Transcript benefits

The Economics of
Collective Decision Making
1. The Size and Growth of Government
2. Market vs Government Actions
3. Economic Insights on Political Behavior
4. Democratic Government and Economic Efficiency
5. Conflicts Between Winning Politics and
Economic Efficiency?
6. Economic Organization and Efficient
Resource Use
Government Spending as a Share
of the Economy, 1930-2003
• Total government spending accounted for only
9.4% of GDP in 1929, and only one third of
this spending was at the federal level.
• Government spending, particularly at the
federal level, soared from 1929 to 1970.
• Total government spending rose from 9.4%
of GDP in 1929 to 30.2% of GDP in 1970.
• Since 1970, government spending has been
relatively constant at about one-third of the
U.S. economy.
The Size of Government
Government Expenditures as a Share (%) of GDP
1930
1940
1950
1960
1970
3.0
6.5
8.4
7.3
14.7
16.5
21.1
7.6
19.4
21.0
1990
21.6
2003
State & local
15.7
6.3
1980
2000
Federal
9.4
19.0
20.6
24.1
10.9
30.2
11.8
12.6
12.9
13.7
32.8
34.2
31.9
34.3
• As is shown here, government expenditures as a share of GDP
have risen over time.
How the Federal Government Spends
Defense
Social Security
18.8%
Net Interest
22%
7.1%
Transportation
3.1%
15.5%
11.8%
21.7%
Other
Income Security
Medicare and health
Sources: Economic Report of the President, 2004, and Statistical Abstract of the United States, 2003.
• A breakdown of the government expenditures at the federal
level in 2003 are listed above.
How State & Local Government Spends
Insurance trusts
Public welfare
& Health
7.7%
Education
32.2%
22.3%
7.9%
Police &
Fire Protection
12.2%
6.3%
7.1%
4.3%
Transportation
Utilities &
liquor stores
Administration
& other
Interest on debt
Sources: Economic Report of the President, 2004, and Statistical Abstract of the United States, 2003.
• Government expenditures at the state and local level in 2000
The Growth of Government Transfer
Payments
Transfer payments as a % of national income
13.4%
State & local governments
Federal government
11.1% 11.3%
11.8%
7.7%
5.1% 5.2%
2.6%
1.1%
1930 1940
1950 1960
1970
Sources: Bureau of Economic Analysis, http://www.bea.gov.
1980
1990
2000
2002
• Government transfer payments have grown rapidly in the last
75 years.
Differences and Similarities Between
Government and Markets
1.
Both the market and public sectors are
competitive.
a. Politicians for office
b. Bureaucrats for budgets and authority
c. Lobbyists for program funding.
2. Public sector organization can break the
payment for consumption link.
- costs do not always match benefits derived
3. Scarcity imposes opportunity costs for both.
- even “free goods”
4. Private sector: voluntary mutual agreement
-like trade
Public sector (when democratic) : majority rule.-direct voting or legislation
- minority must accept it
Differences and Similarities Between
Government and Markets
5. Voters must choose among candidates who
represent a bundle (slate) of positions on
issues.
Shoppers can choose for each item
6. People who supply valued resources in the
marketplace have higher incomes.
(money talks)
vs
1 person, one vote in a democratic government.
Public Choice Analysis
• –economics meets politics
• Self-interested behavior is present in both
sectors.
• The political process is a complex interaction
among:
• voter-taxpayers
• politicians
• bureaucrats
Public Choice Analysis
• Voter incentives:
• Voters support candidates who will provide them
with the most government services and transfer
benefits, net of personal costs.
• Rational Ignorance Effect:
Recognizing their vote is unlikely to be decisive,
most voters have little incentive to obtain
information on issues and alternative candidates.
• Because of the rational ignorance effect, voters
will be uninformed on many issues; such issues will
not enter into their decision making process.
Public Choice Analysis
• The Politician-Supplier:
• Political officials must win elections to be
successful and achieve their goals.
• Rationally uninformed voters often must be
convinced to “want” a candidate. $$$
• Face competition from other “suppliers”
Public Choice Analysis
• The Bureacrats:
• Bureaucrats get the job done
• Often are focused on their budget and their
agency’s goals.
• Leads to expanding budgets beyond what is
economically efficient.
When The Process Works
Benefits and Costs Among Voters
Distribution of costs
among voters
Distribution of benefits
among voters
Widespread
Concentrated
Widespread
Type
1
Type
2
Concentrated
Type
4
Type
3
• Consider how the 4 possible distributions of benefits and costs
among voters affect the operation of representative government.
• When benefits or costs are either both widespread or concentrated
(type 1 or type 3), representative government tends to undertake
projects that are productive and reject those that are unproductive.
When Voting Works Well
 Other things constant, legislators will have a strong incentive to
support political actions that provide voters with large total
benefits relative to costs.
• If a government project is productive, it will
always be possible to allocate the project’s cost
so that all voters will gain.
• When voters pay in proportion to benefits
received, all voters will gain if the government
action is productive (and all will lose if it is
unproductive).
• Under these circumstances, there is a harmony
between good politics and economic efficiency.
Benefits Derived by Voters from
Hypothetical Road Project
Tax payment
Voter
Adams
Chan
Green
Lee
Diaz
Total
Benefits received
$ 20
12
4
2
2
$40
Plan A
Plan B
$ 5
5
5
5
5
$25
$ 12.50
7.50
2.50
1.25
1.25
$25.00
• Plan A may be simple and seem fair, but even as Adams is getting
a real deal (she values the program at $20 and only pays $5)
Green, Lee, and Diaz do not even receive the value of their taxes.
• When each voter pays in proportion to benefits received (plan B),
each receives more benefits than costs. If tax plan B is used, all
voters gain and the program would pass unanimously, showing that
harmony between politics and economic efficiency can exist.
Voter
Adam
Benefit Equal Tax
Benefit Tax
Benefit
Equal Tax Benefit Tax
$140
$50
$105
$5
$40
$6
Bob
40
50
30
50
40
60
Cathy
20
50
15
45
40
54
Totals
$200
$150
$150
$100
$120
$120
a.
Proposal A creates a total benefit of $200, and the total
cost of the project (as shown by the total tax needed) is
$150.
- Is project A efficient?
- Is project B efficient?
b. Suppose only the equal tax plans are considered and majority
rule is used to make the decisions.
- Would proposal A pass (win majority approval) under the equal
tax-sharing arrangement?
- Would proposal B pass under the equal tax-sharing arrangement?
c. Are the outcomes in part b consistent with the criterion of
efficiency in part a?
Voter
Adam
Benefit Equal Tax Benefit Tax
Benefit
Equal Tax Benefit Tax
$140
$50
$105
$5
$40
$6
Bob
40
50
30
50
40
60
Cathy
20
50
15
45
40
54
Totals
$200
$150
$150
$100
$120
$120
d.
Under the benefits shown, each taxpayer is assessed the same
proportion of the total tax as the proportion of the benefits
they receive from the project.
- Under the benefits of the plan, would proposal A pass?
- Would proposal B pass under the benefits tax?
e. Are the outcomes in part d consistent with the criterion of efficiency
in part a? - If you want government to pass only efficient projects,
would it be better to use equal taxes or taxes in proportion to benefits
received?
When It Does Not work well
Benefits and Costs Among Voters
Distribution of costs
among voters
Distribution of benefits
among voters
Widespread
Concentrated
Widespread
Type
1
Type
2
Concentrated
Type
4
Type
3
• When benefits are concentrated and costs widespread (type 2),
representative government is biased towards the adoption of
counterproductive (inefficient) activity.
• Last, when benefits are widespread but the costs are concentrated
(type 4), the political process often rejects productive projects.
Special Interest Effect
• A special interest
• - large personal benefit for a small number of
constituents
• -a small individual cost on a large number of
others.
• Interest group members feel strongly about
issues that provide them with substantial
personal benefits. Such issues will dominate
their political choices.
• In contrast, voters bearing the cost often are
uninformed on the issue because it exerts only
a small impact on their personal welfare
(rational ignorance effect.)
Classify each of the following as type 1, 2, 3 or 4 according to Table
b. For which types of action
is government likely to have a
bias against adopting actions
even if they are inefficient?
Distribution of costs
among voters
a. For which types of action is
government likely to work the
best (that is most consistent)
with economic efficiency?
Distribution of benefits
among voters
Widespread
Concentrated
Widespread
Type
1
Type
2
Concentrated
Type
4
Type
3
c. For which types of action is government likely to have a bias
against adopting actions even if they are efficient?
a
b
c
Classify each of the following as type 1, 2, 3 or 4 according to Table
d. A $1 tax on every citizen
to provide large subsidies to
tobacco farmers.
f. An increase in the income
tax to finance an increase in
national defense spending.
Distribution of costs
among voters
e. A 10 percent tax on the
profits of major gasoline
retailers (BP, Shell, Exxon, etc.)
to finance government-funded
research on solar energy.
Distribution of benefits
among voters
Widespread
Concentrated
Widespread
Type
1
Type
2
Concentrated
Type
4
Type
3
g. A $5 increase in student tuition to finance increases in professor salaries.
h. A law allowing consumers to buy prescription drugs on the advice of
their pharmacist without a visit to a medical doctor (who are strongly
represented by the AMA).
Classify each of the following as type 1, 2, 3 or 4 according to Table
h. A 1 percent increase in
Social Security taxes on
current workers to finance
large benefit increases for
those currently receiving
Social Security payments.
Distribution of costs
among voters
Distribution of benefits
among voters
Widespread
Concentrated
Widespread
Type
1
Type
2
Concentrated
Type
4
Type
3
i. Reductions in subsidies to sugar farmers to finance the
increases in Social Security benefits.
Special Interest Effect
• Politicians have a strong incentive to favor
the views of special interests even if action is
inefficient.
• Logrolling and pork-barrel legislation
strengthen the special interest effect.
Vote Trading and Passing Counterproductive
Legislation
–– Net Benefits (+) or Costs (-) to the Voters in Respective District ––
Voters of
New bridge
Dredging harbor New military base
district*
Total
in A
in B
in C
A
+$10
- $03
- $03
+ $4
B
- $03
+ $10
- $03
+ $4
C
- $03
- $03
+$10
+ $4
D
- $03
- $03
- $03
- $9
E
- $03
- $03
- $03
- $9
Total
- $02
- $02
- $02
- $6
* the districts are of equal size.
Assume
• Benefits to A, B, and C voters vary by project.
In total, voters in A, B, & C districts come out ahead despite the costs
of paying taxes for activities in other districts – if they agree to vote
together. (logrolling)
• With this bill, there are no benefits to voters in D and E; further,
the sum of benefits & costs for all voters together is negative.
• With majority rule, the majority can pass counterproductive
legislation benefiting themselves but creating negative net
benefits for the whole.
Net Benefits (+) or Costs (-) to District
Representative
of District
A
B
C
Totals
a.
New Road in
District A
$+10
-6
-6
-2
New Park in
District B
$-5
+9
-5
-1
New Dam in
District C
$-2
-2
+13
+9
By looking at the Totals row at the bottom of the table, which of
these projects are efficient?
- Which are inefficient?
b.
If each project was put up for vote individually (by majority rule),
which would pass?
- Which would fail?
Net Benefits (+) or Costs (-) to District
Representative
of District
A
B
C
Totals
c.
New Road in
District A
$+10
-6
-6
-2
New Park in
District B
$-5
+9
-5
-1
New Dam in
District C
$-2
-2
+13
+9
Suppose you were the representative of District A and wanted
to get your new road passed. You only need on more vote for a
majority.
- Would both you and the representative from District B be willing to
“trade” votes to get your projects passed? That is, would you be
willing to vote for B’s park if he voted for your road?
- Would he agree to the trade as well?
d. Now consider a “pork-barrel” bill that contained all three projects.
How would each representative vote on the total bill containing all
three projects?
When Voting Conflicts with Economic Efficiency
 Shortsightedness Effect:
Issues that yield clearly defined current benefits
at the expense of future costs that are difficult-to-identify.
• Political process is biased toward the adoption of
such proposals even when they are inefficient.
• The shortsightedness effect explains why
politicians will find debt financing and unfunded
promises attractive:
• (current benefits to voters without levying
• taxes to pay for them).
When Voting Conflicts
with Economic Efficiency

Rent Seeking:
Actions by individuals and interest groups designed
to restructure public policy to either directly or
indirectly redistribute more income to themselves.
• Widespread use of the taxing, spending, and
regulatory powers of government that favor some
at the expense of others will encourage rent
seeking.
• Rent seeking moves resources away from
productive activities. The output of economies
with substantial amounts of rent seeking will fall
below their potential.
Economics of the Transfer Society
 A large and growing part of government is dedicated
to transferring income.
• Why large-scale redistribution will reduce the
size of the economic pie:
1. More taxes, less fun working.
2. More taxes, more resources flow into rentseeking.
3. More taxes induces tax payers to focus less on
income-producing activities, and protecting their
income.
Consider the supply and demand for public sector action, and decide
whether each of the following illustrates
(a) rent-seeking behavior by private parties,
(b) vote-seeking behavior by elected officials, or the
(c) rational ignorance effect.
a. Members of Congress rejected bills that would have restricted the
lobbying activities of political action committees (PACs).
b. Election results are often distorted by poorly informed voters and low
voter turnouts
c. Liquor wholesalers in most states have lobbied for state laws that
compel retailers to buy their liquor supplies only from the nearest available
wholesaler instead of shopping around
d. Many voters support import tariffs and quotas on foreign goods even
though such protectionism costs consumers billions of dollars.
e. A steel company sends a $50 million campaign contribution to a legislator
in a year in which a bill is being debated that would affect the steel
industry.
Economic Inefficiency
and Government Operated Firms
 Consider the lack of incentive for a government firm or
agency to operate efficiently.
• In the public sector:
-no profit motive to try keeping costs low.
-no bankruptcies to weeding out inefficient
producers.
- Managers seldom gain personally from measures
that reduce costs.
- OPM.
Economic Organization:
Who Produces,Who Pays,
andWhy It Matters
Many major economic problems, including rising healthcare costs and dissatisfaction with schools, reflect the
structure of economic organization.
Who Pays? and Who Produces?
Good is produced by:
Good is paid for by:
Consumer purchaser Taxpayer or third party
Private
enterprise
Quadrant 1:
Apples, oranges, TV
sets, food, housing,
& most other goods
Quadrant 2:
Health care, food
purchased with
food stamps
Government
enterprise or
contracting
Quadrant 3:
Post Office, water &
electricity in many
cities, toll roads, and
many hospitals
Quadrant 4:
Public schools, roads,
national defense, and
law enforcement
• The incentive to economize is influenced by who produces a good
and who pays for it.
• Economizing behavior will be strongest when consumers purchase
goods produced by private firms (quadrant 1)
• The incentive to economize is reduced when payment is made by
a third party and when production is handled by the government.
Economic Organization & Incentives
Good is paid for by:
Consumer purchaser Taxpayer or third party
Good is produced by:
• Quadrant 1
Private
enterprise
Quadrant 1:
Apples, oranges, TV
sets, food, housing,
& most other goods
Quadrant 2:
Health care, food
purchased with
food stamps
Government
enterprise or
contracting
Quadrant 3:
Post Office, water &
electricity in many
cities, toll roads, and
many hospitals
Quadrant 4:
Public schools, roads,
national defense, and
law enforcement
• Consumers have a strong incentive to economize because they are
spending their own money.
•Producers have a strong incentive to offer consumers value and
produce efficiently because failure to do so will mean fewer customers
and lower profits.
• This combination leads to efficient outcomes.
Economic Organization & Incentives
Good is paid for by:
Consumer purchaser Taxpayer or third party
Good is produced by:
• Quadrant 2
Private
enterprise
Quadrant 1:
Apples, oranges, TV
sets, food, housing,
& most other goods
Quadrant 2:
Health care, food
purchased with
food stamps
Government
enterprise or
contracting
Quadrant 3:
Post Office, water &
electricity in many
cities, toll roads, and
many hospitals
Quadrant 4:
Public schools, roads,
national defense, and
law enforcement
• Consumers have little incentive to economize because someone
else is paying the bill.
• Producers have little incentive to provide the good at a low cost
because consumers are more interested in obtaining the highest
quality, regardless of price.
• This mix leads to high prices & large expenditures on the good.
Economic Organization & Incentives
Good is paid for by:
Consumer purchaser Taxpayer or third party
Good is produced by:
• Quadrant 3:
Private
enterprise
Quadrant 1:
Apples, oranges, TV
sets, food, housing,
& most other goods
Quadrant 2:
Health care, food
purchased with
food stamps
Government
enterprise or
contracting
Quadrant 3:
Post Office, water &
electricity in many
cities, toll roads, and
many hospitals
Quadrant 4:
Public schools, roads,
national defense, and
law enforcement
• Consumers will search for value because they are spending their
own money.
•Government producers are likely to be high-cost suppliers,
particularly if they are a monopolist.
• High prices and inefficiency in production are a likely outcome.
Economic Organization & Incentives
Good is paid for by:
Consumer purchaser Taxpayer or third party
Good is produced by:
• Quadrant 4:
Private
enterprise
Quadrant 1:
Apples, oranges, TV
sets, food, housing,
& most other goods
Quadrant 2:
Health care, food
purchased with
food stamps
Government
enterprise or
contracting
Quadrant 3:
Post Office, water &
electricity in many
cities, toll roads, and
many hospitals
Quadrant 4:
Public schools, roads,
national defense, and
law enforcement
• Political process determines what will be produced, how it will be
produced, and how it will be allocated.
•Consumers are in a weak position to discipline the suppliers.
• The outcome is likely to be high production costs and a disconnect
between the good produced and the preferences of consumers.
The Economic Way of
Thinking about Government
The Economic Way
of Thinking About Government
 Both markets and the political process will sometimes fail to
allocate goods & resources efficiently.
• Public choice analysis - there is sometimes a
conflict between winning elections and following
sound policies.
• For some types of activities, there is reason to
believe that the political action that will help one
get elected will, at the same time, reduce income
levels and living standards.
The Role of a Constitution
 Constitutions establish the procedures used to make political
decisions. They can also limit the activities of government.
• U.S. Constitution incorporates restraints on the
economic role of government.
• Public-choice study highlights the importance of
constitutional rules and procedures capable of
restraining government activities to those areas
where it will promote prosperity.
• The challenge before us is to develop
constitutional rules and political institutions more
consistent with economic efficiency and
prosperity.
1.
In 2003, the combined expenditures of federal, state, and local
governments in the United States were approximately
a.
14 % of GDP.
b.
24 % of GDP.
c
34 % of GDP
d.
44 % of GDP.
2.
Which of the following provides the best summary of
the basic idea of public choice analysis?
a.
Public choice analysis applies the principles of economics to political
science topics
b. Public choice analysis takes the principles of political science and
applies them to the traditional topics of economics.
c. Public choice analysis uses the principle of majority rule to determine
the efficiency of an action.
d. Public choice analysis indicates there is a sharp distinction between
economic and political topics.
3.
The rational-ignorance effect is a result of
a. externalities that lead to an excess supply of information.
b. the limited incentive of the news media to cover political campaigns.
c. the expectation of individual voters that their vote will not be decisive
d. the lack of a college education on the part of most voters in the
United States.
4.
When voters pay taxes in proportion to the benefits
they receive from government projects,
a. efficient projects will tend to be opposed by a majority of voters.
b. inefficient projects will often be favored by a majority of voters.
c. projects that are efficient will tend to be favored by an overwhelming
majority of voters
d. democratic political decision making can be expected to work poorly.
5.
a.
Most voters will likely be concerned with
most issues since most issues have some impact, however slight, on
each citizen.
b. only a few special issues (those that exert the most impact on the
voters’ personal welfare)
c. most issues since information on most issues can be obtained at a low
cost.
d. the views of a particular political candidate on all issues.
6.
Special-interest programs are highly attractive to voteseeking politicians because
a.
these programs are highly efficient, and therefore, they
tend to enhance the general welfare of the populace.
b.
members of special interest groups favoring these
programs are less likely to vote than the taxpayers who pay for them.
c.
low-income recipients are the primary beneficiaries of
special-interest programs.
d
members of special interest groups favoring these
programs feel strongly about them while most other voters are rationally
uninformed about them
7.
Current tax rates are insufficient to finance the benefits promised
by both the Social Security and Medicare programs. Are these unfunded
promises surprising according to economic theory?
a.
Yes, political representatives have a strong incentive to
levy taxes that are sufficient to cover the cost of all programs they favor.
b
No, the unfunded promises reflect the shortsighted nature
of the political process
c.
Yes, political representatives generally favor balancing the
government budget because this is best for the economy.
d.
No, even though debt financing often makes sense,
politicians are reluctant to use it because it will damage their chances of
being reelected.
8.
Public choice theory suggests politicians will be most likely to favor
redistribution of income from
a.
the rich to the poor.
b
unorganized taxpayers to well-organized interest groups
c.
middle-income taxpayers to both the rich and the poor.
d.
well-organized businesses and labor groups to consumers.
9.
Which of the following explains why managers of government
agencies have little incentive to achieve operational efficiency?
a. Public-sector managers need not fear bankruptcy when operational
efficiency is not achieved.
b. Public-sector managers seldom receive personal benefits if they find
ways to improve the efficiency of their operations.
c. Public-sector agencies typically do not face competition.
d. All of the above explain why government agencies have little incentive
to be efficient
10.
When goods are produced privately, but the cost of their purchase
is paid for by the taxpayer or some other third party,
a. consumers have a strong incentive to search out those firms offering
them the best deal.
b. private producers of such goods will have little incentive to control
costs and provide them at low prices
c. goods and services will only be supplied if consumers are willing to pay
an amount sufficient to cover their production costs.
d. the invisible hand will direct consumers and producers toward an
efficient level of output.