PUBLIC

FINANCE

WE EK 3 | PU BL I C F IN A NCE T HEO RY I I

KA YO 2 2 86 | S PR IN G 2 0 2 5

A SS I S T. PR OF . BE RK AY AYH AN
Lecture Contents
• Discussion of News

• Last Week’s Summary

• Three Competing Paradigms of Economics
• Neoclassical
• Keynesian
• Marxist

• Economic Stability

• Redistribution
• Wrap-up

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Theory-Practice Link | News
• Please follow newspapers, TV channels, social media,
parliamentary debates, and relevant websites for news about
public finance in Turkey and the world

• Every week, we will link theory with practice through

discussing the news!

• Any news this week?

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Where Were We? | Last Week’s Summary
• The state needs to intervene in the economy in cases of market failures, redistribution and
economic stability
• Public goods are non-rival and non-excludable goods like national defence that market fails to
provide
• Externalities are the negative/positive effect of an economic transaction on third parties, such as
the case of pollution
• Natural monopolies in the utilities sectors (electricity, gas, etc.) work with economies of scale

• Informational asymmetry in cases of insurance, second-hand car deals undermine the working of
the market

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Why Do We Need Economic Theories?

• Theories tell us how the economy works

• Theories guide policy makers about what to do in the face of economic problems like crisis

• Theories shape society and also shaped by society. The social conditions people live have an impact
on economic thinking

• We are also working with economic theories in our everyday lives. We are producers, consumers,
investors, and voters. In order to make an economic decision, you need to have a theory of how
economy works

• Economic theories don’t agree with each other! That is why we don’t have a single, universal theory

Wolff & Resnick, 2012: 1, 5-6, 9 5

Neoclassical Perspective

• Historical Context: 1870s

• Key Figures: William Stanley Jevons, Carl Menger, Leon Walras, Alfred Marshall

• Main concern is microeconomics! Theory focuses on individual decision making process.

• Endorses humanist philosophy. Individuals come first and how the economy works reflect their
behaviors
• Key concepts are individual preferences, marginal utility, marginal cost, production functions,
general equilibrium

Wolff & Resnick, 2012: 14, 19 6

Keynesian Perspective

• Historical Context: 1929 Great Depression

• Key Figure: John Maynard Keynes (1883-1946)

• Main Concern: Macroeconomics, concepts like

inflation, unemployment etc.
• Endorses structuralist philosophy! Economy
comes first and individuals behavior depends on
and reflects its laws

Wolff & Resnick, 2012: 18-19 7

Marxist Perspective
• Historical Context: Emergence of capitalism in 19th
century
• Key Figures: Karl Marx (1818-1883), Friedrich Engels
(1820-1895)
• Endorses structuralist philoshopy! Class relationships
is the starting point of analysis
• Key Concepts: Surplus labor, exploitation, capitalists
versus proletariat, communism

Wolff & Resnick, 2012: 26-28

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Why Should the
Government
Intervene?

Stabilization
Image Source: https://www.gettyimages.com/detail/news-photo/two-men- 9
wearing-sandwich-boards-advertising-their-news-photo/96743223
Capitalism and Instability

• Capitalist economy is characterized by instability! Periods of growth & expansion followed by

periods of contraction. These ups & downs are called business cycles
• Long lasting inflation and recession undermines resource allocation, leads to social anger,
personal alienation and political unrest
• What are their causes and what should we do about them?

• Three competing paradigms differ in analysing and proposing solutions to business cycles

Wolff & Resnick, 2012: 1-2

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Neoclassical Explanation
• Capitalism is a wonderful system! Capitalism provides wealth as well as political freedom

• In an economy of private property and free markets, self-interested economic agents will deliver
the most wealth possible
• Building on Adam Smith’s theory of “invisible hand”, neoclassical position to capitalism’s instability
is simply leave it alone and it will correct itself
• No state intervention is necessary! State interventions undermine the market system’s self-
corrective properties
• Market is the solution! Private decisions of individuals and buusiness reacting to market incentives
is a means to solve problems

Wolff & Resnick, 2012: 2-3

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Keynesian Explanation

• State needs to intervene to manage market imperfections!

• Corrective mechanism of the market does not work or it is too slow. Keynes said that “in the
long run we are all dead”
• Keynesians favor state as the solution to ups and downs of capitalist economy

• Active demand management by the state can end economic depression by increasing public
expenditures and reducing taxes
• Keynesians prefer state programs to deal with persistent poverty, healthcare, education and
retirement
Wolff & Resnick, 2012: 3; Susam, 2020: 37-39
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Marxist Explanation

• Capitalism is a destructive economic system that exploits labor!

• Capitalism’s cycles and crises are due to its class structure. As long as the system is based on
struggle between capital/labor, the instabilities will continue
• Instead of trying to fix the capitalist cycles & crises, Marxists seek to change the system
altogether with a revolution

Wolff & Resnick, 2012: 4

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Why Should the
Government
Intervene?

Redistribution
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Redistribution

• Think of the economy as a pie! Both the size of the pie (efficiency) and the distribution of the
slices for each person are important
• Distribution of income and wealth may not be fair or just according to society

• Answer to “what is fair?” entails social philosophy and value judgment

• Fiscal policy instruments to be used for redistribution could be:

• Higher taxes for high-income groups
• Subsidies for low-income groups

Gruber, 2013: 7; Musgrave & Musgrave, 1989: 10-11 15

Should We Redistribute? Neoclassical Perspective

• People’s incomes are rewards for what they contribute to production:

• Workers provide labor, wage is its reward
• Landlords provide their land, rent is its reward
• Capitalist their money & equipment, interests and profit is its reward

• Redistribution is unfair because it punishes people who contribute more to production. It could
discourage these people to contribute to production

Wolff & Resnick, 2012: 7

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Should We Redistribute? Alternative Perspectives

• Keynesian perspective underlines mood swings between optimisim & pessimism, confidence
and fears. Expectations of the future impact investment decisions of the present. People may
be laid-off due to pessimistic expectations

• Marxist perspective points out the extraction of surplus value from workers to capitalists.
From this perspective, there is a disguised theft in society

Wolff & Resnick, 2012: 8

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Income Distribution | Case of Turkey

%20 Groups 2018 2019

First 20% 6.1 6.2 Poorest 20%
Second 20% 10.6 10.9
Third 20% 14.8 15.2
Fourth 20% 20.9 21.4
Fifth 20% 47.6 46.3 Richest 20%

• Calculated from Turkish Statistical Institute, Survey on Income and Living Conditions

Susam, 2020: 130

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Economic Theories in Practice | Neoclassical

• Neoclassical economic thought is endorsed by Republican Party leaders in the United States
like Ronald Reagan, George Bush & conservative party leaders like Margaret Thatcher in the
United Kingdom
• Administrations supporting neoclassical views prefer deregulation, less government
monitoring of private sector, lower public spending and lower taxes

Wolff & Resnick, 2012: 25 19

Economic Theories in Practice | Keynesian

• Keynesian economic theory is supported by Democrat Party leaders like Bill Clinton, Barack
Obama and social democrats in Europe
• Administrations supporting Keynesian views prefer an increased control of private sector,
greater regulation, higher public expenditures

Wolff & Resnick, 2012: 25 20

Theories Becoming
Popular/Unpopular

• MARKET Neoclassical economics come

to dominate economics discipline from
1870s until 1929
• STATE Aftermath of Great Depression
gave rise to Keynesian ideas until 1970s
• MARKET Stagflation crisis of 1970s
marked a return to neoclassical ideas,
called as neo-liberalism
• STATE Global financial crisis of 2008
undermined belief in free market
Wolff & Resnick, 2012: 16-18, 21-23 21
Next Week’s Preparation

• NEXT WEEK’S TOPIC

Public Expenditures
• ASSIGNED READING

Musgrave R. A. & Musgrave P. B. (1989) Public Finance in Theory and Practice. New York:
McGraw-Hill, “Public Expenditures: Structure and Growth,” pp. 113-129.

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Final Thank you for your attention this week!
Remarks

“Half the battle is just showing up”

Stephen Hawking

If you have any questions, feel free to visit

my office hours (Friday, 13:00-15:00 @ A2)
or e-mail ([email protected]) me
[email protected]

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References

BOOKS
• Gruber, J. (2013) Public Finance and Public Policy. New York: Worth Publishers.

• Musgrave R. A. & Musgrave P. B. (1989) Public Finance in Theory and Practice. New York:
McGraw-Hill.
• Susam, N. (2020) Kamu Maliyesi: Temel Kavram ve Esaslar. Istanbul: Beta.

• Wolff, R. D., and Resnick, S. A. (2012). Contending economic theories: Neoclassical, Keynesian,
and Marxian. Cambridge: The MIT Press.

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