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Can Labor Market Imperfections Cause Overprovision Of Public Inputs?

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Executive Summary

In a model where trade unions dominate the labor market, a relationship is derived between the rate of unemployment and the provision of a public input in the production. This relationship implies that for conventional rates of unemployment, the public input will be overprovided compared to the first-best level. An important question in public economics is whether the provision of a public good in a second-best economy will exceed, or fall short of, the quantity provided in a first-best setting? In the literature, the main focus has been to analyze how the use of distortionary taxes, or the presence of labor market distortions, may influence the provision of a public good.

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