Economics 511: Public Goods and Market Failures (Public Economics I)
University of Illinois, Urbana-Champaign
Spring 2026
Professor David Albouy
Office: 225A David Kinley Hall (DKH)
Email: albouy@illinois.edu
Lecture: Tuesday and Thursday: 11:00a.m. to 12:20p.m. DKH 215
Office Hours: Wednesday, 11:00-11:50 am, Thursday, 1:00-1:50pm DKH 225A
Description:
Examine the role of government in the economy, and how the market may fail to produce efficient or equitable outcomes.
· Improve historical and contemporary understanding of government role in providing defense, infrastructure, education, pensions, health care, unemployment insurance, etc.
· Overview government budgets at local, national and international levels.
· Deepen understanding of how decentralized individual behavior in markets affects economic outcomes, through the lenses of optimization and equilibrium.
· See how information problems challenge the ability of government to make effective policy and see when markets can help.
· Consider the welfare effects of different policies and the influence of political forces.
The course will have a strong theoretical component based on economic theory, as well as some philosophical content related to science and ethics. I include both
Prerequisites: Master’s level microeconomics and statistics (e.g., ECON 500 & 502).
Grading
30% Six assignments, each worth 5%: (Feb 17, Mar 3, Mar 24, Apr 7, Apr 21, May 5)
5% A good effort with mostly correct answers
4 A fairly good effort with many correct answers
3 A poor effort with many mistakes
2 A very incomplete assignment
1 A sheet with your name on it and the assignment number
0% Missing or late - please hand in whatever you have!
30% Midterm exams (in class Mar 12 & Apr 16)
40% Final exam (Tentatively, May 14, 7-10pm)
Exam will be based primarily on material taught in lecture. However, some questions may refer to material only explained fully in the required reading.
+5% Attendance and Participation
· Attendance will be taken randomly (not every day)
· Participation for asking questions/stimulating discussion in class or office hours.
· Pronouncing my last name correctly (in English, rhymes with “Illinois”)
+?% Additional Extra Credit (To be determined)
Assignments, deadlines, and grades posted on the course website (Canvas). Greater information will also be provided in class, so be sure to attend. I reserve the right to stop posting slides if attendance falls – not attending class exerts a negative externality on other students so please show up.
Reading is a complement, not a substitute for lecture. This course is not “taught out of a book.” Class attendance and taking detailed notetaking is essential. Material not on the slides, either from the book or presented verbally, may be on quizzes, homework, and exams. In fact, these will stress subjects most discussed in class (not necessarily what is in the slides or book).
Laptop computers are not to be used in class. Please take notes on paper/notebook or a tablet.
Please contact me during the first two weeks of class by email to work out arrangements if you have any special needs. Except for documented illnesses and emergencies, no special arrangements for examinations will be made after the second week of class. Bring a picture ID to all examinations.
This class sometimes covers sensitive topics on inequality, race, gender, and other issues. Please let me know if you have needs or requests regarding family or health needs, pronouns, or anything else important to you. You are respected and valued in this class and will not be graded for political, religious, or moral beliefs – viewpoint diversity is welcome and encouraged. Personal attacks, harassment, and bullying are not. You are welcome to come to office hours to chat not only about class, but your aspirations in academia, career, life, and intellectual journey.
Unlike many of the instructors you have had thus far, I am a tenured research-oriented professor. Much of my time is spent engaging in research activities including publishing, peer-review, academic conferences, advising doctoral students, and mentoring junior faculty. This means that I may share with you some of my own published findings, as well as what is currently being discussed. Also, I can provide you with more of an insiders’ view of the research in urban economics. If you are interested in pursuing economics to a higher level, I can advise you on graduate programs or research assistantship when you graduate – do not delay.
Required Reading (a complement with, not a substitute for, lecture!)
Jonathan Gruber, Public Finance and Public Policy (Institutions, empirics, and basic theory)
John Leach, A Course in Public Economics. (More advanced theory)
Jean Hindriks and Gareth D. Myles, Intermediate Public Economics
Additional readings – typically notes and journal articles – will be posted online
Additional References
Edward M. Gramlich, A Guide to Benefit-Cost Analysis, Second Edition.
Walter Nicholson, Microeconomic Theory: Basic Principles and Extensions
COURSE OUTLINE (26 lectures + 1 review session + 2 midterms + final)
Attend all classes! All lecture times are approximate. Some topics may be dropped if time is short.
1) Introduction to Public Economics and Its Past, Present, and Future (6 Lectures)
1/20 Introduction: Definition and scope of public economics; positive & normative analysis.
1/25 A brief history of the public sector
1/27 Overview of federal, state, and local budgets; international comparisons.
Deficit and debt dynamics, generational accounts, and long run prospects.
2/3 The growth of the public sector and debt dynamics
2/7 Theories of the public sector: size and excess
Reading: Gruber Ch 1, 3 and 4; Leach Ch 1; H&M Ch 1, 4, 5.
2) Market Success and Failure: Competitive Equilibrium and Welfare (4 Lectures)
2/10 Cardinal, ordinal, and intercomparable utility; utility possibility sets, social welfare.
Pure exchange economy and planner’s problem. Pareto efficiency; the equity-efficiency tradeoff. Social welfare functions
2/12 Market equilibrium; First and Second Fundamental Theorems of Welfare Economics
2/17 Simple production economy. Production possibility frontiers. Firm profit maximization and supply functions. 2z2 production economy. Community indifference curves. Consumption, production, and match efficiency.
2/22 Consumer and producer surplus, deadweight loss. The use of knowledge in society Socialist-calculation debate.
Reading: Gruber, Ch 2 (including Appendix); Leach Ch 2, 3, 4, 5; H&M Ch 2, 13.1-3,7, 9-11;
3) Increasing Returns to Scale & Imperfect Competition; Subsidies & Taxation (3 Lecture)
2/24 Marginal versus average cost; minimum efficient scale, monopoly pricing, natural monopoly; problems with pricing intellectual property
2/26 Subsidies versus lump-sum transfers. Partial equilibrium model of tax and subsidy incidence.
3/3 Deadweight-loss of taxation and monopoly. Public-sector pricing.
Reading: Leach Ch 14, 15.1-2, 16.1.,17, H&M Ch 8, 15.1-2
***1st Midterm Exam on above material, scheduled in class on Thu, Mar 12 ****
4) Externalities and Public Goods (4 Lectures)
3/5 Positive and negative externalities; free-riding, common resource, and coordination problems. Pigouvian taxation.
3/10 Quantity and price regulation; pollution tax vs. tradable permits
3/24 The Coase Theorem, hold-up and assignment problems. Pure and impure public goods
3/26 Nash equilibrium and strategic inefficiencies, Strategic complements and substitutes. Samuelson’s Rule.
Reading: Gruber, Ch 5, 6, 7; Leach Ch 6, 7, H&M Ch 6,7,8
Spring Break
5) Asymmetric Information (2 lectures)
3/31 Hidden actions, adverse selection and the market for lemons; Insurance markets with imperfect competition
4/2 Hidden types and moral hazard
Reading: Gruber, H&M 10
6) Cost-Benefit Analysis and Valuation Techniques (2 Lectures)
4/7 Hicks-Kaldor compensation principle; stated preference and contingent valuation;
4/9 Revealed preference; hedonic methods, and compensating differentials; Shadow prices the value of time, safety, human life, and cleaner air. Quality of life measurement.
Reading: Gruber, Ch 8; Gramlich
***2nd Midterm Exam on above material, scheduled in class on Thu, Apr 16 ****
7) Social Choice, Political Economy, and Rent Seeking (3 Lectures)
4/14 Lindahl Pricing, Majority voting, Condorcet’s Paradox; Arrow’s Impossibility Theorem
4/21 Median voter theorem, Electoral competition, polarization, Citizen-candidate model.
4/23 Rent-seeking, lobbying and special interests; Complete and Partial Dissipation Theorem
Reading: Gruber Ch 9, H&M Ch. 11.12
8) Local Public Economics and Education (2 Lectures)
4/28 Advantages and disadvantages of federal systems; intergovernmental grants. (e.g. matching, block), flypaper effect. The Tiebout model of local public goods, sorting, and benefit taxation; fiscal zoning
4/30 School finance, school choice and vouchers, private and social return to education;
Reading: Gruber Ch 10, 11; Leach Ch 12. H&M Ch 19, 20
5/5 Final Exam Review
**CUMULATIVE Final Exam on ALL of the above, Thu, May 14, 7-10pm**