chapter 3: public goods and political economy 3 - 1 chapter 3 public goods and political economy...

Chapter 3: Public Goods and Political Economy

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Chapter 3

Public Goods and Political Economy

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin


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Introduction

Political economy

The concept of a public good

The behavior of the government


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The Concept of a Public Good

Competitive markets generally work well, but there is a kind of good that markets cannot be expected to handle well:

PUBLIC GOODS

A public good has 2 properties:

2. Non-excludability

1. Non-rivalry

1. Rivalry

A private good has 2 properties:

2. Excludability


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Non-excludability

Non-Excludability, Free-Riders and Compulsory Taxation

Free Rider

Compulsory Taxation

“I can’t be excluded from using the public good.”

“So I don’t have to pay for that public good.”

Solution?


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After the government raises the money for a public good through taxes, who should produce it?

Who Should Produce a Public Good?

Private Firms? Government?

Both?


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• 3 families on an island

The Island Wall – assumptions

Should a defensive wall (a public good) be built to protect the island from pirates?

• Merchant ships sell private goods to the families

• Pirates sometimes raid the island


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The Island Wall – graph

MBM

MBL

MBH

Wall Thickness (ft)

$900 -

$800 -

$700 -

$600 -

$500 -

$400 -

$300 -

$200 -

$100 -

I I I I I I I 2 4 6 8 10 12 14

Figure 3.1

MC

• Individually, none of the families would build a wall on their own:

MB < MC

• The MB curves are in a ratio of:

3:2:1


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The Island Wall – graph

MBM

MBL

MBH

Wall Thickness (ft)

$900 -

$800 -

$700 -

$600 -

$500 -

$400 -

$300 -

$200 -

$100 -

I I I I I I I 2 4 6 8 10 12 14

Figure 3.1

MC

Summing their marginal benefits, this public good

should be built.

MB > MC

But how thick?

MB 10 feet thick is the socially optimal or efficient thickness

of the wall!!


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At the efficient,

socially optimal quantity of a public good,

MB = MC

Efficiency

At the efficient,

socially optimal quantity of a private good,

MB = MC


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How does a community collectively make decisions concerning a public good?

Political Economy

How do you choose the socially optimal quantity?

Each family, individually, would not build the wall, but if they get together and collectively decide what to do, they would

build the wall.

So… how much will each family be willing to

pay towards the construction of the wall?


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Cost-Share and Efficiency

Unanimous choice of the efficient quantity of the public good depends upon:

Cost-share is the price each family must pay per unit of the public good

• Cooperation

• Each family agreeing to cost-share in the same ratio as their MBs

• Each family being honest about their MB curves


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A Unanimity Rule

Unanimity rule – all families agree in advance to build a certain thickness of a wall if all families support it.

Pros

All families enjoy a net benefit from the public good, and cost-share ratios will be equal to

their MB ratios

Cons

A family may be dishonest about their MB and hold

out for a lower cost-share, preventing the efficient

outcome


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Majority Rule Voting and the Median Voter

Majority rule voting – if two of the three families vote for a certain thickness of a wall, then that thickness will be built.

Median voter – the family with the middle ranking or preference of wall thickness

Outcome

With majority voting, when cost-shares have been assigned, the outcome will be what the median voter prefers, but it may not be the efficient outcome


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Majority Rule Voting: Single and Double-Peaked Preferences

D

thin

thick

int.

L

thin

int.

thick

Choice H M

First thick int.

Second int. thin

Third thin thick

Table 3.1

H, M, and L vote between: H, M, and D vote between:

• Thick and Intermediate

• Intermediate and Thin

Outcome: Outcome:

• Thick and Thin

• Thick and Intermediate

Intermediate Thin


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Majority Rule Voting: Single and Double-Peaked Preferences

Wall thickness (ft)Thin Intermediate Thick

Choice

1st

2nd

3rd

H

D

M, L

Figure 3.2

Pair-wise voting can lead to cycling with no clear, stable outcome.

Outcome


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Government and Optimal Taxation

When there are many families, often a government is established.

How do you tax to provide the efficient quantity of

public goods?

Proportional Taxation

Regressive Taxation

Progressive Taxation

What about practical obstacles?


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The Behavior of Government

Decisions about public goods are made by a legislature, not by citizens directly.

Election between candidates DOVE and HAWK

0% 10% 20% 30% 40%

Figure 3.3

Dovish Voters Hawkish Voters


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Lobbying, Special Interests, Campaigns, Bureaucracies, and Corruption

• Lobbying

• Special interests

• Campaigns

• Bureaucracies

The interaction between special interests and government bureaucracies creates prospects for corruption.

Potential Issue

• Logrolling


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Public Choice, Government Failure, and Constitutions

Public choice economists argue that these legislators need to be restrained by a...

... constitution

… government failure.

Public choice school of economists believes that legislators, executives, and bureaucrats are biased towards expanding the government beyond what is best for the public and there may be a…


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Summary

The concept of a public good

The behavior of the government

Political economy


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Preview of Chapter 4: Cost-Benefit Analysis

Cost-benefit analysis

Building a factory

Benefits from improving the safety of a highway

Mistakes to avoid

Benefits from building a highway

Reducing global warming

Paying for a costly medical treatment

Intervening militarily

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