Figure 162

Maximization of Social Benefits from Government Programs and Public-Sector Investments

Social benefits are maximized from government programs and public-sector investments when the marginal social cost equals marginal social benefits. Output level Q* maximizes society's net benefits.

Present-day dollar value $

Present-day dollar value $

Quantity

and/or project represents an equally effective use of taxpayer funds in that it results in an identical payoff per dollar of marginal social cost.

Alternatively, optimal relative amounts of X and Y are made available to consumers so long as the marginal social benefit to marginal social cost ratio is equal for each respective program or public-sector investment project:

(16 2) Marginal Social BenefitX Marginal Social BenefitY

' Marginal Social CostX Marginal Social CostY

Notice that each side of Equation 16.2 shows the dollar amount of marginal social benefit relative to the dollar amount of marginal social cost for each project. When the MSB/MSC ratio is equal across all government programs and public-sector investment projects, each respective program and/or project represents an equally effective use of taxpayer funds and results in an identical payoff per dollar of marginal social cost. When the ratio MSB/MSC > 1, the value of marginal social benefits exceeds the value of marginal social costs. When the ratio MSB/MSC < 1, then the value of marginal social benefits is less than the value of marginal social costs. If the ratio MSB/MSC = 1, the value of marginal social benefits exactly equals the value of marginal social costs.

When MSB/MSC = 1, a dollar's worth of social benefit is received for each additional dollar spent on government programs and public-investment projects. This relationship implies an important decision rule, assuming that marginal social benefits fall and marginal social costs rise with an increase in the number of government programs and public-sector investment projects. If resources are fully employed throughout the economy, society's net benefit will be maximized when MSB/MSC = 1 for the last or marginal government program or public-sector investment project. Further net marginal benefits to society are possible through an expansion in the public sector when MSB/MSC > 1 for the marginal public-sector project; resources are being squandered in the public sector when MSB/MSC < 1 for the marginal public-sector project. Only when MSB/MSC = 1 for the marginal public-sector project and private-sector project are resources effectively allocated between the public and private sectors.

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