Question

There is an age-old tension between states/localities and the federal government, in regard to which level of government provides public goods more efficiently. Define what is meant by efficient in the context of allocating public goods. Explain the Tiebout hypothesis. What are the limitations of the hypothesis (i.e., factors that many complicate the efficient allocation of public goods)? Describe them. Should public goods be provided by state/local or the national government? Justify your position.

Answer 1

Public goods are those goods which are provided by government to citizens and all citizens can enjoy benefits from these goods irrespective of the fact that whether they have paid any price for it or not .

Example Defense, public parks, air we breathe . All individuals whether a tax payer or non tax payer enjoy benefits of these goods.

The efficient way for allocating public goods is cost benefit analyses. This is done as follows:

• Identify the project which is to be started.
• Make an estimate of all the costs associated with that project.
• Make an estimate of all benefits expected to be received from the project.
• After this convert these costs and benefits into their monetary equivalents.
• Calculate net benefit of this project i.e Costs - Benefits.
• Adjust this value for time value of money and apply suitable discount factor.
• Calculate Net Present Value of the project .
• If benefits are more than the costs then make the project live.

Suppose the government wants to construct a dam. It can take into account benefits like water storage. employment generation, hydro power generation, preservation of flora and fauna in that region. It should also take into account the costs associated like cost of land used., construction and infrastructure charges, labor charges, maintenance charges, time frame etc.

Tiebout Hypothesis

It is human nature that they will always go for that alternative that is more profitable to them. Example If a particular shopkeeper offers your favorite ice cream at a cheaper rate than the other one then obviously you will choose the one which is cheaper.

The same applies to Tiebout Hypothesis. If a government of a particular locality or state levies more taxes and do less spending on the welfare of public then people of that locality will like to move to some other locality or state where government levies less taxes and spend more on public welfare. However, relocation costs, job availability in new place and other factors play an important role.

Limitations

• It states that financing of public goods should be done equally by all residents which promotes inequality.
• Public goods are financed by property tax. This is levies on the basis of homes. Rich have larger houses, so they pay more taxes as compared to poor who have small houses.

Some goods and services which are of regular and basic needs catering to requirements of small population should be provided by state and local governments. These include public parks, fire system, cleanliness projects like garbage collection, construction of public washrooms, sanitation, libraries etc.

Goods and services which serve the interests of larger population and which are of national importance should be provided by central government. These include national defense, air and water quality, railways, dam etc.