ABSTRACT
In conventional macroeconomic analysis, the government sector in each country autonomously decides the levels of taxes and government spending in accordance with its attempt to stabilize the domestic economy. In contrast, the primary reason the government sector exists in the present study is not to stabilize the domestic economy but to provide the public goods and services that its household sector wants it to provide. Presumably, these government-produced goods are “non-rival in consumption” and/or their benefits are “non-excludable in payment” so that it is difficult for the private sector to produce these goods profitably. In the present model, the government sectors produce and distribute these “public” goods to their respective household sectors “free of charge” in the sense that they are not sold to the households in the marketplace. However, because the government sectors must purchase the services of various factors of production in order to provide these public goods, each government must tax its respective household sector in order to finance the production of public goods. Consequently, we distinguish the public goods that enter the household sectors’ utility functions from “government spending,” or outlays by the government for the purpose of acquiring the inputs necessary to the production of public goods. In the present model, the objective of each government is to produce public goods up to the point at which the marginal social benefit to its household sector equals the marginal social cost associated with that production.
