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Swiss Journal of Economics and Statistics

, Volume 152, Issue 3, pp 209–241 | Cite as

The Social Marginal Cost Curve and a Corner Solution of the Second-Best Level of Public Good Provision: A Review and an Extension

  • Ming Chung Chang
  • Hsiao-Ping Peng
  • Yan-Ching Ho
Open Access
Article
  • 102 Downloads

Summary

Assume that the private goods and the public good are weakly separable, the private goods are gross complements, and the private utility function is a homogeneous of degree one function with constant elasticity of substitution. We demonstrate that, under commodity taxation, the social marginal cost curve of public good provision is initially upward sloping and eventually becomes downward sloping. Moreover, the social marginal cost eventually falls below the private marginal cost. These unusual properties arise from a demand-shift effect: An increase in the tax rate raises the marginal willingness to pay for the public good since it pushes up the unit cost of private utility, hence making the public good more attractive than private goods. In other words, the supply of the public good creates its own demand when the funding to cover production costs is raised through distortionary commodity taxes. It follows that there may exist three solutions to the first-order condition for the second-best problem: two of them are interior solutions and one is a corner solution.

Keyword

second-best public good provision social marginal cost demand-shift effect weak Laffer effect 

JEL-Classification

H21 H41 

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Copyright information

© Swiss Society of Economics and Statistics 2016

Authors and Affiliations

  • Ming Chung Chang
    • 1
  • Hsiao-Ping Peng
    • 2
  • Yan-Ching Ho
    • 3
  1. 1.Graduate Institute of Industrial EconomicsNational Central UniversityChung-Li CityTaiwan
  2. 2.Yu Da UniversityTaiwan
  3. 3.Graduate Institute of Industrial EconomicsNational Central UniversityTaiwan

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