Public economics (or economics of the public sector) is the study of government policy through the lens of economics efficiency and equity. At its most basic level, public economics provides a framework for thinking about whether or not the government should participate in economics markets and to what extent its role should be. In order to do so, microeconomic theory is utilized to assess whether the private market is likely to provide efficient outcomes in the absence of governmental interference. Inherently, this study involves the analysis of government taxation and expenditures. This subject encompasses a host of topics including market failures, externalities, and the creation and implementation of government policy. Public economics builds on the theory of welfare economics and is ultimately used as a tool to improve social welfare.

Broad methods and topics include:

• analysis and design of public policy^[1]
• public-finance theory and its application
• distributional effects of taxation and government expenditures
• analysis of market failure and government failure.^[2]

Emphasis is on analytical and scientific methods and normative-ethical analysis, as distinguished from ideology. Examples of topics covered are tax incidence, optimal taxation, and the theory of public goods.^[3]

Macroeconomic Stabilization

• Alan S. Blinder and Robert M. Solow, 1972. "Does Fiscal Policy Matter?" Econometric Research Program
• Alan J. Auerbach and Laurence J. Kotlikoff, 1987. Dynamic Fiscal Policy Cambridge University Press
• Finn E. Kydland and Edmund C. Prescott, 1977. "Rules Rather than Discretion: The Inconsistency of Optimal Plans" The Journal of Political Economy 85(3) 473-492
• Jacques H. Dreze, 1995. "Forty Years of Public Economics: A Personal Perspective" The Journal of Economic Perspectives 9(2) 111-130

Public goods

• Characteristics

Public goods, or collective consumption goods, exhibit two properties; non-rivalry and non-excludability. Something is non-rivaled if one person's consumption of it does not deprive another person, (to a point) a firework display is non-rivaled - since one person watching a firework display does not prevent another person from doing so. Something is non-excludable if its use is cannot be limited to a certain group of people. Again, since one cannot prevent people from viewing a firework display it is non-excludable.

• The demand for pure public goods
• Efficient output of a pure public good
• Free rider problem

Public choice theory

• Voting paradox
• Arrow's impossibility theorem
• Median voter theorem
• Lindahl equilibrium

Public production

• Bureaucracy (book)
• Budget-maximizing model

Cost-benefit analysis

While the origins of cost-benefit analysis can be traced back to Jules Dupuit's classic article "On the Measurement of the Utility of Public Works" (1844), much of the subsequent scholarly development occurred in the United States and arose from the challenges of water-resource development. In 1950, the U.S. Federal Interagency River Basin Committee’s Subcommittee on Benefits and Costs published a report entitled, Proposed Practices for Economic Analysis of River Basin Projects (also known as the Green Book), which became noteworthy for bringing in the language of welfare economics.^[4] In 1958, Otto Eckstein published Water-Resource Development: The Economics of Project Evaluation, and Roland McKean published his Efficiency in Government Through Systems Analysis: With Emphasis on Water Resources Development. The latter book is also considered a classic in the field of operations research. In subsequent years, several other important works appeared: Jack Hirshleifer, James DeHaven, and Jerome W. Milliman published a volume entitled Water Supply: Economics, Technology, and Policy (1960); and a group of Harvard scholars including Robert Dorfman, Stephen Marglin, and others published Design of Water-Resource Systems: New Techniques for Relating Economic Objectives, Engineering Analysis, and Governmental Planning (1962).^[5]

Taxation

Frank P. Ramsey

Irving Fisher

Arnold Harberger

Diamond-Mirrlees Efficiency Theorem

The Taxation of Externalities

One of the achievements for which the great English economist A.C. Pigou is known, was his work on the divergences between marginal private costs and marginal social costs (externalities). In his book, The Economics of Welfare (1932), Pigou describes how these divergences come about:

...one person A, in the course of rendering some service, for which payment is made, to a second person B, incidentally also renders services or disservices to other persons (not producers of like services), of such a sort that payment cannot be extracted from the benefited parties or compensation enforced on behalf of the injured parties (Pigou p. 183).

In particular, Pigou is known for his advocacy of what are known as corrective taxes, or Pigouvian taxes:

It is plain that divergences between private and social net product of the kinds we have so far been considering cannot, like divergences due to tenancy laws, be mitigated by a modification of the contractual relation between any two contracting parties, because the divergence arises out of a service or disservice to persons other than the contracting parties. It is, however, possible for the State, if it so chooses, to remove the divergence in any field by "extraordinary encouragements" or "extraordinary restraints" upon investments in that field. The most obvious forms which these encouragements and restraints may assume are, of course, those of bounties and taxes (Pigou p. 192).

Pigou describes as positive externalities, examples such as resources invested in private parks that improve the surrounding air, and scientific research from which discoveries of high practical utility often grow. Alternatively, he describes negative externalities, such as the factory that destroys a great part of the amenities of neighboring sites.

In 1960, the economist Ronald H. Coase proposed an alternative scheme whereby negative externalities are dealt with through the appropriate assignment of property rights. This result is known as the Coase Theorem.

Fiscal federalism

Wallace E. Oates defines the central problem of fiscal federalism as “the determination of the optimal structure of the public sector in terms of the assignment of decision-making responsibility for specified functions to representatives of the interests of the proper geographical subsets of society (Oates p. 19).”

Deficit finance

• James Tobin, 1965. "The Burden of Public Debt: A Review Article" The Journal of Finance 20(4) 679-682.
• Peter A. Diamond, 1965. "National Debt in a Neoclassical Growth Model" The American Economic Review 55(5) 1126-1150