Optimal Public Investment

The Role of Public Spending

At a given time, the resources available for a country are limited. If resources are used for public services, resources for private consumption are reduced. Thus, the opportunity cost of public services is a reduction of the resources available for the private sector. If the public sector is more productive than the private sector, it is better for the public sector to provide useful services. However, if the private sector is more efficient than the public sector at utilizing resources, it is worse for the public sector to use a lot of resources. The size of public spending should be determined by the efficiency and usefulness of public spending compared with private spending. In this section, let us investigate the optimal level of public investment from the viewpoint of optimization between the two sectors.

In the market economy, private firms’ investments are determined by profit- maximizing conditions in the market. Private investment projects determined in the perfect competitive market are generally desirable from the perspective of efficient resource allocation. If public investment increases, the resources available for private investment are reduced. This could also depress private consumption. Hence, the cost of public investment is the benefit of private consumption and/or private investment. When the government spends on public investment, it is necessary to consider the cost for the private sector. If the private market is not perfect and has some failures, the public sector may have a greater role in public investment even if public investment and private investment have the same returns on the economy.

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