Chapter 10
The Public
Sector
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10-1
Learning Objectives
10.1 Explain externalities and the four
other economic functions of
government.
10.2 Describe the two main political
functions of government and how
decision making differs depending on
whether the individual is in the public
or private sector.
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Learning Objectives
10.3 Distinguish between average and
marginal tax rates and explain the
Canadian tax system.
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Externalities and Other Economic
Functions of Government
Market Failure
 A situation in which an unrestrained
market economy leads to too few or too
many resources going to a specific
economic activity.
 A strong argument in favour of
government intervention.
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Externalities and Other Economic
Functions of Government
Externalities
 Occur when the consequence of an
economic activity spills over to affect third
parties.
Third Parties
 Parties who are not directly involved in a
given activity or transaction.
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Externalities and Other Economic
Functions of Government
S2
Price of Steel per Tonne
S1
P2
Without external costs:
1) Steel mill pays the
the cost of pollution
2) Supply shifts to S2
E1
P1
E
A
With external costs:
1) Residents incur cost
of pollution
2) Supply = S1
D
Q2
Q1
Quantity of Steel per Year
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Externalities and Other Economic
Functions of Government
With external benefits:
1) More shots are given
at a higher price
2) Demand shifts to D2
S
E1
Price of Flu Shots
P2
P1
Without external benefits:
1) Too few influenza shots
are given
2) Demand = D1
E
D2
D1
Q1
Q2
Quantity of Flu Shots per Year
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Externalities and Other Economic
Functions of Government
With external costs, price is too low and
quantity too high and third parties bear
part of the costs.
Without external costs, consumers buying
the product bear the total cost of
production and reduce consumption.
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Externalities and Other Economic
Functions of Government
Correcting for Negative Externalities
 Special taxes commensurate with the
cost to the third parties
 Regulations to determine maximum
allowable production
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Externalities and Other Economic
Functions of Government
Correcting for Positive Externalities
 Special financing for the production of
the product
 Subsidies to the consumer/business of
the good or service
 Regulations to require greater
production
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Externalities and Other Economic
Functions of Government
The Other Economic Functions of Government
 Providing a Legal System
 Defining and protecting property rights
 Promoting Competition
 Market failure may occur if markets are not
competitive
 Monopoly power
 Anticombines legislation
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Externalities and Other Economic
Functions of Government
Providing Public Goods
 Goods to which the principle of rival
consumption does not apply.
• The use of a good is exclusive to the people
who purchase or rent it.
 Free Rider Problem
• Some individuals take advantage of the fact
that others will shoulder the burden of paying
for public goods.
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Externalities and Other Economic
Functions of Government
Ensuring Economywide Stability
 Three goals of the federal government:
• Full employment
• Price stability
• Economic growth
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The Political
Functions of Government
Merit Goods
 Goods deemed socially desirable through
the political process
• museums
• ballet
• concerts
 Provided through subsidization
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The Political
Functions of Government
Demerit Goods
 Goods deemed socially undesirable
through the political process
• cigarettes
• gambling
• illegal drugs
 Controlled by prohibition and taxation
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The Political
Functions of Government
Income Redistribution
 Transfer Payments
• Payments for which no goods or services are
rendered
o old age security
o welfare
o employment insurance benefits
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The Political
Functions of Government
Income Redistribution
 Transfers in Kind
• Payments in actual goods and services for
which no goods or services are concurrently
rendered in return
o health care
o public housing
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The Political
Functions of Government
Collective Decision Making:
The Theory of Public Choice
Collective Decision Making
 How voters, politicians, and other
interested parties act and how these
actions influence nonmarket transactions
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The Political
Functions of Government
Similarities in Market and Public-Sector
Decision Making
1) Individuals motivated by self-interest
2) Scarcity and opportunity cost
3) Competition
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The Political
Functions of Government
Similarities in Market and Public-Sector
Decision Making
4) Similarity of individuals and incentives
• Incentive Structure
o The system of rewards and punishments
individuals face with respect to their actions
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The Political
Functions of Government
Differences Between Market and
Collective Decision Making
1) Government (political) goods at zero
price
• Goods (and services) provided by the public
sector
2) Use of force
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The Political
Functions of Government
Differences Between Market and
Collective Decision Making
3) Voting versus spending
• Political system
o One person gets one vote
• Market system
o The dollars one spends count as votes
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The Political
Functions of Government
Differences Between Market and
Collective Decision Making
3) Voting versus spending
• Political system
o Run by majority rule
• Market system
o Run by proportional rule
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The Political
Functions of Government
Differences Between Market and
Collective Decision Making
3) Voting versus spending
• Spending of dollars can indicate intensity of
want
• Votes cannot
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The Political
Functions of Government
Bureaucrats
 Nonelected government officials who are
responsible for the day-to-day operation
of government and the observance of its
regulations and laws.
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The Political
Functions of Government
Rational Ignorance
 Voters choose to ignore costs and
benefits of many decisions.
Benefits of obtaining information about a
decision are far less than the cost of
obtaining the information.
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Tax Rates and the Canadian
Tax System
change in taxes due
Marginal tax rate 
change in taxable income
total taxes due
Average tax rate 
total taxable income
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Tax Rates and the Canadian
Tax System
Taxation Systems
 Proportional Taxation (flat-rate tax)
• Marginal tax rate = Average tax rate
• Everyone pays the same percentage of their
income in taxes
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Tax Rates and the Canadian
Tax System
Taxation Systems
 Progressive Taxation
• Marginal tax rate > Average tax rate
• As a person’s taxable income increases, the
percentage of income paid in taxes increases
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Tax Rates and the Canadian
Tax System
Taxation Systems
 Regressive Taxation
• Marginal tax rate < Average tax rate
• As a person’s taxable income increases, the
percentage of income paid in taxes decreases
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Tax Rates and the Canadian
Tax System
Arguments for the Progressive Tax
 Redistribution of Income
 Ability to Pay
 Benefits Received
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Tax Rates and the Canadian
Tax System
Who Really Pays the Corporate Income
Tax?
 Tax Incidence (the distribution of tax
burdens among various groups in society)
• Consumer
• Stockholder
• Employees
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Tax Rates and the Canadian
Tax System
Excise
Taxes
6%
Sources of Federal Government Tax Receipts
GST
Other
18%
0%
Personal
and
Corporate
Income
Taxes
64%
Employment
Insurance
Premiums
12%
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Tax Rates and the Canadian
Tax System
Provincial and Municipal Government Tax Receipts
Other
7%
Health
Levies
1%
Sales and
Excise
24%
Property
Taxes
20%
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Personal
and
Corporate
Income
Taxes
30%
Transfers
from Federal
Government
18%
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Tax Rates and the Canadian
Tax System
Federal Spending
Education
3%
Social
Service
47%
Health
Services
2%
Defence
13%
Transfers
19%
Interest on
Debt
16%
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Tax Rates and the Canadian
Tax System
Provincial and Municipal Spending
Health
Services
35%
Defence
Transfers
7%
Interest on
0%
Debt
12%
Education
27%
Social
Service
19%
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