and non-excludable non-rival means the fact that I&#39;m using it doesn&#39;t mean you can&#39;t use it we can use it simultaneously non-excludable means I can&#39;t stop you from using the quintessential example of a public good is defense like national defense if I contribute part of my tax dollars are so part of my tax dollars are going to build an aircraft carrier or let the initial missile defense system I feel safer right because the missile defense system I can&#39;t prevent you from feeling safer right when to this missile defense system is in place and I can&#39;t Ben just because I&#39;m feeling safer doesn&#39;t mean you can feel you can&#39;t feel safe so defense is like the quintessential example of public goods but there are other things too right all public goods could be caring for the homeless right if I spend twenty dollars to distribute money towards the homeless you may feel good that no one is on the streets right that&#39;s a public good I can&#39;t stop you from feeling that way and because I feel good that no one&#39;s on the streets doesn&#39;t mean you can&#39;t feel good that no one&#39;s on the streets so these are many types of public goods and the problem public goods is that when I decide how much is my individual budget to allocate towards a public good I&#39;m going to think about how much utility I get from it how much it&#39;s really do I get from feeling safe I&#39;m not going to think about the fact that my spending also benefits you and we need something bigger than our individual sort of level decision-making to sort of take into account that spillover of public goods right that benefit that global benefit of public goods to optimally allocate our budgets towards public goods because individually because we don&#39;t count the public nature of the good we&#39;re going to under allocate resources to public goods the third sort of market failure failure will discuss is asymmetric information all asymmetric information means is that one side of the market knows more than the other there&#39;s private information this will be particularly particularly pernicious in the case of insurance markets and we&#39;ll talk a good deal about that when it comes to sort of why on insurance markets can often fail they&#39;re subject to the particular market failure of symmetric information what&#39;s liked about health care and health care insurance what&#39;s like when insurance sort of in general finally there&#39;s imperfect competition imperfect competition simply means that either a buyer or a seller can influence price when they make their quantity decision so in the case of a single seller what do we call that only one guy sell something it&#39;s a monopoly exactly that&#39;s a case where the monopolist when he decides how much is something too he&#39;s simultaneously set in quantity and price because he&#39;s the sole supplier there&#39;s also a case when someone is the sole buyer of a good or service anyone know what that&#39;s called a sort of monopsony AO is closer like it sounds like monopoly was a little different as men its monopsony monopsony just means that there&#39;s one buyer so what&#39;s an example of monopsony it could be a situation where there&#39;s only one coal mine an entire county of a state and there aren&#39;t really other employment opportunities right where that coal mine operator is the sole buyer of labor services in that area and so in that case we decides how many workers to hire he&#39;s also simultaneously setting wages because he&#39;s the only only a demander a flavor so these are all cases that we&#39;ll talk about um these are all cases we&#39;ll talk about in different parts of class these are the market failures that sort of give a potential role for government to improve things this is when government might want to intervene it doesn&#39;t mean that government is good at correcting all of these right that sort of depends on sort of how government chooses to intervene so how might government choose to intervene intervene well there are three main ways right there&#39;s the price mechanism in which case the government is taking action to change the prices of things in order to change the quantity demanded or supplied in the case of bad things bad things like on if one is worried about the greenhouse effect right one might find carbon co2 a bad in which case we want less co2 to be released into the air we could tax the release of co2 into the air the release of carbon that&#39;s one that&#39;s taxing a bad we&#39;re increasing the price of just releasing carbon into the air right we have less of it if we curse the price we can also go about you know influencing decision making through price by subsidizing goods subsidizing good things subsidizing vaccines subsidizing on the purchase subsidized we&#39;re subsidizing home ownership right through the home mortgage interest deduction right there&#39;s various ways we do this we get subsides good things we could tax bad things these are both efforts to alter the price in order to change the quantity demanded or support second the government can actually just try to regulate regulate the market in the in the case of Bad&#39;s we could just restrict the sale or purchase is really hard to legally buy cocaine right that&#39;s a regulated market we could regulate insurance markets we could say you know any policy that you issue in the state of New York has to cover maternity that&#39;s a regulation right we&#39;re mandating some type of market um good we can manage the purchase of goods so we could we could restrict the purchase of bad so we could mandate the purchase of goods for example you can&#39;t drive a car in the state of California without insurance we mandate that you purchase insurance come what is it 2014 what else will we all have to buy health care insurance exactly exactly so that&#39;s another form of government intervention is regulation finally there&#39;s provision this is not the government telling you go get this or you can&#39;t get this this is the government saying hey here is this thing right there&#39;s a few different ways we can provide goods and services the first is just the public provision where the person making making the good or providing the service is actually on the government payroll that would be the case of Public Safety right sure there is private safety right there are private cops and stores often have security guards but most of the people would guarantee our safety our government employees right the police or firefighters as the direct provision of safety services by the government another way we could do it is the public financing of goods and services there aren&#39;t very many private air force carriers right in the US that&#39;s something that we provide the financing for through general tax revenues third we can also facilitate or create markets an example of that would be on examples that have been in the news lately it could be Fannie Mae and Freddie Mac right which is just a way the federal government guarantees the loans made in the home mortgage market in order to facilitate the provision of credit for residential real estate okay so that&#39;s the hell now for though what happens right so what happens when government intervenes in the market what happens with different tools that could use this will be a key part of what we talked about in this class because we said the when tells us these are opportunities or the government could potentially make things better the how is which way is it going to do it and now the last piece of it is for these different tools that could use what are the potential outcomes or effects of these interventions so we classify these effect into two main categories the first being direct effects and the second being indirect effect direct effect means what would the effect be if no one changed their behavior in response to the change in policy we all kept doing what we were doing indirect effects take into account the fact that people will change their behavior for example if I Institute a policy where on everybody wearing stripes it&#39;s $100 I believe the direct cost of that policy you in the blue shirt what&#39;s your name Andrews your shirt striped no okay now you wish yeah so I think the direct so the direct cost of that policy would be $200 only Valerie and Jessica of course are Jessica and Valerie are the only recipients of this of this of this cash transfer due to stripe wear what would happen next week if we kept this policy in place there&#39;s like a semester-long policy huge increase the number of stripes right I think there&#39;s a theoretically the 30 of you in here I don&#39;t think all of you are here today but I think let&#39;s just say it&#39;s 30 next week how much would I be paying out in stripe transfers three thousand dollars right so the direct effect may be $200 the indirect effect in this case would be $2,800 because you will likely all change your behavior traffic so actually while direct effects are often what people will naively sort of suggest would be the cost of different policies assessing what the indirect effects of a policy change are and trying to estimate their magnitude is sort of the heart and soul of public finance so what we&#39;ll do is we&#39;ll rely on theory often to sort of get the sign of the indirect effect right so if we increase if we create a transfer program for wearing stripes will get more stripes but how many of you will wear stripes that theory is not going to nestle give us then we need to actually turn to data and figure it out suppose the transfer wasn&#39;t $100 so the transfer was $5 some of you may not own a striped shirt it may not be worth it to you to go procure structured in order to get this five-dollar transfer so even though we know theoretically the chance makes it more likely that all of you will wear stripes how many of you actually will make that behavioral change is sort of a empirical question because there&#39;s other stuff going on then you might not be that responsive to the policy change okay some questions you&#39;ll be able to answer by the end of the term this is to entice you and get you excited for your adventure in public finance okay so we&#39;re gonna first start soon and off you&#39;ll be able to answer the question does taxing interest earnings reduce savings in the US um does the corporate income tax affect job creation do unemployment insurance does the existence of unemployment insurance lengthen lengthen the duration of unemployment spells and finally does welfare discourage people from working and that&#39;s actually a question we&#39;ll tackle today so we&#39;ll talk a lot more about a cash welfare in the second half of this course but it&#39;s actually a great example by which to illuminate some of the theoretical concepts that we&#39;ll be drawing on from micro so we&#39;ll talk about a little today we&#39;ll talk about a lot more later but just one is sort of a story to tell while we&#39;re talking about income and substitution effects etcetera etcetera okay so let&#39;s take a look let&#39;s take a closer look at this well at this cash welfare question so the particular cache Wolfer program we&#39;re going to talk about is called TANF Temporary Assistance to needy families it was created in 1996 as part of welfare reform it replaced the old cash welfare transfer system aid to families with dependent children AFDC TANF provides a monthly check to families who are very who are low-income in each state gets to set its own threshold as to what is low-income so most families will receive cash welfare our single mother or single female-headed they all include children because sort of to be classified as needy according to according this program you have to have minors in the home so the median state offers a maximum benefit of roughly four hundred dollars but there&#39;s a lot of state to state variation in New York a family of three with no other income receives about seven hundred dollars so this is not a hugely generous program but it sort of does help a family with no other resources get by into minimal sense right and why is there so much Geographic variation well there&#39;s differences in preferences for supporting a program like this in different areas this country sure but also you know there&#39;s a simple fact that the cost of living is very different in different states largely due to different real estate prices the costs are renting a place is very different different parts country okay so TANF was a you know so AFDC the old program it replaced we&#39;ll talk much more about this a later on but just to give you a sense of it was a controversial program you know something that we heard a lot about in the 80s there&#39;s a lot of scorn 1480s and it&#39;s part of this large event in in the 90s of welfare reform AFDC was converted to 10 into TANF and it was a big debate then and though that debate has died down right this is not something you hear people talking about every day on the campaign trail right cash welfare it&#39;s still controversial today for example the Great Recession actually renewed debate about this program because the Great Recession to two things in any recession tax revenues go down at all levels of government including state government including federal government so the resources available to provide cash welfare were limited second what else happens during a recession many more families are fat many families are affected by the business cycle and more families are poor right simply isn&#39;t believe that so at a time when there were less government resources there was increased demand for this program and in fact a lot of the states weren&#39;t able to sort of maintain the benefits that they had been paying out let alone address the fact that more families needed support so as part of the stimulus in 2009 that&#39;s 787 billion dollars that was spent or partly spent at this point five billion of those dollars went to went to propping up TANF to that for the states so I think you know many of us have heard sort of the term that there&#39;s a big bailout of the states as part of the stimulus this is one element of that was one of the many element many programs that were sort of bolstered by federal revenues because the states were having a lot of trouble so it is still a controversial probe on Eric Cantor who&#39;s the majority leader of the house actually I ran a contest of sorts where he you know as voters to come to look at his web page and decide you know if they had if they got to choose which federal program received fewer resources a you cut pro contest it was called which would they choose and you know even this era as I said sort of the heat of the discussion of cash welfare has come down but even in this era where it&#39;s not so intensely debated TANF cash welfare was after the most was the quote-unquote winner really the loser right of of this you can of this you could contest yes I&#39;m sorry Jeff this is not a scientific poll this is like this is a friends and family matter Cantor absolutely but I mean I guess the point is even now right it&#39;s something that some people is country do feel very intensely about even after the reform effort we&#39;ll talk much more about welfare reform which on is actually a fascinating topic of both economics and politics I think it&#39;s an interesting story okay anyway um in other parts of the government there&#39;s also discussions of sort of making it more generous or making it better at addressing sort of needs of families so we&#39;re still sort of a less intensely debated but still debated program okay so the main question we want to ask today we&#39;re going to sort of explore in different ways is does TANF discourage work so anecdotes suggest that it might but what so one of the key things I want you to take away from this course your Wagner education in general is that the plural of anecdote is not data right lots of stories a dataset does not make I mean there&#39;s qualitative value to anecdotal research right to going out doing case studies and collecting sort of in-depth uh sort of descriptions of the trajectory of decision making etc so I guess I think sometimes you know and a basic quantitative data set no matter how large we can&#39;t necessarily figure out what the mechanisms behind certain changes are and that kind of in-depth sort of interviewing can be really useful but asking a bunch of people does TANF discourage work is not a way to find evidence on that question right we need to see actions we need to see data we need to see sort of scientifically sampled right databases etc but this woman the Boston Globe talked to his woman in 2009 in June of oh nine this woman Diane Sullivan 35 a mother of six said she has seen how the existing system dissuades many people from working she speaks from the experience of having her benefits and after she found her first job I was tossed off a cliff she said what I realized was that I was worse off than if I didn&#39;t work what kind of incentive is that first of all we had a loved Diane Sullivan for using the word incentive right terrific nice work Diane so that&#39;s the question right it seems at least some people have had this experience that they realize when they work that you know things may not be they may not be doing better financially necessarily so this is you know it&#39;s a question that we as economists ask the parent Li a question that arises the mind of real people as well know we&#39;re real people but of people living with this program as well okay so let&#39;s go ahead and try to actually use some some some economic sort of analysis to assess whether or not TANF effects work incentives so the theoretical tools we&#39;ll use in this course and in public finance in general are the following we&#39;re all stuff you learned in micro so first of all we&#39;re going to start off with constrain utility maximization constrain utility maximization is the process of maximizing one&#39;s utility or happiness given the fact that resources are limited if you have a budget you have a finite level of income or income or resources in general with which to sort of purchase as much happiness as you can right to purchase it&#39;s the best combination of goods to make your utility level as high as possible of course our utility level is subject to our maximization of utility a subject to a budget constraint which is simply the it&#39;s a mathematical expression of your income described by the quantities and prices that you can of the goods you could choose from Oh we&#39;ll talk about utility functions which are simply a mathematical representation of a person&#39;s preferences right suppose so your name Siobhan that&#39;s right suppose I asked Siobhan a lot of questions like Siobhan do you prefer bananas or pears bananas do you prefer raspberries or pears so if we did this all day I could have a pretty good mapping of Siobhan&#39;s preferences but be very hard to analytically deal with that right that would be a some kind of set of notebooks of Stefan&#39;s preferences so we take people&#39;s preferences over a limited number of goods we&#39;re talking about you know our ability to draw in two dimensions and we sort of map them into a mathematical representation which we call utility function and that utility function is what we use to sort of analytically analyze analytically assess sort of the effect of different policies on people&#39;s decisions on what they purchase and how many of each good they purchase that&#39;s really what the purpose of utility function is and we graphically represent the indifference curve the utility function within a difference curve why do we use indifference curve because imagine on the ground here in this direction we were plotting number of bananas eaten in this direction we&#39;re plotting number of pairs eaten and let&#39;s imagine you all like bananas and pears at least to some level right and in this up and down direction we&#39;re plotting the utility level of bananas and pears right so we&#39;d have some sort of shape coming out of the ground right as a function of how many bananas versus pears you were consuming but do you guys remember like when you were a kid you sometimes all these maps that like mountain ranges that were three-dimensional right another way to represent that would be to squish it down into two dimensions where there&#39;d be different colors used to represent sort of the ridges of the mountain that we&#39;re all the same height that&#39;s exactly what indifference curve is we&#39;re taking the three-dimensional utility draw utility graph and squishing the utility down into indifference curves indifference curves simply tell us what combinations of bananas and pears leave this person equally well based on their preference based on how they how much they like bananas relative to pairs that make sense is just a graphical representation of the utility function okay so today we&#39;re going to discuss the example of movies and CDs see these are on the y-axis movies are on the x-axis so there&#39;s a few things we&#39;re going to talk about when it comes to indifference curves so one of the properties of all utility functions we talk about is non-satiation non-satiation non-satiation is another way of saying teresa but what&#39;s another way to say non-satiation you always want more more is always better right you&#39;re always ready for another one even if i&#39;ve given you a million apples you&#39;re still happier having 1,000,001 apples you know you&#39;re at this point you&#39;re up using them for decorating right but you you still want it you never say no to the goods we&#39;re talking about non-satiation that another way to say that is that these indifference curves right are always Banting a higher level of utility as we go this way as we move away from the origin in the north east direction you&#39;re getting happier and happier so indifference curve three is better than two which is invariable which is better than one that&#39;s non-satiation so they also have this property that they&#39;re sort of downward sloping right what does that mean why they shaped like this it&#39;s because we all utility functions we&#39;ll talk about have the property of diminishing marginal utility what do I mean by diminishing marginal utility there&#39;s not as easy a non-satiation you&#39;re always happier with more but each additional unit of a good makes you less happy than the one previous so when you know you come into class and I offer you an apple you&#39;re kind of hungry ready for a snack you&#39;re pretty happy with that I offer you a second apple so want the Apple but you&#39;ve already had an apple you can take it home but you&#39;re not going to take as much joy out of that Apple as the first one and eventually I&#39;m giving you a your thousand Apple right at this point you&#39;re thinking perfect I will decorate my front lawn with apples you still want more you always take them but eventually you&#39;re getting you know you each one is giving you less and less utility diminishing marginal utility another way to describe that is that the slope of this line of the indifference curve gets lower and lower as we move from left to right and why is that oh so okay so I&#39;m no artist we&#39;re not going to mock me for it but uh okay so this is sort of it was movies on this on the X CDs on the Y this is sort of our general indifference curve right what is the slope of an indifference curve does anyone remember what it&#39;s called that&#39;s three words the marginal rates of substitution right the mrs the mrs is the ratio of the marginal utility of the x acid x axis good to the marginal utility of the y axis good mu M over mu C all right bigger it&#39;s bigger it seems bigger here but it looks very small um okay so that&#39;s what the slope of the indifference curve is so is the slope getting steeper or flatter as gee as this individual let&#39;s call her Ellen as Ellen consumes more movies is her indifference curve getting steeper or flatter flat right so what does that saying is happening the mrs it&#39;s going down so a she consumes more movies is their marginal utility of movie consumption going up or down down right because I mean the first movement she sees is like the dark night awesome right and then she sees like the departed eventually this poor woman is seeing Gigli right so margin utility is going down and down and down right so the mu sub M is going down as movies goes up the Mars utility of CDs depending on the utility function could be going upward just be staying constant right but as long as the denominator isn&#39;t going down to right it&#39;s not going down what&#39;s gonna happen the mrs it&#39;s gonna go down as she consumes more and more movies and this curve is gonna get more and more flat because what is what is she really communicating with her mrs it&#39;s how deep in her soul she trades off movies and CDs all right it&#39;s like how she values these two good relative to each other it&#39;s how many movies she&#39;s willing to give up to get a CD right at first which is consuming um sorry it&#39;s how many CDs she&#39;s willing to get up.get how many CDs she&#39;s willing to give up to get a movie it&#39;s always y 4x the mrs so over here she&#39;s going to zooming very few movies right to be willing to give up a lot of CDs in order to see a movie she really wants to the Dark Knight but as you see the Dark Knight and the part and The Departed etc etc she&#39;s willing to give up fewer and fewer CDs in order to see a movie because she&#39;s seen a lot of the movies she prefers most right this is diminishing marginal utility of movie viewing let make sense to everybody so one of the things that I think will help is remember it&#39;s always the margent ility of the XX is good over the margin utility of the y-axis good I mean you might have another way of remembering it and that&#39;s terrific but this is always helped with me okay oh wait so that is our RI our indifference curve slow there&#39;s another line on here it&#39;s the budget constraint right the budget concern is a lot is the straight line connecting ah that has intercept on the y axis and the x axis so what does is what is the y axis intercept of the budget constraint represent the number of CDs Ellen could buy if she spent all of her income on CDs the x axis intercept simply represents the maximum number of movies she could see agent all of her income on movies and every point between those two intercepts is an affordable bundle to her it&#39;s a combination of CDs and movies that she could purchase using her income in this in case Tori because this is a line it&#39;s not a bunch of points we&#39;re assuming CDs and movies are infinitesimally divisible you can buy eight point three movies sort of a convenient assumption we&#39;re gonna go with it okay terrific so but when we actually so when we think about what the budget constraint is I&#39;m sorry it&#39;s a little annoying that we have to do this dog camera thing but there&#39;s no whiteboard in here so we have to do it this way so this is the budget constraint right the budget constraint so let&#39;s say we have some income level I income well income is some number but I&#39;m just going to call it I and the problem I tell you it&#39;s like a hundred or a thousand or something right what is this point going to be it&#39;s going to be if you spent all of her income on movies so it&#39;s I divided by P sub M the price of movies this point over here is going to be her income divided by the price of CDs let me sense everybody right suppose you have $1 income CDs are $10 and maximum Erb CDs you can buy is ten done okay so when we write the budget constraint we&#39;re going to write it in terms of the quantity and prices of each of the goods so we&#39;re going to spend all of our income this is a model with no savings this person doesn&#39;t say if it&#39;s been all their income and they&#39;re not going to not spend their income right because they want to be as happy as possible dollars give them no utility only CDs and movies give them utility so income is a function of what you spend at the Sun which he spends on movies right so it&#39;s P sub M times M and quantity of movies or sorry let me call this Q&#39;s of them let me keep the notation plus the price of CDs times the quantity of CDs what does this do is this something we can graph on those axes where where the y axis is the quantity of CD she buys and the x axis is the quantity of movie she buys no we have to rearrange this right in fact we want to write this in terms of Q sub C right one the right keys we&#39;re going to isolate Q sub C because that&#39;s the y axis good so Q sub C equals I minus P sub M times Q sub M divided by P sub C ha this is our intercept right that&#39;s I divided by P sub C is our intercept that&#39;s what that is then our slope of this line is what negative piece of M over P sub C right what&#39;s the name for that price ratio or what&#39;s the name for the slope of the budget constraint it&#39;s a marginal rate of transformation similar to later substitution the slope with indifference curve so the budget did I just miss did I just say indifference curve or something no okay cuz over the budget constraint is called the marginal rate of transport a cop true the marginal rate of transformation excuse me um and we call it the MRT so the MRT as I do this without signs these are all negative right these are all negative or you know whatever MRT is negative P sub M over P sub C it&#39;s the price race you have the x-axis good to the price of the y-axis good I&#39;ll show your name Kelly sure I&#39;m sorry it looks so tiny up here I mean I swear to god it&#39;s much bigger here um yes I will do that for sure it&#39;s piece of M over P sub C it&#39;s the marginal rate of transformation let me write that again better okay so um okay so the so we did the margin rate of substitution tells us how Ellen in her hearts right which things about her preferences how she creates off seeing a movie or seeing or water listening to a CD on the March right giving her a bundle at that point how does she view those two Goods if she had one more of one or the other the marginal rate of transformation tells us how the market trades off CDs versus movies it&#39;s always constant right her mo RS is a function of how many movies and CDs she&#39;s consumed because that&#39;s why the slope changes as we go along the MRT is constant this line always has the same slope a straight line the MRT is telling us how the market trades off movies and CDs it could be that each movie is ten dollars CDs five dollars in which case it&#39;s two CDs per movie right and that&#39;s true no matter how many she wants to buy because she the tiny consumer there&#39;s no monopoly I&#39;m an absolute monopoly here so that the marginal a transformation tells us how the the market trades off the two okay so how does how do we actually maximize utility what their constraint utility maximization she wants to buy she wants to make herself as happy as possible right she wants to consume the highest indifference curve she can the one farthest away from the origin but why can&#39;t you can sue why can&#39;t she be on the infinity indifference curve gently got this many resources would she ever want to be on a difference curve I someone I see someone know right cuz she can do better by doing what by pushing out a little bit what about I see sub three that&#39;s unaffordable what the limit of her affordable bundle that&#39;s the best you can do the point of tangency right the the indifference curve that barely touches the budget constraint is the constrained utility a maximum okay so we talked about all of this stuff already or the first two anyway but we&#39;re gonna talk about income effects and substitution effects so income effects um is the idea that when you change someone&#39;s income level it&#39;s going to change the amount of stuff they buy right we&#39;re going to only talk about what are called normal Goods in this class a normal good just means we have more money you want to buy more of it you only have it that&#39;s all in normal good is we won&#39;t talk but if you&#39;re inferior goods in this class so I will often use the phrase she has more money so she wants to buy more of everything she&#39;s gonna demand more of everything that&#39;s the way to think about it she has the less income she&#39;s she&#39;s going to demand less of everything is a phrase will often use substitution effect on the other hand or about relative price changes so let&#39;s say there is a price change let&#39;s say the price of movies has gone up so movies are now relatively more expensive by relative mean relative to CDs right so she&#39;s going to substitute away from movies toward CDs right because the price of movies has gone up but at the same time that price change which definitely has a substitution effect which is to reduce the number of movies she consumes will trigger an income effect why is that it&#39;s because her cost of living has gone up the same income she had before goes less far now right she can consume fewer movies for the price of movies has gone up if she richer or poorer now because the price of movies has gone up she&#39;s relatively poor she&#39;s going to demand less of everything including movies so her consumption of movies will fall because of a substitution effect right the price of movies has gone up student substitute two word CDs but it will also go down because she&#39;s poor he&#39;s to demand less of everything both the income effect and the substitution effect of a price increase leader to consume fewer movies to make sense cool okay so back to Tanna so um so back to 10 Tanith has to wolf the way we talked about 10 we&#39;re gonna talk about two key features the first of Benefit Guaranty you can always think of that think of that as an income guarantee it&#39;s the level of transfer that will be made to the individual if they work zero hours right there&#39;s the minimum level of income they&#39;ll receive there&#39;s also benefit reduction rate which is the rate by which their benefit is reduced for every dollar they earn so if there was a hundred percent benefit reduction rate if Ellen went out and worked an hour she would lose a dollar of benefits I&#39;m sorry earned a dollar who lose a dollar of benefits that&#39;s a 100 percent benefit reduction rate better production rates tend to be less than 100 percent right there so some return to working so if a benefit reduction rate was if her benefit reduction rate was 50 percent for each dollar she earned she would lose 50 cents in benefits the way this would work let&#39;s say Ellen had a job as a server and restaurant let&#39;s say she worked for an hour she earned $10 an hour the restaurant owner would write her a check for $10 right so she&#39;s going with that paycheck but suppose you&#39;ve been receiving some benefit in TANF that benefit would fall by $5 so the net total sort of return on an hour of her labor is now $5 right her employer is still paying her the 10 but it&#39;s her loss of five dollars of benefits that makes the net wage only five okay terrific so we&#39;re gonna talk about a single woman again her name is going to be Ellen who can work up to 2,000 hours per year she has a time allocation right of 2000 hours there&#39;s gonna a liqu 8 that between work and leisure and she earns $10 per hour she spends in the labor market so people generally don&#39;t like to work is the way we think about it I mean I I you know I love my job but it&#39;s not as good as watching Law &amp; Order reruns which is what I would do my time if I didn&#39;t have a job so I love you know leisure is what we love to do work is what we have to do right so we think of labor supply as a negative it&#39;s a it creates disutility we&#39;re less happy when we work versus spending time on leisure which may be whatever it is but it&#39;s really hard you know it&#39;s tricky and sort of confusing to graph bad stuff we&#39;d like to think about buying things that we like right so we&#39;re instead of graphing labor we&#39;re gonna graph leisure you guys cover labor supply and micro at all oh yeah so when a graph of leisure on the x-axis so we&#39;re gonna trade off leisure versus food consumption and the units of food consumption we&#39;ll talk about are just dollars of food that&#39;s pretty easy unit okay so we&#39;re gonna graph our budget constraint so what are the intercepts where did you spend every hour on leisure how many hours of leisure could she have 2000 what if she worked every single hour how many dollars our food good something could you have 20,000 bingo what&#39;s the slope of this line $10 I mean negative 10 what does the slope tell us it tells us how an hour of leisure given up translates into units of food consumption right it&#39;s how many or another way to put that is how many units of food consumption does she have to give up to spend in another hour on leisure because we don&#39;t think of this is our buying leisure and buying food consumption okay now let&#39;s introduce 10 that&#39;s like the labor market as it functions on its own now let&#39;s add cash welfare so cash welfare here is a $5,000 benefit that&#39;s reduced by 50 cents for every dollar she earns so what&#39;s like going to do is going to elevate our budget constraint so before if she spent all her time on leisure she got zero food consumption now if she spent all her time on leisure she gets five thousand dollars a food consumption that will continue until some point where she&#39;s exhausted her benefit and she&#39;s back to no longer losing benefits when she works right when is that gonna happen how BIG&#39;s our benefit again five thousand dollars how many for each hour of labor she she she provides for afraid for every hour she spends on work how many dollars does she lose of benefits five right because she gets $10 an hour she loses five dollars of benefits how many hours does she have to work until she gets no more benefits a thousand right because it&#39;s five she loses five dollars of benefits per hour she works so the $5,000 benefit when she worked her a thousandth hour her benefit is now zero okay did that the King point that&#39;s gonna be point B when she spent a thousand hours on leisure a thousand hours on labor right cuz that&#39;s the midpoint she is now exhausted her benefit and then when she decides to work for the one thousand first hour how much her employer will pay her $10 and there&#39;s no benefit on this side to be taken away so she gets a net return of $10 starting with her thousand first hour of labor or her 999th hour of leisure any sense to everybody so the slope increases of ten again after a thousand I wonder as we move left one thousand okay perfect now let&#39;s think about changing this program we&#39;re going to restructure this program we&#39;re worried that it creates strong disincentives to work let&#39;s see what happens if we change it in the following way we&#39;re going to reduce the benefit guarantee to $3,000 but leave the benefit reduction rate the same so at $3,000 let&#39;s figure out where our new king point will be so we know that for the first few hours of labor she&#39;s only going to get a net return of five dollars right not 10 because she&#39;s gonna be losing benefits she will lose benefits at 50 cents on the dollar until her benefit is gone her benefit is again what again three thousand dollars she how many dollars of benefit does she leaves for every hour she works five 3,000 divided by five is 600 right so after she&#39;s worked 600 hours out the point she&#39;s reached 1400 hours of leisure we have our kick points again okay so let&#39;s think about how does this change her incentives to work suppose she was in this range and there&#39;s a range of zero to a thousand hours of leisure does it affect her this reform now she was never really part of the program she still a part of the program or life continues exactly this what if she was over here what if she was in the 1400 to 2,000 hours of leisure range in that range has her slope changed no it was five before with the $5,000 benefit and with the $3,000 benefit still five right so a trick is that there&#39;s no substitution effect unless there&#39;s a slope change right because what is the pride wouldn&#39;t what is a price change it changes the marginal rate of transformation of the two goods right it by a part and parcel of its very definition requires a change in the slope that&#39;s how we graph a change in price so change it slow okay so there there&#39;s no slope change but is there an income change between like the kink to blue line of the Kings red line yes she has less money right we could her benefit if she&#39;d rich or poor poorer she&#39;s gonna want to buy less of everything including leisure so the income effect if she was between 1400 and 2,000 hours the income effect a leader to work more or less more because you&#39;re gonna get to less of everything including leisure Social Work more everyone with me awesome now let&#39;s like with the middle segment the thousand to 1400 hours of leisure so we&#39;re comparing the King to blue line to the kinked red line is is she poor when we go from blue to red yeah it&#39;s lower right so she&#39;s poorer she&#39;s gonna buy less of everything including and so she&#39;s gonna work more as their slope change has the price of leisure gone up or down so it used to be the blue line out the red line the price has gone up the slope is now steeper so the price of leisure has gone up when prices go up - we consume more or less of something less so she&#39;s she gonna consume in fact a leader to consume less leisure in other words work more so in that middle range both the substitution effect and the income effect are going to push her to work more to the right so between 1400 and 2000 hours of leisure the income effect the leader to work more so by reforming this program in this way we&#39;ve strengthened work incentives some people are untouched some people have two reasons to be working are more some people of their just income effect right okay so let&#39;s think about what would this is this you know if this was her utility function and so this is a log utility function and the weights are 101 and 175 if she was initially sort of working on 19 10 hours with this utility function right go she would be she would actually end up working um she&#39;d end up having working more having stock she was initially enjoying 19 10 hours of leisure should end up working worn and doing less leisure where after the reform but this is a person who sort of likes leisure and consumption similarly how can I see that because the weights on her terms they&#39;re her log terms are kind of er similar right 100 and 175 so she kind of was balancing the two right she was gonna doing some of each let&#39;s look at somebody else so this is a typo the 175 should be a 300 I will change that before I post these so if that&#39;s 300 does this this person likes leisure relative to consumption much more than the previous person right this person loves leisure this is like me and Lord right I want to spend all day watching long order reruns I want to watch a Lennie Briscoe solve the same crime again and again and again so I love leisure so much that even with the initial program of the $5,000 benefits I was not working at all all day long Marathon Monday right even after the reform I still prefer that to the point that I&#39;m still out of the labor force I&#39;m at point B I&#39;m not going to work still why is that graphically why&#39;s that true graphically it&#39;s because I love leisure so much that my indifference curves are so steeply sloped that is my marginal utility of leisure is so high that my slope is so steep but the only point of tangency I can find with that budget constraint is at that king point I love leisure ok so the idea here is this this Fair reform for this person changing welfare in this way right reducing the cash benefit led them to work more in this case we got no change in work it&#39;s because the preferences are different right we can say theoretically this is the way this should work out here the into effect to leave them to work more the substitution effect would also make work more on this range but whether or not they respond it sort of depends on who they and what their preferences look like we know there&#39;s no way she&#39;s going to work less right that&#39;s ruled out but to what degree should respond this sort of an empirical question okay so now we&#39;re gonna move on to welfare economics oh so so this term welfare is used it&#39;s one of many confusions in this course in this field so right now I&#39;m using the term cash welfare disk liar to describe TANF that&#39;s what I mean by checks written by the government to poor people I&#39;m gonna call that cash welfare this kind of welfare is like economics discussion of how well society is doing welfare like societal welfare or individual welfare sort of discussions so I&#39;m just called this kind of welfare welfare I&#39;ll call the other one cash welfare or tan okay so welfare economics is the study of the determinants of well-being or welfare in society we are used when we talk about society we&#39;re moving away from indifference curves and budget constraints to aggregate demand and aggregate supply right how do we add up I would demand aggregate supply we do something like a survey right if I say so does their $1 manisa how many sodas would you like awesome Valerie how many sodas would you like if so does their dollar once of our entire market was the two of them at $1 as sort of demand is three then I&#39;d really like manisa sodas are two dollars how many would you demand you would say some number will be less than the previous number fellow Valerie to the same thing and we&#39;d add up quantities at given price levels right we don&#39;t add up this way we add up this way for each price we&#39;re going to add up the quantity does that make sense I mean to add horizontally so we add up the quantities for at every price level we do the same thing for supply we&#39;d say hey suppliers at if we can sell soda at a dollar how many sodas would you make etc Center so that&#39;s why we aggregate demand aggregate supply oh then we&#39;re going to use that market equilibrium of these demand supply curves to assess the size of the pie and when I say the pie I mean how big is consumer surplus and how big is producer surplus consumer surplus is the difference between the benefit consumers derive from purchasing a good and the price they pay for that good producer surplus is the difference between what price producers receive for the good and what their mark their cost of production was what their variable cost of production social efficiency is the sum of consumer surplus and producer surplus when there is something happening such that the competitive equilibrium is not being achieved or that somehow the social optimum is not being received because there are market failures right there are externalities there are public goods etc etc there is loss we call that loss deadweight loss it&#39;s sort of the suboptimal it&#39;s the difference between what&#39;s happening and the optimum the first fundamental theorem of welfare economics tells us the competitive equilibrium in a well-functioning market maximized efficiency right what did I say well function if their market failures will be this will not be true anymore the second fundamental theorem welfare economics tells us that the social Emax if the social efficiency maximizing outcome the second welfare theorem tells us that we could reallocate initial bundles to achieve any post equilibrium allocation of resources but like I said earlier reallocating initial bundles is really hard right it&#39;s not very easy to take away someone&#39;s assets and give them to somebody else that&#39;s not allowed Society because of those restrictions we fundamentally face in economics this trade-off between efficiency and equity in order to redistribute resources we have to weaken incentives by taxing by by sort of taking right way weaken incentives accumulate to work to invest in order to create redistribution and so we&#39;re funding really of this trade-off between equity having a distribution of income or resources that we like and efficiency we&#39;re just having the biggest possible pie trade-off between how the pie is divided and how big that pie is because we really can&#39;t transfer initial resources very effectively we just can&#39;t really do it by law okay so let&#39;s take a look at what our social efficiency picture looks like so we have supply and demand here I said the consumer surplus is the difference between the benefit consumers demand and the price they pay right the demand curve is in fact a lining up of people by how much they&#39;re willing to pay for this good so let&#39;s say this is uh you know whatever good this is the Kahless the canna soda I&#39;m really thirsty I&#39;m an I love soda like I love corn syrup right so I am that guy on the on the y-axis I get the full difference between W and X because I love soda I pay much more above the equilibrium price I think we&#39;ve been prices where supply equals demand I would be far more than that I&#39;d pay W for a soda so if I just have two if I only if I only have to pay P so B it&#39;s a win it&#39;s a big win for me the next person the next person over is someone who like soda but not quite as much as I do their willingness to pay a slightly less than mine but again they would pay way more than equilibrium price to we&#39;re gonna line these folks up until we actually hit equilibrium right at that point the last person at Z is a person who&#39;s basically indifferent between buying the soda at piece of B and not having it a piece of e that&#39;s exactly their willingness to pay the person to the right of equilibrium right the person like over here they don&#39;t buy a soda and why is that because they don&#39;t value it at what they&#39;d have to pay for it okay so when similarly the producer surplus is the difference between what producers receive and their marginal cost of production so the supply curve is the supply curve is the marginal cost of production above the average variable cost right summed up over the different producers so that the beige triangle is producer surplus the blue triangle is consumer surplus with these triangles be bigger or smaller if these lines were more steeply sloped bigger I love it smaller bigger yes okay um yes it would be bigger right cuz what what does let&#39;s talk about consumers if demand is more steeply sloped what does it mean it is it&#39;s more or less elastic less it&#39;s more inelastic right it&#39;s more inelastic when we say that demand is very inelastic what we&#39;re really saying is that the consumer does not have good substitutes for this good right for me I don&#39;t think Pepsi is anything even close to Coca Cola there&#39;s no substitute for Coca Cola for me so my demand is incredibly inelastic if you offer me a free Pepsi or so or a coke for two bucks I&#39;ll buy the coke right I&#39;ve no interest in Pepsi for me there are no good substitutes for Coca Cola so my demand be very inelastic very steeply sloped people like me if society is made up of people like me the society is made up by slightly more reasonable people right people who found perhaps you to be a fairly Goods up to you for Coke demand to be far more alas taking the curve would be flatter and there&#39;d be less consumer surplus because purchasing coke doesn&#39;t make them as happy because there&#39;s also Pepsi right it&#39;s the fact that there&#39;s no good substitutes that makes demand far more elastic excellent ok so let&#39;s talk about oh let&#39;s talk about price floors I could um so let&#39;s say um you know Mayor Bloomberg really doesn&#39;t want a price floor he wants uh I mean he wants that he wants to know what the price for and I&#39;m not a price ceiling he wanted to get rid of my you want to lower soda consumption but we&#39;re gonna think of an example of some other government that says you know what soda prices are too damn high we&#39;re going to restrict Toto prices we&#39;re actually going to say that they can&#39;t exceed piece of our so the equilibrium prices piece of B but this government fiat has said that soda prices cannot exceed P sub R so all soda will be sold at P sub R how how many units of soda would consumers like to buy at P sub R all the way out there right where that piece of our line intersects the demand curve they&#39;re out of luck right because suppliers are willing to produce how much Q sub R so what&#39;s not going to happen all those units that would have been sold in the competitive equilibrium so the units between Q sub R and Q sub e those trades will never happen so instead we will have a market where at P sub R quantity Q sub R is supplied what&#39;s the new consumer surplus going to be I&#39;ll give it to me in shapes are the names of shapes a and what else and what Bay and B B as in boy because DNA no longer exists right those trades don&#39;t happen that is deadweight loss so the new consumer surplus is a and B or the new producer surplus just C and D and E or deadweight loss because this government restriction has prevented trades that would have an other would have otherwise benefited both consumers and suppliers from happening these trades would have happened and now those units of soda are forever lost right so that&#39;s deadweight loss the any other deadweight loss so what was the so part of the impact was that there&#39;s Ed we lost DNA what happened to be it went from whom to whom Zoomers so it changed the distribution of the pie but there was a cost to changing the distribution of surplus namely with D and E terrific okay so that&#39;s sort of you know that&#39;s sort of our efficiency now in target welfare which is sort of our notion of equity and how people are doing so the way you represent society sort of aggregation of individual utility is called social welfare function it&#39;s how we added utilities or different members of society to get a measure of sort of societal welfare we call this a social welfare function we&#39;re gonna talk about two particular forms of social welfare functions so social welfare functions could be very different right what a social welfare function could be like I only care about how short people feel about things how well they are doing they are my people they&#39;re the only people whose utility I put any weight on if you&#39;re over five six I don&#39;t care about you that could be oh you two that could be social welfare function right it&#39;s not a common one right we&#39;re gonna talk about two in particular what is the utilitarian social welfare function in which case we value everyone equally we just add up their utilities I you know to penal to I value a unit of Jeff&#39;s happiness of utility so I just add it all up if we have the utilitarian social welfare function it will be true that&#39;s a maximized social welfare we want to equate the marginal utilities of people now to quit the utilities but the marginal utilities why is that it&#39;s not that I care of us right it&#39;s not that I care about a unit of mass happiness the unit of Jeff&#39;s happiness equally it&#39;s that can we do this yeah I care about it equally so I&#39;m going to want to equate marzan utilities across people why is that suppose suppose Jeff had on much higher marginal utility of soda than Matt did or consumption let&#39;s just say some consumption good somehow your consumption good in that case taking a unit away from Matt and giving it to Jeff would be a win for the social welfare function because his marginal utility is higher than Matt&#39;s when I take a unit away from Matt Matt is sadder sure but Jeff is happier for that extra unit by more than Matt is sad so when I&#39;m just adding up people&#39;s utilities I&#39;m going to want a quaint margin utilities because I&#39;m going to want to make those trades until there&#39;s no more gain from moving around consumption until marginal utilities or equal across people that make sense good excellent the other kinds of welfare function we&#39;ll talk about is a sprawl Xion social welfare function this is the case we&#39;re going to maximize the welfare of the worst off person in society so the minimum of all utilities is what we want to maximize so this notion comes from John Wallace&#39;s idea that suppose we were like at a dinner party before any of us were born like some kind of pre-existence in our party and we&#39;re talking about you know how we should allocate this resources in society and we had no idea whether we be princess Ruby poppers we&#39;d be investment bankers we&#39;d be god knows right we had no idea we would be very concerned about being the worst off member of the Society of we&#39;re know John wall&#39;s right we very concerned about how that person would fare because we don&#39;t have a decent shot of being that person if we had this dinner party ex-ante do exist to existing that&#39;s where this idea come from that we want to take care of the least well-off because uh you know behind the veil of ignorance that could well open us so this implies that social welfare is maximized by making sure the worst off person is not doing so too bad simple idea under Rawls okay so let&#39;s go back to our TANF example so the blue supply curves and demand is constant here the blue supply curve is of the labor supply of single women with no TANF program in place with the $5,000 Benefit Guaranty version of TANF in place our supply curve as S sub 2 when we reformed welfare and reduce the benefit guarantee and increase work right we move back towards the initial equilibrium and we&#39;re at S sub 3 so what happens to efficiency in this story when there is a lot of there is dead weight loss created by the initial program right when we have the $5,000 benefit the deadweight loss triangle has ABCDE when we cut benefits and increase work incentives these people the single women work more and are deadweight loss is reduced to D&amp;E so efficiency is enhanced by reducing the benefit guarantee program is society better off unclear right depends on first of all well the women are certainly individually worse off when we cut benefits right because sure they&#39;re working more their income levels haven&#39;t fully fallen but they&#39;re giving up leisure to do that and their incomes are less the women are certainly worse off but maybe we value the sort of societal surplus of ABC more than we value their discomfort of working it depends on our social welfare function depends on the weights we put on different parts of society ok let&#39;s look at two examples so in the we&#39;re going to actually use a we&#39;re gonna look at a utilitarian Social Welfare function and each individual&#39;s utility in this case is simply a square root so your Tildy level is simply the square root of your consumption we&#39;re just talking about a consumption good is some kind of aggregate measure of consumption so u equals 3 to the 1/2 suppose on the population of the poor is to share the population of poor people is 10% and then on poor are 90% okay so with the Big Ten of benefit our incomes are sort of post labor market incomes are the benefit ends up with the poor getting $10,000 a piece and the non poor having $50,000 in post taxing post tax post transferring the average income of the society right is 0.1 times 10,000 because a weight on oh there&#39;s point 1 the weight of poor people is point 1 the weight of non poor people is 0.9 so the average income is 0.1 times 10 K plus 0.9 times 50 K which amounts to 46,000 dollars that&#39;s the average income what&#39;s the ad worthless to social welfare of the society well what&#39;s the utility of a poor person here it&#39;s 10 K to the 1/2 right and how many of those folks are there there&#39;s 0.1 right but what&#39;s the utility of a non poor person it&#39;s 50,000 to the 1/2 and the weight on that type of person is 0.9 it&#39;s a question know so the social welfare is going to be to 11 point 2 let&#39;s say we cut TANF benefits when we cut 10 of benefits we need to let raise less revenue right there&#39;s less stuff for spending money on so we can actually reduce taxes it&#39;s going to change post transfer post tax incomes for these two groups the poor now are only getting $5,000 a piece in the society the non poor there they&#39;re not paying as much in taxes so they&#39;re just getting 51,000 dollars apiece so what&#39;s average income in the society what&#39;s going to be 5 K times 0.1 plus 51 K times 0.9 average income has gone up to forty six thousand four hundred let&#39;s look at Social Welfare so what&#39;s the utility of a poor person now it&#39;s five K to the one half and there&#39;s 0.1 of them what&#39;s the utility of a non poor person now it&#39;s 51 K to the one half times 0.9 right that&#39;s the way on them so our total social welfare is to ten point three so even though average incomes are higher because we&#39;ve strengthened the incentives to work for the poor and the non poor right we&#39;re taxing the non poor lest wear something we&#39;re giving smaller gear benefit guarantees to the poor&#39;s everyone has stronger work incentives average incomes have gone up but society according to this social welfare function is not better off how could we have taught how could you have told me that before even doing this calculation that if we change and comes in this way people won&#39;t be better off at the income levels of 10k and 50k who&#39;s it notice that that the same utility function right they don&#39;t pour a non pour not fundamentally different they value consumption according the same function so if the incomes are 10k in 50k who has the higher marginal utility the poor the non poor the poor because they&#39;re consuming less right marginal utility Falls as we consume more and more right the finishing marginal utility so you could like you could have told me that if we are take income away from the poor and give it to the non poor we&#39;re distributing redistributing from someone who have the high marginal utility of income above consumption determines a low margin utility of consumption so we&#39;re guaranteed to not be better off for sure when we trade that in that direction we&#39;re going to have a lower social welfare why is that because this is utilitarian social welfare function we&#39;re making trades away from high margin utility people towards low marginal utility people we&#39;re going to be worse off and that&#39;s because this society is some a utilitarian society it&#39;s it&#39;s got this particular functional form for social welfare a difference of welfare function could come up with a different a different um a different uh welfare consequence so for example um in scenario two so different assumptions can have different in fact so it&#39;s very simple for me to say if our social welfare function were different we&#39;d have different outweigh i&#39;ve different outcome like if we have social welfare function where we only cared about the non poor it would be pretty clear right that we would be better off and say when we cut welfare benefits if we had a social welfare function where we only cared about the poor it would be clear that we would be worse off when you cut that all right so let&#39;s not mess with the social welfare function at the cop-out let&#39;s make other assumptions about how this change in the benefit structure affects incomes so let&#39;s say that the disincentive to work for the rich of big tax so much to pay for that benefit was really high let&#39;s say in fact when we cut benefits sure the poor are still going to get $5,000 but because they&#39;re being taxed less the non-poor work a lot more they in fact have fifty-five thousand dollars of income in this case the labor supply response of the non poor is so big they make so much more money that society&#39;s actually better off because um average income has gone up to fifty thousand we have the same so that one half should be I&#39;m sorry those should be superscripts it should be the same utility function so the utility of a poor person now right is five K to the one half but the utility of a non poor person is fifty five K to the one half because they worked a lot more because of the reduction in their taxes right they do earned a lot more in this case with a different assumption about the responsiveness of the non porta taxes we end up with a society that&#39;s actually better off for having cut benefits that make sense um so in in this case um because the income increase that&#39;s the non poor experience from having lower taxes lower disincentives to work is so large that society is actually better off for the benefit cut because I said transferring so let me go back for a second I sort of misspoke earlier transferring income from the poor to the non poor right it&#39;s sort of we&#39;re making trades from high margin utility people to low marginal utility people but in this case the increase in income that the non poor earning is so big it offsets the fact that we&#39;re trading from high margin Atilla T people to low marginal to lay people the increase in consumption is so big for the non poor it actually society Bute to be well-off is anyone confused I sort of misspoke earlier it&#39;s okay it&#39;s my fault if you are anyone want me to say it again let me say so in this case here we know that we&#39;re transferring money from someone who&#39;s high margin utility someone who is low Marchon utility right we&#39;re going from reducing the consumption of the poor increasing consumption of a non poor whether or not society is going to be worse off or better off when that trade happens depends on how much more income is in this pie right in this case we cut the benefits of the poor by five thousand we increase the income of the rich by a thousand there are a lot more rich people right there&#39;s nine times more rich people are non poor than poor so it could be true the society is better all right but in this case it happens not to be because the increase in consumption for the low marginal utility guys the non poor is not big enough and they&#39;re not enough of a site that the margins need to the production consumption of high marginal utility people was so big right society&#39;s worse off in this case and this another way to think of this is that changing the distribution of the pie didn&#39;t increase the size of the pie enough for society to be better off in this scenario but in a case where the non poor are far more responsive to tax cuts right they&#39;re working a lot more the fact that we&#39;re taxing them less is growing the pie to be much larger right there earning a lot more income this means that even though we&#39;re still making the trade from a high marginal utility part of society to a lower marginal utility part of society the increase in consumption for the non poor so big it&#39;s five K here that were actually better off as a society we grew the pie enough that the fact that we&#39;re redistributing this way didn&#39;t yeah it still led us to be better off let me send Eric with okay it depends me um so you know if that were true I mean maybe it&#39;s true I mean it doesn&#39;t a Pyrrhic or question right if uh you know if it was over in the US we&#39;re talking a lot more about this uh investment income is taxed a lot less than the earned income and that&#39;s partly capitols mobile I can go broader you&#39;ve invested elsewhere so if the fact that society undercapitalized is costing us so much productivity that we&#39;re better off reducing taxes on investments or the people invest here in the US it could be true that even though people who tend to hold capital people tend to be investors tend to be aunt you know burned by an empirical fasting to be wealthier than people who derive was their income from labor um that if your utility are you mean I feel really great about that redistribution in that sense but it could be true that the productivity effects of having more capital invested here in the US could offset the pie growth could be big it&#39;s an empirical question theoretically there&#39;s no you know this is not going to we&#39;re going to get there were theory a lot um we&#39;re we&#39;re said it&#39;s an empirical question so we&#39;re not talking I mean that&#39;s a whole other set of lectures we&#39;re not we&#39;re not going to get there okay terrific okay empirical tools of public finance so that&#39;s all the theory like I told you there&#39;s nothing I talked about today that you haven&#39;t seen before Micro right they&#39;re not going to learn a lot of new theory but you can apply it in weird in different ways fun in different ways plant in different ways okay terrific okay let&#39;s talk about empirical stuff we&#39;re going to go through this relatively quickly we may not finish all of it that&#39;s okay you can always I the problems for homework are doable if you read the chapter but okay empirics so empirical public finance is all about estimating the size of indirect effects how big or people&#39;s responses in the direction that theory predicts they would respond do they respond how bigger the effects so fundamental empirical public finance suffers from the identification problem this is the notion that if two variables a and B are correlated we still don&#39;t know exactly how their causal relationship or whether exact causal relationship is for example um it could be true that on I give this complicated example during a day class we can do it again suppose we see that people who use asthma inhalers tend to be a better running times than people who don&#39;t right is it that asthma inhalers are causing people to be faster runners it could be it could be that people who are really into running fast sort of really look into the you know the the whatever benefits they could get so they already would have been fast they use inhalers it could be that the people who have the resources to go to the doctor and be diagnosed as asthmatic also can afford better sneakers and so they&#39;re better faster runners and they&#39;re more likely to have an inhaler right um that so those are our separate those are right it could be that the inhaler is actually causing people to run faster it could be that faster runners sort of care about every edge they can get so they actually go out and get tailors right it could be causing it it could be that there&#39;s some third factor see sort of income levels that&#39;s causing both a and B right it could be any of those so we want to sort this out we want to figure out is a causing be the gold standard of research and empirical public finance in motion Paris is the randomized trial randomized trial means that for each of you I go around the room for each of you fo per coin if it&#39;s heads during the treatment group if its tail&#39;s or in the control group and if it&#39;s heads I you know give you an inhaler and make you take two puffs of it right this is a randomized trial half you get albuterol half of you don&#39;t and then we go out to the field and you run and we time it that&#39;s a randomized trial it&#39;s the gold standard because what&#39;s the problem with suppose some of you know I use in hammer so some of us use inhalers right the fact that I use an inhaler is may or may not affect my running times but it&#39;s certainly correlated with many things about me right it&#39;s correlated with my income level it&#39;s correlated with my education level potentially that I know that when I&#39;m having breathing problems there&#39;s some solution to it it&#39;s correlated with my interest in exercise right maybe if I never exercise I wouldn&#39;t know I had asthma right it&#39;s correlated with so many things about me that you can&#39;t really disentangle the two without randomizing because when you randomize what determines whether or not I got an inhaler today a coin nothing about me nothing about my income nothing about my exercise preferences I think about my shoe size nothing about me is determining whether or not I didn&#39;t alert that&#39;s what randomization does is it sort of creates a treatment and control group that in all other respects besides the treatments are statistically identical there&#39;s no reason why one group is poorer richer than the other as long as the group is big in right there&#39;s no reason once a group exercises more than that the other the coin didn&#39;t know anything about you right so that&#39;s why randomized trials are the goals yet but there are lots of issues with this right like there&#39;s a lot feasibility so maybe with this inhalers and running times thing we could maybe do this but something like you know macroeconomic problems we only really have one macro economy we can&#39;t really run randomised trials on the macro economy right sometimes just too big a on a system to actually randomize it second ethical concerns so I&#39;m guessing that Wagner probably would not let me do this right NYU has a standards Bureau and they probably wouldn&#39;t let me pump albuterol on some of your lungs and not in other songs and see what happens I mean let alone the lack of education it would probably be unethical right you could have side-effect and do we really care about this question etcetera etcetera there&#39;s ethical concerns there&#39;s threats to internal validity so um when you run these types of trials only you can&#39;t typically mandate people stay in your trial so suppose you know do we divide the room decide guess then hailers some of you have some bad reaction to they mean it to the to the inhalers and you know you are you stay in the room and you don&#39;t somehow I missed the fact that you&#39;re not on the field with us it&#39;s not random who&#39;s gonna have a bat it may not be random right who has a bad sort of reacting to albuterol right it could be people who are weaker lungs to begin with and adjust their the slower runners in general and it&#39;s going to make the inhaler look better than they are because the population of people who use the inhaler who actually runs the race is different than the than the entire treatment group right this is called attrition my silly inhaler example is silly it&#39;s a real problem with something like let&#39;s say charter schools right so suppose we have a lottery right and we actually lottery kids into charter schools randomized trial we&#39;re totally psyched we&#39;re going to you know have a great sort of clean experiment publishing a great journal while very excited but then some kids when you enter the charter school have a rough time it&#39;s not working for them they are likely to be not the kids was working really well for who are likely to drop out of that school and go to a different school it&#39;s the case of it wasn&#39;t working for so we may see them drop out of the whole system they may go into private schools let me drop out of school period right so the sample that we get out comes on May where very well be different than the sample we randomized that with a group we randomized people into and that attrition is unlikely to be random it&#39;s unlikely to be random it&#39;s going to be some sort of selected group that doesn&#39;t make it through to the outcome so attrition is a real threat to what we call internal validity that even within the people who are subject to the treatment of the control we may not be assessing the average impact correctly more broadly we have threats to external validity right our sample may somehow be unrepresentative with our inhaler running times trial who am i doing this to people I can write my students you guys are you really representative of most New Yorkers no right you&#39;re clearly well you&#39;re clearly more educated than average you are eagerly here bright-eyed bushy-tailed right you are somehow afraid of me enough that you could put your cooperating in this study you&#39;re right these are not things for most people and so the external validity it comes from the unrepresentative nests of the sample this could be that you know the cities which lets you run charter school lotteries may not may be more progressive or more research minded than the average American see this the people who live there may be slightly different people who live in other cities because of that right but their various things about the places were allowed to run studies that may be sort of different than the society at large so that&#39;s externality okay so what are our empirical tools first look about time series regression um sometimes there&#39;s regression is the idea that we&#39;re going to analyze the co movement of two series over time so for each date we have a one observation of these two series you know whatever they are and we&#39;re going to see how they&#39;re related over time let&#39;s look at this the red line is the average hours of work by single mothers each year the Green Line is the average monthly benefit guarantee for a family of four so what would you say you know if you&#39;re naive Lee looked at this you would say hey it looks like monthly benefits go down right and labor force participation or hours worked I participated by hours work seemed to go up so naively you could thank you you know what it seems like one goes down the other goes up they&#39;re negatively related cutting benefits increases labor supply but this is a long period of time right 1968 to 1998 was the only thing that was were there other factors besides welfare benefits changing during this time that could potentially affect the labor force choices of women yes sorry yeah more work opportunities right this is a time where technology was changing there&#39;s a lot more home technology right maybe women were more able to sort of leave therefore their traditional roles and work more right there were changes in equal rights movement that allowed women to earn more for the same work right that made work more made work higher return for women that could have changed uh hours worked there are we&#39;re changes and other policies as well right during this time in between the late 90s in between the mid nineties and now we greatly expanded a program called the EITC which is sort of a wage subsidy program that clearly probably affected labor supply of women starting the 90s and isn&#39;t is not in these are all confounding factors right the effect labor supply in ways that the monthly benefit guarantee is not fully captured another thing that happened was there&#39;s a huge there&#39;s a business cycle right there was a general growth this was generally a period of growth you&#39;re not missing the nineties we know the 90s rest period a very strong growth you can see labor force hours work hours are going up very steeply there another sort of telltale right is that there&#39;s there are subsets of time where these two things are not negatively related right we could look at um benefits are sort of going up in the first couple years and so is average work hours right this isn&#39;t everywhere true and it&#39;s more or less - in different periods so this sort of wobbliness of a series suggest that you know what they seem to both be kind of declining in some general sense or great one is declining another is increasing but in this very general way right there&#39;s nothing sharp in a time series where time series evidence to be compelling we want to see is sharp changes in one series and sharp changes in the other series that are contemporaneous or have some kind of fixed lag to them right that it&#39;s always happening a year after or something we&#39;d like to see sharp changes and hopefully multiple changes right where one picked up suddenly and then picked up again later and we see the same pattern in the other series that that contemporaneously or in some kind of fixed lag period there&#39;s no structure to their relationship and we see it in sharp changes for example your textbook talks about an example with cigarette prices and teen smoking that&#39;s a very sharp change right there&#39;s two changes at a time when prices we&#39;re getting down because of a price war a time a time when prices went up because of the tobacco lawsuit and we see sort of sharp changes in teen smoking behavior in the directions we&#39;d predict at both of those times right that&#39;s compelling time series evidence and it&#39;s not that answers is never good it&#39;s just got to be very compelling Frost and really believe the second empirical tool will use is cross-sectional regression this should take two three I know this is three doses very this is three oh sorry this is three its cross-sectional regression so how sectional regression is the analysis of variables across people within the same time period so this would be you know me asking you how tall you are and what you&#39;re great in micro was right you&#39;re different people and in the same period of time asking questions about we&#39;re comparing across individuals the same period of time so in our tentative example we could try to run a regression where we look at the hours worked by different women as a function of the benefits they receive employing some set of controls right because so what is the problem you&#39;re suppose I just looked at on TANF benefits and labor force hours what if you don&#39;t benefits vary by state right and different like right now different states are faring differently in this akan me right so it could be true that a state that is not doing well right has low work hours by women because they&#39;re particularly hard hit by this recession and they can&#39;t afford a lot of benefits right that wouldn&#39;t give us the opposite relationship that low benefits and low out and low work hours go go oh yeah and low work hours go hand in hand right but that&#39;s not really about TANF and how it affects labor supply that&#39;s about how there&#39;s a variable see the recession affecting both of those things right so we can try to employ controls we could out of control for the state unemployment rate the unemployment rate in the state the woman lives scare that but you know there&#39;s also just fundamentally preferences right people are different the same benefit may you know I&#39;m a really love law-and-order right doesn&#39;t matter what my welfare benefit is I&#39;m not going to work that&#39;s going to give us a that&#39;s a confounding factor right my personal feelings about leisure versus consumption are going to affect the way TANF benefit changes change my hours worked so even if we do unemployment rates and we do industry composition and we&#39;ve do 50 things we&#39;re fundamentally never going to be able to control for the preferences of individuals that differ across people right what I mean by that is there&#39;s always an X Factor the no matter how much data we have we can never really control for the individual fixed characteristics that are unobservable that affect both our TANF recipients ii and our work hours does that make sense and this is why cross-sectional regression is dangerous when i can I ask you guys questions about you know how tall you are and how well you did in micro it&#39;s less true here this is America it&#39;s a well fit society but if we look at suppose we&#39;re trying to do an analysis of the returns to height in an area of the world that has had very high rates of famine or poverty right that&#39;s not going to be the returns to earning of height right it&#39;s going to be where&#39;s your family poor maybe of poor family both has shorter children because they&#39;re more affected by famine and couldn&#39;t afford education right that&#39;s not going to give us a causal interpretation of the effect of height on earnings if there are factors that we can&#39;t control for that affect both it could also be that you know some families take better care of their children and are more apt to feed them properly and more apt to give them the skills that lead them to earn more and we can try to control for you know the income of your family education of your mother the height of your father you tire all that in will never fundamentally gift to the family preferences right we&#39;re sort of trying to get idea data we&#39;re never going to get to ask for the X Factor so all cross-sectional regression is potentially confounded but individual fixed characteristics about differences of preferences differences in sort of spunk right and that&#39;s going to fundamentally sort of um make cross-sectional regression difficult interpret so this is an example of a line from your textbook you can go ahead and read this on your own I want to get on to oh you know what we&#39;re already over so we&#39;ll talk about panel data and quasi experimental methods next time do read it in the chapter this week and we&#39;ll just talk about it next time

okay so let&amp;#39;s start off with what is public finance well public finance is what I call it because it&amp;#39;s what I was raised to call it but it&amp;#39;s also we know what it really is as public economics because what we&amp;#39;re not going to be really talking about is the actual financing of government right we won&amp;#39;t be talking about muni bonds and stuff like that we&amp;#39;ll be talking about deficits and debt come on in we&amp;#39;ll be talking my deficits and debt and stuff like that does I&amp;#39;m do an entire lecture in fact we&amp;#39;ll talk about government budgets we&amp;#39;re not going to be talking about the muni bond market that&amp;#39;s not going to happen so really when I call it public finance I mean public economics public economics is the study of the interaction or the role of government in the economy public finance seeks to answer three main questions the first is when is there a role for government when&amp;#39;s your government intervene in the economy the second question is how might the government choose to intervene what are the different ways in which it could intervene in the economy it&amp;#39;s different policy tools and the final question is of these alternative alternative interventions what are the potential effects of these different tools so what are the direct effects what are the indirect effects of these particular ways the government could intervene so let&amp;#39;s talk on the first question when should the government intervene well there&amp;#39;s two main reasons the government might choose to intervene the first being that there is some sense that there is a potential for redistribution that would be more optimal that somehow whatever the equilibrium in the economy is whatever the competitive equilibrium is is not achieving an allocation of resources that society is pleased with Society or like things divided up differently in that case the competitive equilibrium won&amp;#39;t handle that on its own there are some special cases in which sort of the second fundamental theorem of welfare tells us that ah you know if we reallocate initial sort of resources the competitive equilibrium can then achieve any post equilibrium allocation of resources but that takes the frictionless transfer of assets between people and that&amp;#39;s generally pretty hard to do right it&amp;#39;s very hard to say hey mr. Buffett that&amp;#39;s a fine billion dollars you have over there we&amp;#39;re just going to give it to mat you know it&amp;#39;s very it&amp;#39;s not something society we typically Rabil to do we call this transfer has lump sum taxes and while there are theoretical possibility there in actuality pretty hard to actually achieve so in general if we want the outcome the equilibrium allocation of resources to be different we need we need to have something larger than the competitive competitive forces sort of intervening to redistribute resources the second reason we might see a role for government why government may have a role to play or potential to improve the equilibrium is in the case of market failures market failures just mean that the competitive equilibrium isn&amp;#39;t achieving sort of maximum efficiency but there are sort of missing blind spots in in the competitive equilibrium that government could potentially fix what types of market failures am i talking about the first is simply externalities so the spillover of one person&amp;#39;s of oh the so it&amp;#39;s this case where one person&amp;#39;s decisions spill over onto other people right or other actors in the economy there&amp;#39;s a case of positive externalities like vaccinations right when I choose to get vaccinated against measles I actually make other people better off right people who have no real people aren&amp;#39;t vaccinated or less likely to get measles if I&amp;#39;m unlikely to get it because because I&amp;#39;m vaccinated that&amp;#39;s a positive externality it might be true that when I am well educated I work better with other people unless I&amp;#39;m less sort of likely to commit crimes etc etc that all benefits my community members rights almost like there&amp;#39;s a crime on them or I&amp;#39;m a more pleasant person to be around so I could be a positive externality of education but they&amp;#39;re also negative externalities right the classic example being a paper mill that&amp;#39;s upstream from say a fishing village as the paper mill decides to perhaps dump you know say dioxin or something into the stream because that&amp;#39;s the most cost effective way for it to dispose of the dioxin right it&amp;#39;s making a decision based on its profit function its objective but what does that have a spill over it has spill over onto the fisherman downstream because their productivity Falls for every hour they spend fishing they catch fewer healthy fish right because the water is polluted that&amp;#39;s a negative externality the paper mill is exerting on the fisherman a second there&amp;#39;s the there&amp;#39;s a market failure if there are public goods a public good is simply a good that is non-rival and non-excludable non-rival means the fact that I&amp;#39;m using it doesn&amp;#39;t mean you can&amp;#39;t use it we can use it simultaneously non-excludable means I can&amp;#39;t stop you from using the quintessential example of a public good is defense like national defense if I contribute part of my tax dollars are so part of my tax dollars are going to build an aircraft carrier or let the initial missile defense system I feel safer right because the missile defense system I can&amp;#39;t prevent you from feeling safer right when to this missile defense system is in place and I can&amp;#39;t Ben just because I&amp;#39;m feeling safer doesn&amp;#39;t mean you can feel you can&amp;#39;t feel safe so defense is like the quintessential example of public goods but there are other things too right all public goods could be caring for the homeless right if I spend twenty dollars to distribute money towards the homeless you may feel good that no one is on the streets right that&amp;#39;s a public good I can&amp;#39;t stop you from feeling that way and because I feel good that no one&amp;#39;s on the streets doesn&amp;#39;t mean you can&amp;#39;t feel good that no one&amp;#39;s on the streets so these are many types of public goods and the problem public goods is that when I decide how much is my individual budget to allocate towards a public good I&amp;#39;m going to think about how much utility I get from it how much it&amp;#39;s really do I get from feeling safe I&amp;#39;m not going to think about the fact that my spending also benefits you and we need something bigger than our individual sort of level decision-making to sort of take into account that spillover of public goods right that benefit that global benefit of public goods to optimally allocate our budgets towards public goods because individually because we don&amp;#39;t count the public nature of the good we&amp;#39;re going to under allocate resources to public goods the third sort of market failure failure will discuss is asymmetric information all asymmetric information means is that one side of the market knows more than the other there&amp;#39;s private information this will be particularly particularly pernicious in the case of insurance markets and we&amp;#39;ll talk a good deal about that when it comes to sort of why on insurance markets can often fail they&amp;#39;re subject to the particular market failure of symmetric information what&amp;#39;s liked about health care and health care insurance what&amp;#39;s like when insurance sort of in general finally there&amp;#39;s imperfect competition imperfect competition simply means that either a buyer or a seller can influence price when they make their quantity decision so in the case of a single seller what do we call that only one guy sell something it&amp;#39;s a monopoly exactly that&amp;#39;s a case where the monopolist when he decides how much is something too he&amp;#39;s simultaneously set in quantity and price because he&amp;#39;s the sole supplier there&amp;#39;s also a case when someone is the sole buyer of a good or service anyone know what that&amp;#39;s called a sort of monopsony AO is closer like it sounds like monopoly was a little different as men its monopsony monopsony just means that there&amp;#39;s one buyer so what&amp;#39;s an example of monopsony it could be a situation where there&amp;#39;s only one coal mine an entire county of a state and there aren&amp;#39;t really other employment opportunities right where that coal mine operator is the sole buyer of labor services in that area and so in that case we decides how many workers to hire he&amp;#39;s also simultaneously setting wages because he&amp;#39;s the only only a demander a flavor so these are all cases that we&amp;#39;ll talk about um these are all cases we&amp;#39;ll talk about in different parts of class these are the market failures that sort of give a potential role for government to improve things this is when government might want to intervene it doesn&amp;#39;t mean that government is good at correcting all of these right that sort of depends on sort of how government chooses to intervene so how might government choose to intervene intervene well there are three main ways right there&amp;#39;s the price mechanism in which case the government is taking action to change the prices of things in order to change the quantity demanded or supplied in the case of bad things bad things like on if one is worried about the greenhouse effect right one might find carbon co2 a bad in which case we want less co2 to be released into the air we could tax the release of co2 into the air the release of carbon that&amp;#39;s one that&amp;#39;s taxing a bad we&amp;#39;re increasing the price of just releasing carbon into the air right we have less of it if we curse the price we can also go about you know influencing decision making through price by subsidizing goods subsidizing good things subsidizing vaccines subsidizing on the purchase subsidized we&amp;#39;re subsidizing home ownership right through the home mortgage interest deduction right there&amp;#39;s various ways we do this we get subsides good things we could tax bad things these are both efforts to alter the price in order to change the quantity demanded or support second the government can actually just try to regulate regulate the market in the in the case of Bad&amp;#39;s we could just restrict the sale or purchase is really hard to legally buy cocaine right that&amp;#39;s a regulated market we could regulate insurance markets we could say you know any policy that you issue in the state of New York has to cover maternity that&amp;#39;s a regulation right we&amp;#39;re mandating some type of market um good we can manage the purchase of goods so we could we could restrict the purchase of bad so we could mandate the purchase of goods for example you can&amp;#39;t drive a car in the state of California without insurance we mandate that you purchase insurance come what is it 2014 what else will we all have to buy health care insurance exactly exactly so that&amp;#39;s another form of government intervention is regulation finally there&amp;#39;s provision this is not the government telling you go get this or you can&amp;#39;t get this this is the government saying hey here is this thing right there&amp;#39;s a few different ways we can provide goods and services the first is just the public provision where the person making making the good or providing the service is actually on the government payroll that would be the case of Public Safety right sure there is private safety right there are private cops and stores often have security guards but most of the people would guarantee our safety our government employees right the police or firefighters as the direct provision of safety services by the government another way we could do it is the public financing of goods and services there aren&amp;#39;t very many private air force carriers right in the US that&amp;#39;s something that we provide the financing for through general tax revenues third we can also facilitate or create markets an example of that would be on examples that have been in the news lately it could be Fannie Mae and Freddie Mac right which is just a way the federal government guarantees the loans made in the home mortgage market in order to facilitate the provision of credit for residential real estate okay so that&amp;#39;s the hell now for though what happens right so what happens when government intervenes in the market what happens with different tools that could use this will be a key part of what we talked about in this class because we said the when tells us these are opportunities or the government could potentially make things better the how is which way is it going to do it and now the last piece of it is for these different tools that could use what are the potential outcomes or effects of these interventions so we classify these effect into two main categories the first being direct effects and the second being indirect effect direct effect means what would the effect be if no one changed their behavior in response to the change in policy we all kept doing what we were doing indirect effects take into account the fact that people will change their behavior for example if I Institute a policy where on everybody wearing stripes it&amp;#39;s $100 I believe the direct cost of that policy you in the blue shirt what&amp;#39;s your name Andrews your shirt striped no okay now you wish yeah so I think the direct so the direct cost of that policy would be $200 only Valerie and Jessica of course are Jessica and Valerie are the only recipients of this of this of this cash transfer due to stripe wear what would happen next week if we kept this policy in place there&amp;#39;s like a semester-long policy huge increase the number of stripes right I think there&amp;#39;s a theoretically the 30 of you in here I don&amp;#39;t think all of you are here today but I think let&amp;#39;s just say it&amp;#39;s 30 next week how much would I be paying out in stripe transfers three thousand dollars right so the direct effect may be $200 the indirect effect in this case would be $2,800 because you will likely all change your behavior traffic so actually while direct effects are often what people will naively sort of suggest would be the cost of different policies assessing what the indirect effects of a policy change are and trying to estimate their magnitude is sort of the heart and soul of public finance so what we&amp;#39;ll do is we&amp;#39;ll rely on theory often to sort of get the sign of the indirect effect right so if we increase if we create a transfer program for wearing stripes will get more stripes but how many of you will wear stripes that theory is not going to nestle give us then we need to actually turn to data and figure it out suppose the transfer wasn&amp;#39;t $100 so the transfer was $5 some of you may not own a striped shirt it may not be worth it to you to go procure structured in order to get this five-dollar transfer so even though we know theoretically the chance makes it more likely that all of you will wear stripes how many of you actually will make that behavioral change is sort of a empirical question because there&amp;#39;s other stuff going on then you might not be that responsive to the policy change okay some questions you&amp;#39;ll be able to answer by the end of the term this is to entice you and get you excited for your adventure in public finance okay so we&amp;#39;re gonna first start soon and off you&amp;#39;ll be able to answer the question does taxing interest earnings reduce savings in the US um does the corporate income tax affect job creation do unemployment insurance does the existence of unemployment insurance lengthen lengthen the duration of unemployment spells and finally does welfare discourage people from working and that&amp;#39;s actually a question we&amp;#39;ll tackle today so we&amp;#39;ll talk a lot more about a cash welfare in the second half of this course but it&amp;#39;s actually a great example by which to illuminate some of the theoretical concepts that we&amp;#39;ll be drawing on from micro so we&amp;#39;ll talk about a little today we&amp;#39;ll talk about a lot more later but just one is sort of a story to tell while we&amp;#39;re talking about income and substitution effects etcetera etcetera okay so let&amp;#39;s take a look let&amp;#39;s take a closer look at this well at this cash welfare question so the particular cache Wolfer program we&amp;#39;re going to talk about is called TANF Temporary Assistance to needy families it was created in 1996 as part of welfare reform it replaced the old cash welfare transfer system aid to families with dependent children AFDC TANF provides a monthly check to families who are very who are low-income in each state gets to set its own threshold as to what is low-income so most families will receive cash welfare our single mother or single female-headed they all include children because sort of to be classified as needy according to according this program you have to have minors in the home so the median state offers a maximum benefit of roughly four hundred dollars but there&amp;#39;s a lot of state to state variation in New York a family of three with no other income receives about seven hundred dollars so this is not a hugely generous program but it sort of does help a family with no other resources get by into minimal sense right and why is there so much Geographic variation well there&amp;#39;s differences in preferences for supporting a program like this in different areas this country sure but also you know there&amp;#39;s a simple fact that the cost of living is very different in different states largely due to different real estate prices the costs are renting a place is very different different parts country okay so TANF was a you know so AFDC the old program it replaced we&amp;#39;ll talk much more about this a later on but just to give you a sense of it was a controversial program you know something that we heard a lot about in the 80s there&amp;#39;s a lot of scorn 1480s and it&amp;#39;s part of this large event in in the 90s of welfare reform AFDC was converted to 10 into TANF and it was a big debate then and though that debate has died down right this is not something you hear people talking about every day on the campaign trail right cash welfare it&amp;#39;s still controversial today for example the Great Recession actually renewed debate about this program because the Great Recession to two things in any recession tax revenues go down at all levels of government including state government including federal government so the resources available to provide cash welfare were limited second what else happens during a recession many more families are fat many families are affected by the business cycle and more families are poor right simply isn&amp;#39;t believe that so at a time when there were less government resources there was increased demand for this program and in fact a lot of the states weren&amp;#39;t able to sort of maintain the benefits that they had been paying out let alone address the fact that more families needed support so as part of the stimulus in 2009 that&amp;#39;s 787 billion dollars that was spent or partly spent at this point five billion of those dollars went to went to propping up TANF to that for the states so I think you know many of us have heard sort of the term that there&amp;#39;s a big bailout of the states as part of the stimulus this is one element of that was one of the many element many programs that were sort of bolstered by federal revenues because the states were having a lot of trouble so it is still a controversial probe on Eric Cantor who&amp;#39;s the majority leader of the house actually I ran a contest of sorts where he you know as voters to come to look at his web page and decide you know if they had if they got to choose which federal program received fewer resources a you cut pro contest it was called which would they choose and you know even this era as I said sort of the heat of the discussion of cash welfare has come down but even in this era where it&amp;#39;s not so intensely debated TANF cash welfare was after the most was the quote-unquote winner really the loser right of of this you can of this you could contest yes I&amp;#39;m sorry Jeff this is not a scientific poll this is like this is a friends and family matter Cantor absolutely but I mean I guess the point is even now right it&amp;#39;s something that some people is country do feel very intensely about even after the reform effort we&amp;#39;ll talk much more about welfare reform which on is actually a fascinating topic of both economics and politics I think it&amp;#39;s an interesting story okay anyway um in other parts of the government there&amp;#39;s also discussions of sort of making it more generous or making it better at addressing sort of needs of families so we&amp;#39;re still sort of a less intensely debated but still debated program okay so the main question we want to ask today we&amp;#39;re going to sort of explore in different ways is does TANF discourage work so anecdotes suggest that it might but what so one of the key things I want you to take away from this course your Wagner education in general is that the plural of anecdote is not data right lots of stories a dataset does not make I mean there&amp;#39;s qualitative value to anecdotal research right to going out doing case studies and collecting sort of in-depth uh sort of descriptions of the trajectory of decision making etc so I guess I think sometimes you know and a basic quantitative data set no matter how large we can&amp;#39;t necessarily figure out what the mechanisms behind certain changes are and that kind of in-depth sort of interviewing can be really useful but asking a bunch of people does TANF discourage work is not a way to find evidence on that question right we need to see actions we need to see data we need to see sort of scientifically sampled right databases etc but this woman the Boston Globe talked to his woman in 2009 in June of oh nine this woman Diane Sullivan 35 a mother of six said she has seen how the existing system dissuades many people from working she speaks from the experience of having her benefits and after she found her first job I was tossed off a cliff she said what I realized was that I was worse off than if I didn&amp;#39;t work what kind of incentive is that first of all we had a loved Diane Sullivan for using the word incentive right terrific nice work Diane so that&amp;#39;s the question right it seems at least some people have had this experience that they realize when they work that you know things may not be they may not be doing better financially necessarily so this is you know it&amp;#39;s a question that we as economists ask the parent Li a question that arises the mind of real people as well know we&amp;#39;re real people but of people living with this program as well okay so let&amp;#39;s go ahead and try to actually use some some some economic sort of analysis to assess whether or not TANF effects work incentives so the theoretical tools we&amp;#39;ll use in this course and in public finance in general are the following we&amp;#39;re all stuff you learned in micro so first of all we&amp;#39;re going to start off with constrain utility maximization constrain utility maximization is the process of maximizing one&amp;#39;s utility or happiness given the fact that resources are limited if you have a budget you have a finite level of income or income or resources in general with which to sort of purchase as much happiness as you can right to purchase it&amp;#39;s the best combination of goods to make your utility level as high as possible of course our utility level is subject to our maximization of utility a subject to a budget constraint which is simply the it&amp;#39;s a mathematical expression of your income described by the quantities and prices that you can of the goods you could choose from Oh we&amp;#39;ll talk about utility functions which are simply a mathematical representation of a person&amp;#39;s preferences right suppose so your name Siobhan that&amp;#39;s right suppose I asked Siobhan a lot of questions like Siobhan do you prefer bananas or pears bananas do you prefer raspberries or pears so if we did this all day I could have a pretty good mapping of Siobhan&amp;#39;s preferences but be very hard to analytically deal with that right that would be a some kind of set of notebooks of Stefan&amp;#39;s preferences so we take people&amp;#39;s preferences over a limited number of goods we&amp;#39;re talking about you know our ability to draw in two dimensions and we sort of map them into a mathematical representation which we call utility function and that utility function is what we use to sort of analytically analyze analytically assess sort of the effect of different policies on people&amp;#39;s decisions on what they purchase and how many of each good they purchase that&amp;#39;s really what the purpose of utility function is and we graphically represent the indifference curve the utility function within a difference curve why do we use indifference curve because imagine on the ground here in this direction we were plotting number of bananas eaten in this direction we&amp;#39;re plotting number of pairs eaten and let&amp;#39;s imagine you all like bananas and pears at least to some level right and in this up and down direction we&amp;#39;re plotting the utility level of bananas and pears right so we&amp;#39;d have some sort of shape coming out of the ground right as a function of how many bananas versus pears you were consuming but do you guys remember like when you were a kid you sometimes all these maps that like mountain ranges that were three-dimensional right another way to represent that would be to squish it down into two dimensions where there&amp;#39;d be different colors used to represent sort of the ridges of the mountain that we&amp;#39;re all the same height that&amp;#39;s exactly what indifference curve is we&amp;#39;re taking the three-dimensional utility draw utility graph and squishing the utility down into indifference curves indifference curves simply tell us what combinations of bananas and pears leave this person equally well based on their preference based on how they how much they like bananas relative to pairs that make sense is just a graphical representation of the utility function okay so today we&amp;#39;re going to discuss the example of movies and CDs see these are on the y-axis movies are on the x-axis so there&amp;#39;s a few things we&amp;#39;re going to talk about when it comes to indifference curves so one of the properties of all utility functions we talk about is non-satiation non-satiation non-satiation is another way of saying teresa but what&amp;#39;s another way to say non-satiation you always want more more is always better right you&amp;#39;re always ready for another one even if i&amp;#39;ve given you a million apples you&amp;#39;re still happier having 1,000,001 apples you know you&amp;#39;re at this point you&amp;#39;re up using them for decorating right but you you still want it you never say no to the goods we&amp;#39;re talking about non-satiation that another way to say that is that these indifference curves right are always Banting a higher level of utility as we go this way as we move away from the origin in the north east direction you&amp;#39;re getting happier and happier so indifference curve three is better than two which is invariable which is better than one that&amp;#39;s non-satiation so they also have this property that they&amp;#39;re sort of downward sloping right what does that mean why they shaped like this it&amp;#39;s because we all utility functions we&amp;#39;ll talk about have the property of diminishing marginal utility what do I mean by diminishing marginal utility there&amp;#39;s not as easy a non-satiation you&amp;#39;re always happier with more but each additional unit of a good makes you less happy than the one previous so when you know you come into class and I offer you an apple you&amp;#39;re kind of hungry ready for a snack you&amp;#39;re pretty happy with that I offer you a second apple so want the Apple but you&amp;#39;ve already had an apple you can take it home but you&amp;#39;re not going to take as much joy out of that Apple as the first one and eventually I&amp;#39;m giving you a your thousand Apple right at this point you&amp;#39;re thinking perfect I will decorate my front lawn with apples you still want more you always take them but eventually you&amp;#39;re getting you know you each one is giving you less and less utility diminishing marginal utility another way to describe that is that the slope of this line of the indifference curve gets lower and lower as we move from left to right and why is that oh so okay so I&amp;#39;m no artist we&amp;#39;re not going to mock me for it but uh okay so this is sort of it was movies on this on the X CDs on the Y this is sort of our general indifference curve right what is the slope of an indifference curve does anyone remember what it&amp;#39;s called that&amp;#39;s three words the marginal rates of substitution right the mrs the mrs is the ratio of the marginal utility of the x acid x axis good to the marginal utility of the y axis good mu M over mu C all right bigger it&amp;#39;s bigger it seems bigger here but it looks very small um okay so that&amp;#39;s what the slope of the indifference curve is so is the slope getting steeper or flatter as gee as this individual let&amp;#39;s call her Ellen as Ellen consumes more movies is her indifference curve getting steeper or flatter flat right so what does that saying is happening the mrs it&amp;#39;s going down so a she consumes more movies is their marginal utility of movie consumption going up or down down right because I mean the first movement she sees is like the dark night awesome right and then she sees like the departed eventually this poor woman is seeing Gigli right so margin utility is going down and down and down right so the mu sub M is going down as movies goes up the Mars utility of CDs depending on the utility function could be going upward just be staying constant right but as long as the denominator isn&amp;#39;t going down to right it&amp;#39;s not going down what&amp;#39;s gonna happen the mrs it&amp;#39;s gonna go down as she consumes more and more movies and this curve is gonna get more and more flat because what is what is she really communicating with her mrs it&amp;#39;s how deep in her soul she trades off movies and CDs all right it&amp;#39;s like how she values these two good relative to each other it&amp;#39;s how many movies she&amp;#39;s willing to give up to get a CD right at first which is consuming um sorry it&amp;#39;s how many CDs she&amp;#39;s willing to get up.get how many CDs she&amp;#39;s willing to give up to get a movie it&amp;#39;s always y 4x the mrs so over here she&amp;#39;s going to zooming very few movies right to be willing to give up a lot of CDs in order to see a movie she really wants to the Dark Knight but as you see the Dark Knight and the part and The Departed etc etc she&amp;#39;s willing to give up fewer and fewer CDs in order to see a movie because she&amp;#39;s seen a lot of the movies she prefers most right this is diminishing marginal utility of movie viewing let make sense to everybody so one of the things that I think will help is remember it&amp;#39;s always the margent ility of the XX is good over the margin utility of the y-axis good I mean you might have another way of remembering it and that&amp;#39;s terrific but this is always helped with me okay oh wait so that is our RI our indifference curve slow there&amp;#39;s another line on here it&amp;#39;s the budget constraint right the budget concern is a lot is the straight line connecting ah that has intercept on the y axis and the x axis so what does is what is the y axis intercept of the budget constraint represent the number of CDs Ellen could buy if she spent all of her income on CDs the x axis intercept simply represents the maximum number of movies she could see agent all of her income on movies and every point between those two intercepts is an affordable bundle to her it&amp;#39;s a combination of CDs and movies that she could purchase using her income in this in case Tori because this is a line it&amp;#39;s not a bunch of points we&amp;#39;re assuming CDs and movies are infinitesimally divisible you can buy eight point three movies sort of a convenient assumption we&amp;#39;re gonna go with it okay terrific so but when we actually so when we think about what the budget constraint is I&amp;#39;m sorry it&amp;#39;s a little annoying that we have to do this dog camera thing but there&amp;#39;s no whiteboard in here so we have to do it this way so this is the budget constraint right the budget constraint so let&amp;#39;s say we have some income level I income well income is some number but I&amp;#39;m just going to call it I and the problem I tell you it&amp;#39;s like a hundred or a thousand or something right what is this point going to be it&amp;#39;s going to be if you spent all of her income on movies so it&amp;#39;s I divided by P sub M the price of movies this point over here is going to be her income divided by the price of CDs let me sense everybody right suppose you have $1 income CDs are $10 and maximum Erb CDs you can buy is ten done okay so when we write the budget constraint we&amp;#39;re going to write it in terms of the quantity and prices of each of the goods so we&amp;#39;re going to spend all of our income this is a model with no savings this person doesn&amp;#39;t say if it&amp;#39;s been all their income and they&amp;#39;re not going to not spend their income right because they want to be as happy as possible dollars give them no utility only CDs and movies give them utility so income is a function of what you spend at the Sun which he spends on movies right so it&amp;#39;s P sub M times M and quantity of movies or sorry let me call this Q&amp;#39;s of them let me keep the notation plus the price of CDs times the quantity of CDs what does this do is this something we can graph on those axes where where the y axis is the quantity of CD she buys and the x axis is the quantity of movie she buys no we have to rearrange this right in fact we want to write this in terms of Q sub C right one the right keys we&amp;#39;re going to isolate Q sub C because that&amp;#39;s the y axis good so Q sub C equals I minus P sub M times Q sub M divided by P sub C ha this is our intercept right that&amp;#39;s I divided by P sub C is our intercept that&amp;#39;s what that is then our slope of this line is what negative piece of M over P sub C right what&amp;#39;s the name for that price ratio or what&amp;#39;s the name for the slope of the budget constraint it&amp;#39;s a marginal rate of transformation similar to later substitution the slope with indifference curve so the budget did I just miss did I just say indifference curve or something no okay cuz over the budget constraint is called the marginal rate of transport a cop true the marginal rate of transformation excuse me um and we call it the MRT so the MRT as I do this without signs these are all negative right these are all negative or you know whatever MRT is negative P sub M over P sub C it&amp;#39;s the price race you have the x-axis good to the price of the y-axis good I&amp;#39;ll show your name Kelly sure I&amp;#39;m sorry it looks so tiny up here I mean I swear to god it&amp;#39;s much bigger here um yes I will do that for sure it&amp;#39;s piece of M over P sub C it&amp;#39;s the marginal rate of transformation let me write that again better okay so um okay so the so we did the margin rate of substitution tells us how Ellen in her hearts right which things about her preferences how she creates off seeing a movie or seeing or water listening to a CD on the March right giving her a bundle at that point how does she view those two Goods if she had one more of one or the other the marginal rate of transformation tells us how the market trades off CDs versus movies it&amp;#39;s always constant right her mo RS is a function of how many movies and CDs she&amp;#39;s consumed because that&amp;#39;s why the slope changes as we go along the MRT is constant this line always has the same slope a straight line the MRT is telling us how the market trades off movies and CDs it could be that each movie is ten dollars CDs five dollars in which case it&amp;#39;s two CDs per movie right and that&amp;#39;s true no matter how many she wants to buy because she the tiny consumer there&amp;#39;s no monopoly I&amp;#39;m an absolute monopoly here so that the marginal a transformation tells us how the the market trades off the two okay so how does how do we actually maximize utility what their constraint utility maximization she wants to buy she wants to make herself as happy as possible right she wants to consume the highest indifference curve she can the one farthest away from the origin but why can&amp;#39;t you can sue why can&amp;#39;t she be on the infinity indifference curve gently got this many resources would she ever want to be on a difference curve I someone I see someone know right cuz she can do better by doing what by pushing out a little bit what about I see sub three that&amp;#39;s unaffordable what the limit of her affordable bundle that&amp;#39;s the best you can do the point of tangency right the the indifference curve that barely touches the budget constraint is the constrained utility a maximum okay so we talked about all of this stuff already or the first two anyway but we&amp;#39;re gonna talk about income effects and substitution effects so income effects um is the idea that when you change someone&amp;#39;s income level it&amp;#39;s going to change the amount of stuff they buy right we&amp;#39;re going to only talk about what are called normal Goods in this class a normal good just means we have more money you want to buy more of it you only have it that&amp;#39;s all in normal good is we won&amp;#39;t talk but if you&amp;#39;re inferior goods in this class so I will often use the phrase she has more money so she wants to buy more of everything she&amp;#39;s gonna demand more of everything that&amp;#39;s the way to think about it she has the less income she&amp;#39;s she&amp;#39;s going to demand less of everything is a phrase will often use substitution effect on the other hand or about relative price changes so let&amp;#39;s say there is a price change let&amp;#39;s say the price of movies has gone up so movies are now relatively more expensive by relative mean relative to CDs right so she&amp;#39;s going to substitute away from movies toward CDs right because the price of movies has gone up but at the same time that price change which definitely has a substitution effect which is to reduce the number of movies she consumes will trigger an income effect why is that it&amp;#39;s because her cost of living has gone up the same income she had before goes less far now right she can consume fewer movies for the price of movies has gone up if she richer or poorer now because the price of movies has gone up she&amp;#39;s relatively poor she&amp;#39;s going to demand less of everything including movies so her consumption of movies will fall because of a substitution effect right the price of movies has gone up student substitute two word CDs but it will also go down because she&amp;#39;s poor he&amp;#39;s to demand less of everything both the income effect and the substitution effect of a price increase leader to consume fewer movies to make sense cool okay so back to Tanna so um so back to 10 Tanith has to wolf the way we talked about 10 we&amp;#39;re gonna talk about two key features the first of Benefit Guaranty you can always think of that think of that as an income guarantee it&amp;#39;s the level of transfer that will be made to the individual if they work zero hours right there&amp;#39;s the minimum level of income they&amp;#39;ll receive there&amp;#39;s also benefit reduction rate which is the rate by which their benefit is reduced for every dollar they earn so if there was a hundred percent benefit reduction rate if Ellen went out and worked an hour she would lose a dollar of benefits I&amp;#39;m sorry earned a dollar who lose a dollar of benefits that&amp;#39;s a 100 percent benefit reduction rate better production rates tend to be less than 100 percent right there so some return to working so if a benefit reduction rate was if her benefit reduction rate was 50 percent for each dollar she earned she would lose 50 cents in benefits the way this would work let&amp;#39;s say Ellen had a job as a server and restaurant let&amp;#39;s say she worked for an hour she earned $10 an hour the restaurant owner would write her a check for $10 right so she&amp;#39;s going with that paycheck but suppose you&amp;#39;ve been receiving some benefit in TANF that benefit would fall by $5 so the net total sort of return on an hour of her labor is now $5 right her employer is still paying her the 10 but it&amp;#39;s her loss of five dollars of benefits that makes the net wage only five okay terrific so we&amp;#39;re gonna talk about a single woman again her name is going to be Ellen who can work up to 2,000 hours per year she has a time allocation right of 2000 hours there&amp;#39;s gonna a liqu 8 that between work and leisure and she earns $10 per hour she spends in the labor market so people generally don&amp;#39;t like to work is the way we think about it I mean I I you know I love my job but it&amp;#39;s not as good as watching Law &amp;amp; Order reruns which is what I would do my time if I didn&amp;#39;t have a job so I love you know leisure is what we love to do work is what we have to do right so we think of labor supply as a negative it&amp;#39;s a it creates disutility we&amp;#39;re less happy when we work versus spending time on leisure which may be whatever it is but it&amp;#39;s really hard you know it&amp;#39;s tricky and sort of confusing to graph bad stuff we&amp;#39;d like to think about buying things that we like right so we&amp;#39;re instead of graphing labor we&amp;#39;re gonna graph leisure you guys cover labor supply and micro at all oh yeah so when a graph of leisure on the x-axis so we&amp;#39;re gonna trade off leisure versus food consumption and the units of food consumption we&amp;#39;ll talk about are just dollars of food that&amp;#39;s pretty easy unit okay so we&amp;#39;re gonna graph our budget constraint so what are the intercepts where did you spend every hour on leisure how many hours of leisure could she have 2000 what if she worked every single hour how many dollars our food good something could you have 20,000 bingo what&amp;#39;s the slope of this line $10 I mean negative 10 what does the slope tell us it tells us how an hour of leisure given up translates into units of food consumption right it&amp;#39;s how many or another way to put that is how many units of food consumption does she have to give up to spend in another hour on leisure because we don&amp;#39;t think of this is our buying leisure and buying food consumption okay now let&amp;#39;s introduce 10 that&amp;#39;s like the labor market as it functions on its own now let&amp;#39;s add cash welfare so cash welfare here is a $5,000 benefit that&amp;#39;s reduced by 50 cents for every dollar she earns so what&amp;#39;s like going to do is going to elevate our budget constraint so before if she spent all her time on leisure she got zero food consumption now if she spent all her time on leisure she gets five thousand dollars a food consumption that will continue until some point where she&amp;#39;s exhausted her benefit and she&amp;#39;s back to no longer losing benefits when she works right when is that gonna happen how BIG&amp;#39;s our benefit again five thousand dollars how many for each hour of labor she she she provides for afraid for every hour she spends on work how many dollars does she lose of benefits five right because she gets $10 an hour she loses five dollars of benefits how many hours does she have to work until she gets no more benefits a thousand right because it&amp;#39;s five she loses five dollars of benefits per hour she works so the $5,000 benefit when she worked her a thousandth hour her benefit is now zero okay did that the King point that&amp;#39;s gonna be point B when she spent a thousand hours on leisure a thousand hours on labor right cuz that&amp;#39;s the midpoint she is now exhausted her benefit and then when she decides to work for the one thousand first hour how much her employer will pay her $10 and there&amp;#39;s no benefit on this side to be taken away so she gets a net return of $10 starting with her thousand first hour of labor or her 999th hour of leisure any sense to everybody so the slope increases of ten again after a thousand I wonder as we move left one thousand okay perfect now let&amp;#39;s think about changing this program we&amp;#39;re going to restructure this program we&amp;#39;re worried that it creates strong disincentives to work let&amp;#39;s see what happens if we change it in the following way we&amp;#39;re going to reduce the benefit guarantee to $3,000 but leave the benefit reduction rate the same so at $3,000 let&amp;#39;s figure out where our new king point will be so we know that for the first few hours of labor she&amp;#39;s only going to get a net return of five dollars right not 10 because she&amp;#39;s gonna be losing benefits she will lose benefits at 50 cents on the dollar until her benefit is gone her benefit is again what again three thousand dollars she how many dollars of benefit does she leaves for every hour she works five 3,000 divided by five is 600 right so after she&amp;#39;s worked 600 hours out the point she&amp;#39;s reached 1400 hours of leisure we have our kick points again okay so let&amp;#39;s think about how does this change her incentives to work suppose she was in this range and there&amp;#39;s a range of zero to a thousand hours of leisure does it affect her this reform now she was never really part of the program she still a part of the program or life continues exactly this what if she was over here what if she was in the 1400 to 2,000 hours of leisure range in that range has her slope changed no it was five before with the $5,000 benefit and with the $3,000 benefit still five right so a trick is that there&amp;#39;s no substitution effect unless there&amp;#39;s a slope change right because what is the pride wouldn&amp;#39;t what is a price change it changes the marginal rate of transformation of the two goods right it by a part and parcel of its very definition requires a change in the slope that&amp;#39;s how we graph a change in price so change it slow okay so there there&amp;#39;s no slope change but is there an income change between like the kink to blue line of the Kings red line yes she has less money right we could her benefit if she&amp;#39;d rich or poor poorer she&amp;#39;s gonna want to buy less of everything including leisure so the income effect if she was between 1400 and 2,000 hours the income effect a leader to work more or less more because you&amp;#39;re gonna get to less of everything including leisure Social Work more everyone with me awesome now let&amp;#39;s like with the middle segment the thousand to 1400 hours of leisure so we&amp;#39;re comparing the King to blue line to the kinked red line is is she poor when we go from blue to red yeah it&amp;#39;s lower right so she&amp;#39;s poorer she&amp;#39;s gonna buy less of everything including and so she&amp;#39;s gonna work more as their slope change has the price of leisure gone up or down so it used to be the blue line out the red line the price has gone up the slope is now steeper so the price of leisure has gone up when prices go up - we consume more or less of something less so she&amp;#39;s she gonna consume in fact a leader to consume less leisure in other words work more so in that middle range both the substitution effect and the income effect are going to push her to work more to the right so between 1400 and 2000 hours of leisure the income effect the leader to work more so by reforming this program in this way we&amp;#39;ve strengthened work incentives some people are untouched some people have two reasons to be working are more some people of their just income effect right okay so let&amp;#39;s think about what would this is this you know if this was her utility function and so this is a log utility function and the weights are 101 and 175 if she was initially sort of working on 19 10 hours with this utility function right go she would be she would actually end up working um she&amp;#39;d end up having working more having stock she was initially enjoying 19 10 hours of leisure should end up working worn and doing less leisure where after the reform but this is a person who sort of likes leisure and consumption similarly how can I see that because the weights on her terms they&amp;#39;re her log terms are kind of er similar right 100 and 175 so she kind of was balancing the two right she was gonna doing some of each let&amp;#39;s look at somebody else so this is a typo the 175 should be a 300 I will change that before I post these so if that&amp;#39;s 300 does this this person likes leisure relative to consumption much more than the previous person right this person loves leisure this is like me and Lord right I want to spend all day watching long order reruns I want to watch a Lennie Briscoe solve the same crime again and again and again so I love leisure so much that even with the initial program of the $5,000 benefits I was not working at all all day long Marathon Monday right even after the reform I still prefer that to the point that I&amp;#39;m still out of the labor force I&amp;#39;m at point B I&amp;#39;m not going to work still why is that graphically why&amp;#39;s that true graphically it&amp;#39;s because I love leisure so much that my indifference curves are so steeply sloped that is my marginal utility of leisure is so high that my slope is so steep but the only point of tangency I can find with that budget constraint is at that king point I love leisure ok so the idea here is this this Fair reform for this person changing welfare in this way right reducing the cash benefit led them to work more in this case we got no change in work it&amp;#39;s because the preferences are different right we can say theoretically this is the way this should work out here the into effect to leave them to work more the substitution effect would also make work more on this range but whether or not they respond it sort of depends on who they and what their preferences look like we know there&amp;#39;s no way she&amp;#39;s going to work less right that&amp;#39;s ruled out but to what degree should respond this sort of an empirical question okay so now we&amp;#39;re gonna move on to welfare economics oh so so this term welfare is used it&amp;#39;s one of many confusions in this course in this field so right now I&amp;#39;m using the term cash welfare disk liar to describe TANF that&amp;#39;s what I mean by checks written by the government to poor people I&amp;#39;m gonna call that cash welfare this kind of welfare is like economics discussion of how well society is doing welfare like societal welfare or individual welfare sort of discussions so I&amp;#39;m just called this kind of welfare welfare I&amp;#39;ll call the other one cash welfare or tan okay so welfare economics is the study of the determinants of well-being or welfare in society we are used when we talk about society we&amp;#39;re moving away from indifference curves and budget constraints to aggregate demand and aggregate supply right how do we add up I would demand aggregate supply we do something like a survey right if I say so does their $1 manisa how many sodas would you like awesome Valerie how many sodas would you like if so does their dollar once of our entire market was the two of them at $1 as sort of demand is three then I&amp;#39;d really like manisa sodas are two dollars how many would you demand you would say some number will be less than the previous number fellow Valerie to the same thing and we&amp;#39;d add up quantities at given price levels right we don&amp;#39;t add up this way we add up this way for each price we&amp;#39;re going to add up the quantity does that make sense I mean to add horizontally so we add up the quantities for at every price level we do the same thing for supply we&amp;#39;d say hey suppliers at if we can sell soda at a dollar how many sodas would you make etc Center so that&amp;#39;s why we aggregate demand aggregate supply oh then we&amp;#39;re going to use that market equilibrium of these demand supply curves to assess the size of the pie and when I say the pie I mean how big is consumer surplus and how big is producer surplus consumer surplus is the difference between the benefit consumers derive from purchasing a good and the price they pay for that good producer surplus is the difference between what price producers receive for the good and what their mark their cost of production was what their variable cost of production social efficiency is the sum of consumer surplus and producer surplus when there is something happening such that the competitive equilibrium is not being achieved or that somehow the social optimum is not being received because there are market failures right there are externalities there are public goods etc etc there is loss we call that loss deadweight loss it&amp;#39;s sort of the suboptimal it&amp;#39;s the difference between what&amp;#39;s happening and the optimum the first fundamental theorem of welfare economics tells us the competitive equilibrium in a well-functioning market maximized efficiency right what did I say well function if their market failures will be this will not be true anymore the second fundamental theorem welfare economics tells us that the social Emax if the social efficiency maximizing outcome the second welfare theorem tells us that we could reallocate initial bundles to achieve any post equilibrium allocation of resources but like I said earlier reallocating initial bundles is really hard right it&amp;#39;s not very easy to take away someone&amp;#39;s assets and give them to somebody else that&amp;#39;s not allowed Society because of those restrictions we fundamentally face in economics this trade-off between efficiency and equity in order to redistribute resources we have to weaken incentives by taxing by by sort of taking right way weaken incentives accumulate to work to invest in order to create redistribution and so we&amp;#39;re funding really of this trade-off between equity having a distribution of income or resources that we like and efficiency we&amp;#39;re just having the biggest possible pie trade-off between how the pie is divided and how big that pie is because we really can&amp;#39;t transfer initial resources very effectively we just can&amp;#39;t really do it by law okay so let&amp;#39;s take a look at what our social efficiency picture looks like so we have supply and demand here I said the consumer surplus is the difference between the benefit consumers demand and the price they pay right the demand curve is in fact a lining up of people by how much they&amp;#39;re willing to pay for this good so let&amp;#39;s say this is uh you know whatever good this is the Kahless the canna soda I&amp;#39;m really thirsty I&amp;#39;m an I love soda like I love corn syrup right so I am that guy on the on the y-axis I get the full difference between W and X because I love soda I pay much more above the equilibrium price I think we&amp;#39;ve been prices where supply equals demand I would be far more than that I&amp;#39;d pay W for a soda so if I just have two if I only if I only have to pay P so B it&amp;#39;s a win it&amp;#39;s a big win for me the next person the next person over is someone who like soda but not quite as much as I do their willingness to pay a slightly less than mine but again they would pay way more than equilibrium price to we&amp;#39;re gonna line these folks up until we actually hit equilibrium right at that point the last person at Z is a person who&amp;#39;s basically indifferent between buying the soda at piece of B and not having it a piece of e that&amp;#39;s exactly their willingness to pay the person to the right of equilibrium right the person like over here they don&amp;#39;t buy a soda and why is that because they don&amp;#39;t value it at what they&amp;#39;d have to pay for it okay so when similarly the producer surplus is the difference between what producers receive and their marginal cost of production so the supply curve is the supply curve is the marginal cost of production above the average variable cost right summed up over the different producers so that the beige triangle is producer surplus the blue triangle is consumer surplus with these triangles be bigger or smaller if these lines were more steeply sloped bigger I love it smaller bigger yes okay um yes it would be bigger right cuz what what does let&amp;#39;s talk about consumers if demand is more steeply sloped what does it mean it is it&amp;#39;s more or less elastic less it&amp;#39;s more inelastic right it&amp;#39;s more inelastic when we say that demand is very inelastic what we&amp;#39;re really saying is that the consumer does not have good substitutes for this good right for me I don&amp;#39;t think Pepsi is anything even close to Coca Cola there&amp;#39;s no substitute for Coca Cola for me so my demand is incredibly inelastic if you offer me a free Pepsi or so or a coke for two bucks I&amp;#39;ll buy the coke right I&amp;#39;ve no interest in Pepsi for me there are no good substitutes for Coca Cola so my demand be very inelastic very steeply sloped people like me if society is made up of people like me the society is made up by slightly more reasonable people right people who found perhaps you to be a fairly Goods up to you for Coke demand to be far more alas taking the curve would be flatter and there&amp;#39;d be less consumer surplus because purchasing coke doesn&amp;#39;t make them as happy because there&amp;#39;s also Pepsi right it&amp;#39;s the fact that there&amp;#39;s no good substitutes that makes demand far more elastic excellent ok so let&amp;#39;s talk about oh let&amp;#39;s talk about price floors I could um so let&amp;#39;s say um you know Mayor Bloomberg really doesn&amp;#39;t want a price floor he wants uh I mean he wants that he wants to know what the price for and I&amp;#39;m not a price ceiling he wanted to get rid of my you want to lower soda consumption but we&amp;#39;re gonna think of an example of some other government that says you know what soda prices are too damn high we&amp;#39;re going to restrict Toto prices we&amp;#39;re actually going to say that they can&amp;#39;t exceed piece of our so the equilibrium prices piece of B but this government fiat has said that soda prices cannot exceed P sub R so all soda will be sold at P sub R how how many units of soda would consumers like to buy at P sub R all the way out there right where that piece of our line intersects the demand curve they&amp;#39;re out of luck right because suppliers are willing to produce how much Q sub R so what&amp;#39;s not going to happen all those units that would have been sold in the competitive equilibrium so the units between Q sub R and Q sub e those trades will never happen so instead we will have a market where at P sub R quantity Q sub R is supplied what&amp;#39;s the new consumer surplus going to be I&amp;#39;ll give it to me in shapes are the names of shapes a and what else and what Bay and B B as in boy because DNA no longer exists right those trades don&amp;#39;t happen that is deadweight loss so the new consumer surplus is a and B or the new producer surplus just C and D and E or deadweight loss because this government restriction has prevented trades that would have an other would have otherwise benefited both consumers and suppliers from happening these trades would have happened and now those units of soda are forever lost right so that&amp;#39;s deadweight loss the any other deadweight loss so what was the so part of the impact was that there&amp;#39;s Ed we lost DNA what happened to be it went from whom to whom Zoomers so it changed the distribution of the pie but there was a cost to changing the distribution of surplus namely with D and E terrific okay so that&amp;#39;s sort of you know that&amp;#39;s sort of our efficiency now in target welfare which is sort of our notion of equity and how people are doing so the way you represent society sort of aggregation of individual utility is called social welfare function it&amp;#39;s how we added utilities or different members of society to get a measure of sort of societal welfare we call this a social welfare function we&amp;#39;re gonna talk about two particular forms of social welfare functions so social welfare functions could be very different right what a social welfare function could be like I only care about how short people feel about things how well they are doing they are my people they&amp;#39;re the only people whose utility I put any weight on if you&amp;#39;re over five six I don&amp;#39;t care about you that could be oh you two that could be social welfare function right it&amp;#39;s not a common one right we&amp;#39;re gonna talk about two in particular what is the utilitarian social welfare function in which case we value everyone equally we just add up their utilities I you know to penal to I value a unit of Jeff&amp;#39;s happiness of utility so I just add it all up if we have the utilitarian social welfare function it will be true that&amp;#39;s a maximized social welfare we want to equate the marginal utilities of people now to quit the utilities but the marginal utilities why is that it&amp;#39;s not that I care of us right it&amp;#39;s not that I care about a unit of mass happiness the unit of Jeff&amp;#39;s happiness equally it&amp;#39;s that can we do this yeah I care about it equally so I&amp;#39;m going to want to equate marzan utilities across people why is that suppose suppose Jeff had on much higher marginal utility of soda than Matt did or consumption let&amp;#39;s just say some consumption good somehow your consumption good in that case taking a unit away from Matt and giving it to Jeff would be a win for the social welfare function because his marginal utility is higher than Matt&amp;#39;s when I take a unit away from Matt Matt is sadder sure but Jeff is happier for that extra unit by more than Matt is sad so when I&amp;#39;m just adding up people&amp;#39;s utilities I&amp;#39;m going to want a quaint margin utilities because I&amp;#39;m going to want to make those trades until there&amp;#39;s no more gain from moving around consumption until marginal utilities or equal across people that make sense good excellent the other kinds of welfare function we&amp;#39;ll talk about is a sprawl Xion social welfare function this is the case we&amp;#39;re going to maximize the welfare of the worst off person in society so the minimum of all utilities is what we want to maximize so this notion comes from John Wallace&amp;#39;s idea that suppose we were like at a dinner party before any of us were born like some kind of pre-existence in our party and we&amp;#39;re talking about you know how we should allocate this resources in society and we had no idea whether we be princess Ruby poppers we&amp;#39;d be investment bankers we&amp;#39;d be god knows right we had no idea we would be very concerned about being the worst off member of the Society of we&amp;#39;re know John wall&amp;#39;s right we very concerned about how that person would fare because we don&amp;#39;t have a decent shot of being that person if we had this dinner party ex-ante do exist to existing that&amp;#39;s where this idea come from that we want to take care of the least well-off because uh you know behind the veil of ignorance that could well open us so this implies that social welfare is maximized by making sure the worst off person is not doing so too bad simple idea under Rawls okay so let&amp;#39;s go back to our TANF example so the blue supply curves and demand is constant here the blue supply curve is of the labor supply of single women with no TANF program in place with the $5,000 Benefit Guaranty version of TANF in place our supply curve as S sub 2 when we reformed welfare and reduce the benefit guarantee and increase work right we move back towards the initial equilibrium and we&amp;#39;re at S sub 3 so what happens to efficiency in this story when there is a lot of there is dead weight loss created by the initial program right when we have the $5,000 benefit the deadweight loss triangle has ABCDE when we cut benefits and increase work incentives these people the single women work more and are deadweight loss is reduced to D&amp;amp;E so efficiency is enhanced by reducing the benefit guarantee program is society better off unclear right depends on first of all well the women are certainly individually worse off when we cut benefits right because sure they&amp;#39;re working more their income levels haven&amp;#39;t fully fallen but they&amp;#39;re giving up leisure to do that and their incomes are less the women are certainly worse off but maybe we value the sort of societal surplus of ABC more than we value their discomfort of working it depends on our social welfare function depends on the weights we put on different parts of society ok let&amp;#39;s look at two examples so in the we&amp;#39;re going to actually use a we&amp;#39;re gonna look at a utilitarian Social Welfare function and each individual&amp;#39;s utility in this case is simply a square root so your Tildy level is simply the square root of your consumption we&amp;#39;re just talking about a consumption good is some kind of aggregate measure of consumption so u equals 3 to the 1/2 suppose on the population of the poor is to share the population of poor people is 10% and then on poor are 90% okay so with the Big Ten of benefit our incomes are sort of post labor market incomes are the benefit ends up with the poor getting $10,000 a piece and the non poor having $50,000 in post taxing post tax post transferring the average income of the society right is 0.1 times 10,000 because a weight on oh there&amp;#39;s point 1 the weight of poor people is point 1 the weight of non poor people is 0.9 so the average income is 0.1 times 10 K plus 0.9 times 50 K which amounts to 46,000 dollars that&amp;#39;s the average income what&amp;#39;s the ad worthless to social welfare of the society well what&amp;#39;s the utility of a poor person here it&amp;#39;s 10 K to the 1/2 right and how many of those folks are there there&amp;#39;s 0.1 right but what&amp;#39;s the utility of a non poor person it&amp;#39;s 50,000 to the 1/2 and the weight on that type of person is 0.9 it&amp;#39;s a question know so the social welfare is going to be to 11 point 2 let&amp;#39;s say we cut TANF benefits when we cut 10 of benefits we need to let raise less revenue right there&amp;#39;s less stuff for spending money on so we can actually reduce taxes it&amp;#39;s going to change post transfer post tax incomes for these two groups the poor now are only getting $5,000 a piece in the society the non poor there they&amp;#39;re not paying as much in taxes so they&amp;#39;re just getting 51,000 dollars apiece so what&amp;#39;s average income in the society what&amp;#39;s going to be 5 K times 0.1 plus 51 K times 0.9 average income has gone up to forty six thousand four hundred let&amp;#39;s look at Social Welfare so what&amp;#39;s the utility of a poor person now it&amp;#39;s five K to the one half and there&amp;#39;s 0.1 of them what&amp;#39;s the utility of a non poor person now it&amp;#39;s 51 K to the one half times 0.9 right that&amp;#39;s the way on them so our total social welfare is to ten point three so even though average incomes are higher because we&amp;#39;ve strengthened the incentives to work for the poor and the non poor right we&amp;#39;re taxing the non poor lest wear something we&amp;#39;re giving smaller gear benefit guarantees to the poor&amp;#39;s everyone has stronger work incentives average incomes have gone up but society according to this social welfare function is not better off how could we have taught how could you have told me that before even doing this calculation that if we change and comes in this way people won&amp;#39;t be better off at the income levels of 10k and 50k who&amp;#39;s it notice that that the same utility function right they don&amp;#39;t pour a non pour not fundamentally different they value consumption according the same function so if the incomes are 10k in 50k who has the higher marginal utility the poor the non poor the poor because they&amp;#39;re consuming less right marginal utility Falls as we consume more and more right the finishing marginal utility so you could like you could have told me that if we are take income away from the poor and give it to the non poor we&amp;#39;re distributing redistributing from someone who have the high marginal utility of income above consumption determines a low margin utility of consumption so we&amp;#39;re guaranteed to not be better off for sure when we trade that in that direction we&amp;#39;re going to have a lower social welfare why is that because this is utilitarian social welfare function we&amp;#39;re making trades away from high margin utility people towards low marginal utility people we&amp;#39;re going to be worse off and that&amp;#39;s because this society is some a utilitarian society it&amp;#39;s it&amp;#39;s got this particular functional form for social welfare a difference of welfare function could come up with a different a different um a different uh welfare consequence so for example um in scenario two so different assumptions can have different in fact so it&amp;#39;s very simple for me to say if our social welfare function were different we&amp;#39;d have different outweigh i&amp;#39;ve different outcome like if we have social welfare function where we only cared about the non poor it would be pretty clear right that we would be better off and say when we cut welfare benefits if we had a social welfare function where we only cared about the poor it would be clear that we would be worse off when you cut that all right so let&amp;#39;s not mess with the social welfare function at the cop-out let&amp;#39;s make other assumptions about how this change in the benefit structure affects incomes so let&amp;#39;s say that the disincentive to work for the rich of big tax so much to pay for that benefit was really high let&amp;#39;s say in fact when we cut benefits sure the poor are still going to get $5,000 but because they&amp;#39;re being taxed less the non-poor work a lot more they in fact have fifty-five thousand dollars of income in this case the labor supply response of the non poor is so big they make so much more money that society&amp;#39;s actually better off because um average income has gone up to fifty thousand we have the same so that one half should be I&amp;#39;m sorry those should be superscripts it should be the same utility function so the utility of a poor person now right is five K to the one half but the utility of a non poor person is fifty five K to the one half because they worked a lot more because of the reduction in their taxes right they do earned a lot more in this case with a different assumption about the responsiveness of the non porta taxes we end up with a society that&amp;#39;s actually better off for having cut benefits that make sense um so in in this case um because the income increase that&amp;#39;s the non poor experience from having lower taxes lower disincentives to work is so large that society is actually better off for the benefit cut because I said transferring so let me go back for a second I sort of misspoke earlier transferring income from the poor to the non poor right it&amp;#39;s sort of we&amp;#39;re making trades from high margin utility people to low marginal utility people but in this case the increase in income that the non poor earning is so big it offsets the fact that we&amp;#39;re trading from high margin Atilla T people to low marginal to lay people the increase in consumption is so big for the non poor it actually society Bute to be well-off is anyone confused I sort of misspoke earlier it&amp;#39;s okay it&amp;#39;s my fault if you are anyone want me to say it again let me say so in this case here we know that we&amp;#39;re transferring money from someone who&amp;#39;s high margin utility someone who is low Marchon utility right we&amp;#39;re going from reducing the consumption of the poor increasing consumption of a non poor whether or not society is going to be worse off or better off when that trade happens depends on how much more income is in this pie right in this case we cut the benefits of the poor by five thousand we increase the income of the rich by a thousand there are a lot more rich people right there&amp;#39;s nine times more rich people are non poor than poor so it could be true the society is better all right but in this case it happens not to be because the increase in consumption for the low marginal utility guys the non poor is not big enough and they&amp;#39;re not enough of a site that the margins need to the production consumption of high marginal utility people was so big right society&amp;#39;s worse off in this case and this another way to think of this is that changing the distribution of the pie didn&amp;#39;t increase the size of the pie enough for society to be better off in this scenario but in a case where the non poor are far more responsive to tax cuts right they&amp;#39;re working a lot more the fact that we&amp;#39;re taxing them less is growing the pie to be much larger right there earning a lot more income this means that even though we&amp;#39;re still making the trade from a high marginal utility part of society to a lower marginal utility part of society the increase in consumption for the non poor so big it&amp;#39;s five K here that were actually better off as a society we grew the pie enough that the fact that we&amp;#39;re redistributing this way didn&amp;#39;t yeah it still led us to be better off let me send Eric with okay it depends me um so you know if that were true I mean maybe it&amp;#39;s true I mean it doesn&amp;#39;t a Pyrrhic or question right if uh you know if it was over in the US we&amp;#39;re talking a lot more about this uh investment income is taxed a lot less than the earned income and that&amp;#39;s partly capitols mobile I can go broader you&amp;#39;ve invested elsewhere so if the fact that society undercapitalized is costing us so much productivity that we&amp;#39;re better off reducing taxes on investments or the people invest here in the US it could be true that even though people who tend to hold capital people tend to be investors tend to be aunt you know burned by an empirical fasting to be wealthier than people who derive was their income from labor um that if your utility are you mean I feel really great about that redistribution in that sense but it could be true that the productivity effects of having more capital invested here in the US could offset the pie growth could be big it&amp;#39;s an empirical question theoretically there&amp;#39;s no you know this is not going to we&amp;#39;re going to get there were theory a lot um we&amp;#39;re we&amp;#39;re said it&amp;#39;s an empirical question so we&amp;#39;re not talking I mean that&amp;#39;s a whole other set of lectures we&amp;#39;re not we&amp;#39;re not going to get there okay terrific okay empirical tools of public finance so that&amp;#39;s all the theory like I told you there&amp;#39;s nothing I talked about today that you haven&amp;#39;t seen before Micro right they&amp;#39;re not going to learn a lot of new theory but you can apply it in weird in different ways fun in different ways plant in different ways okay terrific okay let&amp;#39;s talk about empirical stuff we&amp;#39;re going to go through this relatively quickly we may not finish all of it that&amp;#39;s okay you can always I the problems for homework are doable if you read the chapter but okay empirics so empirical public finance is all about estimating the size of indirect effects how big or people&amp;#39;s responses in the direction that theory predicts they would respond do they respond how bigger the effects so fundamental empirical public finance suffers from the identification problem this is the notion that if two variables a and B are correlated we still don&amp;#39;t know exactly how their causal relationship or whether exact causal relationship is for example um it could be true that on I give this complicated example during a day class we can do it again suppose we see that people who use asthma inhalers tend to be a better running times than people who don&amp;#39;t right is it that asthma inhalers are causing people to be faster runners it could be it could be that people who are really into running fast sort of really look into the you know the the whatever benefits they could get so they already would have been fast they use inhalers it could be that the people who have the resources to go to the doctor and be diagnosed as asthmatic also can afford better sneakers and so they&amp;#39;re better faster runners and they&amp;#39;re more likely to have an inhaler right um that so those are our separate those are right it could be that the inhaler is actually causing people to run faster it could be that faster runners sort of care about every edge they can get so they actually go out and get tailors right it could be causing it it could be that there&amp;#39;s some third factor see sort of income levels that&amp;#39;s causing both a and B right it could be any of those so we want to sort this out we want to figure out is a causing be the gold standard of research and empirical public finance in motion Paris is the randomized trial randomized trial means that for each of you I go around the room for each of you fo per coin if it&amp;#39;s heads during the treatment group if its tail&amp;#39;s or in the control group and if it&amp;#39;s heads I you know give you an inhaler and make you take two puffs of it right this is a randomized trial half you get albuterol half of you don&amp;#39;t and then we go out to the field and you run and we time it that&amp;#39;s a randomized trial it&amp;#39;s the gold standard because what&amp;#39;s the problem with suppose some of you know I use in hammer so some of us use inhalers right the fact that I use an inhaler is may or may not affect my running times but it&amp;#39;s certainly correlated with many things about me right it&amp;#39;s correlated with my income level it&amp;#39;s correlated with my education level potentially that I know that when I&amp;#39;m having breathing problems there&amp;#39;s some solution to it it&amp;#39;s correlated with my interest in exercise right maybe if I never exercise I wouldn&amp;#39;t know I had asthma right it&amp;#39;s correlated with so many things about me that you can&amp;#39;t really disentangle the two without randomizing because when you randomize what determines whether or not I got an inhaler today a coin nothing about me nothing about my income nothing about my exercise preferences I think about my shoe size nothing about me is determining whether or not I didn&amp;#39;t alert that&amp;#39;s what randomization does is it sort of creates a treatment and control group that in all other respects besides the treatments are statistically identical there&amp;#39;s no reason why one group is poorer richer than the other as long as the group is big in right there&amp;#39;s no reason once a group exercises more than that the other the coin didn&amp;#39;t know anything about you right so that&amp;#39;s why randomized trials are the goals yet but there are lots of issues with this right like there&amp;#39;s a lot feasibility so maybe with this inhalers and running times thing we could maybe do this but something like you know macroeconomic problems we only really have one macro economy we can&amp;#39;t really run randomised trials on the macro economy right sometimes just too big a on a system to actually randomize it second ethical concerns so I&amp;#39;m guessing that Wagner probably would not let me do this right NYU has a standards Bureau and they probably wouldn&amp;#39;t let me pump albuterol on some of your lungs and not in other songs and see what happens I mean let alone the lack of education it would probably be unethical right you could have side-effect and do we really care about this question etcetera etcetera there&amp;#39;s ethical concerns there&amp;#39;s threats to internal validity so um when you run these types of trials only you can&amp;#39;t typically mandate people stay in your trial so suppose you know do we divide the room decide guess then hailers some of you have some bad reaction to they mean it to the to the inhalers and you know you are you stay in the room and you don&amp;#39;t somehow I missed the fact that you&amp;#39;re not on the field with us it&amp;#39;s not random who&amp;#39;s gonna have a bat it may not be random right who has a bad sort of reacting to albuterol right it could be people who are weaker lungs to begin with and adjust their the slower runners in general and it&amp;#39;s going to make the inhaler look better than they are because the population of people who use the inhaler who actually runs the race is different than the than the entire treatment group right this is called attrition my silly inhaler example is silly it&amp;#39;s a real problem with something like let&amp;#39;s say charter schools right so suppose we have a lottery right and we actually lottery kids into charter schools randomized trial we&amp;#39;re totally psyched we&amp;#39;re going to you know have a great sort of clean experiment publishing a great journal while very excited but then some kids when you enter the charter school have a rough time it&amp;#39;s not working for them they are likely to be not the kids was working really well for who are likely to drop out of that school and go to a different school it&amp;#39;s the case of it wasn&amp;#39;t working for so we may see them drop out of the whole system they may go into private schools let me drop out of school period right so the sample that we get out comes on May where very well be different than the sample we randomized that with a group we randomized people into and that attrition is unlikely to be random it&amp;#39;s unlikely to be random it&amp;#39;s going to be some sort of selected group that doesn&amp;#39;t make it through to the outcome so attrition is a real threat to what we call internal validity that even within the people who are subject to the treatment of the control we may not be assessing the average impact correctly more broadly we have threats to external validity right our sample may somehow be unrepresentative with our inhaler running times trial who am i doing this to people I can write my students you guys are you really representative of most New Yorkers no right you&amp;#39;re clearly well you&amp;#39;re clearly more educated than average you are eagerly here bright-eyed bushy-tailed right you are somehow afraid of me enough that you could put your cooperating in this study you&amp;#39;re right these are not things for most people and so the external validity it comes from the unrepresentative nests of the sample this could be that you know the cities which lets you run charter school lotteries may not may be more progressive or more research minded than the average American see this the people who live there may be slightly different people who live in other cities because of that right but their various things about the places were allowed to run studies that may be sort of different than the society at large so that&amp;#39;s externality okay so what are our empirical tools first look about time series regression um sometimes there&amp;#39;s regression is the idea that we&amp;#39;re going to analyze the co movement of two series over time so for each date we have a one observation of these two series you know whatever they are and we&amp;#39;re going to see how they&amp;#39;re related over time let&amp;#39;s look at this the red line is the average hours of work by single mothers each year the Green Line is the average monthly benefit guarantee for a family of four so what would you say you know if you&amp;#39;re naive Lee looked at this you would say hey it looks like monthly benefits go down right and labor force participation or hours worked I participated by hours work seemed to go up so naively you could thank you you know what it seems like one goes down the other goes up they&amp;#39;re negatively related cutting benefits increases labor supply but this is a long period of time right 1968 to 1998 was the only thing that was were there other factors besides welfare benefits changing during this time that could potentially affect the labor force choices of women yes sorry yeah more work opportunities right this is a time where technology was changing there&amp;#39;s a lot more home technology right maybe women were more able to sort of leave therefore their traditional roles and work more right there were changes in equal rights movement that allowed women to earn more for the same work right that made work more made work higher return for women that could have changed uh hours worked there are we&amp;#39;re changes and other policies as well right during this time in between the late 90s in between the mid nineties and now we greatly expanded a program called the EITC which is sort of a wage subsidy program that clearly probably affected labor supply of women starting the 90s and isn&amp;#39;t is not in these are all confounding factors right the effect labor supply in ways that the monthly benefit guarantee is not fully captured another thing that happened was there&amp;#39;s a huge there&amp;#39;s a business cycle right there was a general growth this was generally a period of growth you&amp;#39;re not missing the nineties we know the 90s rest period a very strong growth you can see labor force hours work hours are going up very steeply there another sort of telltale right is that there&amp;#39;s there are subsets of time where these two things are not negatively related right we could look at um benefits are sort of going up in the first couple years and so is average work hours right this isn&amp;#39;t everywhere true and it&amp;#39;s more or less - in different periods so this sort of wobbliness of a series suggest that you know what they seem to both be kind of declining in some general sense or great one is declining another is increasing but in this very general way right there&amp;#39;s nothing sharp in a time series where time series evidence to be compelling we want to see is sharp changes in one series and sharp changes in the other series that are contemporaneous or have some kind of fixed lag to them right that it&amp;#39;s always happening a year after or something we&amp;#39;d like to see sharp changes and hopefully multiple changes right where one picked up suddenly and then picked up again later and we see the same pattern in the other series that that contemporaneously or in some kind of fixed lag period there&amp;#39;s no structure to their relationship and we see it in sharp changes for example your textbook talks about an example with cigarette prices and teen smoking that&amp;#39;s a very sharp change right there&amp;#39;s two changes at a time when prices we&amp;#39;re getting down because of a price war a time a time when prices went up because of the tobacco lawsuit and we see sort of sharp changes in teen smoking behavior in the directions we&amp;#39;d predict at both of those times right that&amp;#39;s compelling time series evidence and it&amp;#39;s not that answers is never good it&amp;#39;s just got to be very compelling Frost and really believe the second empirical tool will use is cross-sectional regression this should take two three I know this is three doses very this is three oh sorry this is three its cross-sectional regression so how sectional regression is the analysis of variables across people within the same time period so this would be you know me asking you how tall you are and what you&amp;#39;re great in micro was right you&amp;#39;re different people and in the same period of time asking questions about we&amp;#39;re comparing across individuals the same period of time so in our tentative example we could try to run a regression where we look at the hours worked by different women as a function of the benefits they receive employing some set of controls right because so what is the problem you&amp;#39;re suppose I just looked at on TANF benefits and labor force hours what if you don&amp;#39;t benefits vary by state right and different like right now different states are faring differently in this akan me right so it could be true that a state that is not doing well right has low work hours by women because they&amp;#39;re particularly hard hit by this recession and they can&amp;#39;t afford a lot of benefits right that wouldn&amp;#39;t give us the opposite relationship that low benefits and low out and low work hours go go oh yeah and low work hours go hand in hand right but that&amp;#39;s not really about TANF and how it affects labor supply that&amp;#39;s about how there&amp;#39;s a variable see the recession affecting both of those things right so we can try to employ controls we could out of control for the state unemployment rate the unemployment rate in the state the woman lives scare that but you know there&amp;#39;s also just fundamentally preferences right people are different the same benefit may you know I&amp;#39;m a really love law-and-order right doesn&amp;#39;t matter what my welfare benefit is I&amp;#39;m not going to work that&amp;#39;s going to give us a that&amp;#39;s a confounding factor right my personal feelings about leisure versus consumption are going to affect the way TANF benefit changes change my hours worked so even if we do unemployment rates and we do industry composition and we&amp;#39;ve do 50 things we&amp;#39;re fundamentally never going to be able to control for the preferences of individuals that differ across people right what I mean by that is there&amp;#39;s always an X Factor the no matter how much data we have we can never really control for the individual fixed characteristics that are unobservable that affect both our TANF recipients ii and our work hours does that make sense and this is why cross-sectional regression is dangerous when i can I ask you guys questions about you know how tall you are and how well you did in micro it&amp;#39;s less true here this is America it&amp;#39;s a well fit society but if we look at suppose we&amp;#39;re trying to do an analysis of the returns to height in an area of the world that has had very high rates of famine or poverty right that&amp;#39;s not going to be the returns to earning of height right it&amp;#39;s going to be where&amp;#39;s your family poor maybe of poor family both has shorter children because they&amp;#39;re more affected by famine and couldn&amp;#39;t afford education right that&amp;#39;s not going to give us a causal interpretation of the effect of height on earnings if there are factors that we can&amp;#39;t control for that affect both it could also be that you know some families take better care of their children and are more apt to feed them properly and more apt to give them the skills that lead them to earn more and we can try to control for you know the income of your family education of your mother the height of your father you tire all that in will never fundamentally gift to the family preferences right we&amp;#39;re sort of trying to get idea data we&amp;#39;re never going to get to ask for the X Factor so all cross-sectional regression is potentially confounded but individual fixed characteristics about differences of preferences differences in sort of spunk right and that&amp;#39;s going to fundamentally sort of um make cross-sectional regression difficult interpret so this is an example of a line from your textbook you can go ahead and read this on your own I want to get on to oh you know what we&amp;#39;re already over so we&amp;#39;ll talk about panel data and quasi experimental methods next time do read it in the chapter this week and we&amp;#39;ll just talk about it next time

Transcript for:Public Finance Lecture Notes

Transcript for:
Public Finance Lecture Notes