|Public Choice & The Public Sector
|Many decisions in the U.S.
economy are made in the public sector (by government).
Public choice theory applies economic principles to public sector
Government failure – occurs when government action results in a less
efficient allocation of resources.
The primary motivation in the public sector is assumed to be
Voters cannot vote for the exact political policies that they favor.
Low voter turnout occurs because many voters see the costs of voting as
greater than the benefits.
The median voter model suggests that the median voter must be captured
to achieve a majority vote. Thus, a candidate will:
- It is very unlikely that one person’s vote will decide the
outcome of an election.
- It is rational to remain ignorant if the cost of gaining
information is greater than the benefit of having the
information. Most voters will not be well-informed due to
rational voter ignorance.
Elected officials will tend to support policies that yield benefits in
the short run and impose costs in the long run. Elected officials
will tend to oppose policies that yield costs in the short run and
yield benefits in the long run.
- Aim for a middle-of-the-road position
- Label his or her opponents as extremists
- Adjust his or her positions in response to polls
- Speak in general rather than specific terms
Elected officials will tend to be responsive to special-interest groups.
The influence of special-interest groups is increased by:
1. Low voter turnout
2. Rational ignorance
Because of special-interest group influence, elected officials will
tend to favor policies that yield concentrated benefits and impose
dispersed costs, and will tend to oppose policies that impose
concentrated costs and yield dispersed benefits.
A congressional district can be a special-interest group.
Legislators often trade votes in order to pass legislation beneficial
to their own districts. This vote trading is called logrolling. Logrolling often
leads to “pork barrel” legislation.
|The actual functioning of
government is usually through government bureaus.
Government bureaus are likely to be very inefficient because:
1. They have no profit
motive. Thus, the bureau will be motivated to spend all of its
funding and to be less concerned about
2. They have no owner. There is no owner with an incentive
to monitor the efficiency of
3. They usually face no competition. Thus, they do not have
to be very responsive to
consumer demand, or very concerned about
minimizing costs of production.
4. They seek to grow. A govt. bureau is a special-interest
group in favor of its own
continued existence and growth.
sources of government failure:
1. Difficulty in measuring
the marginal social benefit and the marginal social cost of
2. Taxes collected do not reflect the full cost of a govt.
program. Two types of costs are incurred when the government
collects taxes and uses resources.
a. the opportunity cost of the resources
used. The opportunity cost may be greater
than the price
paid by the government.
b. the excess burden of the tax
3. The inefficiencies caused by income redistribution
a. income redistribution reduces the
incentive for productivity
b. income redistribution encourages rent
c. income redistribution leads to higher
tax rates, which increases the excess burden
4. Unintended consequences of government policies.
5. Majority voting may be economically
6. Government may stand in the way of creative destruction.
describes the short run upheaval caused by the
development of new technology.
Creative destruction will impose concentrated
costs and yield dispersed benefits.
7. Government suffers from the principal-agent problem.
- Our goal is to produce the optimal mix of output,
that is, the most desirable combination of output attainable with
existing resources, technology and social values.
- The market mechanism moves resources from one industry to
another in response to consumer demands.
Sources of Market Failure
- Market Mechanism – The use of market prices
and sales to signal desired outputs (or resource allocations).
- Changes in market prices direct resources from one
to another, moving us along the perimeter of the
- The market mechanism may produce a mix of output that is
from the one society desires. This is called market failure.
- Market Failure – An imperfection in the
market mechanism that prevents optimal outcomes.
- Market failure implies that the forces of supply and
have not led us to the best point on the production-possibilities curve.
- Market failure establishes a basis for government
- Public goods.
- Market power.
- Private Good - A good or service whose
consumption by one person excludes consumption by others.
- An example of a private good is a donut. When one
consumes the donut, the process of consumption excludes others from
that same donut.
- Public Good - A good or service whose
consumption by one person does not exclude consumption by others.
- An example of a public good is national defense.
One person’s consumption
of national defense does not preclude others from consuming the same
of national defense.
|The Free-Rider Dilemma
- The “communal” nature of public goods may cause consumers
to try for a free ride.
- Free Rider – An individual who reaps direct
benefits from someone else’s purchase (consumption) of a public
- The consumers will not demand the product hoping that
else will purchase it thus providing them with the benefit(s) of the
or service without any cost to them.
- An example of the free rider problem is flood
If your neighbor provides flood protection for her home and that also
your home, then you will not provide your own flood protection.
- If public goods were marketed like private goods, everyone
would wait for someone else to pay. The result might be a total
of public services.
- Either the government or the private sector can produce
public and private goods.
- Because of the inability of the market mechanism to get us
to the optimal mix of output (public goods), we need a non-market force
intervention) to get there.
- Externalities - Costs (or benefits) of
a market activity borne by a third party; the difference between the
and private costs (benefits) of a market activity.
- The Social Demand is the market demand minus
the external cost of consumption (assuming the externalities are
associated with consumption).
- The optimal production mix is where the social demand curve
intersects the social supply curve.
- When externalities are present, the market mechanism will
get us the optimal mix of output; we may need government intervention.
- Market Power
- With public goods and externalities, the market fails
achieve the optimal mix of output because the price signal is
- Market power - The ability to alter
the market price of a good or service
- Market power gives a producer the ability to maximize
profits rather than produce the optimal mix of output.
- A natural monopoly is the classic example.
- Natural Monopoly – An industry in which
one firm can achieve economies of scale over the entire range of market
- Government intervention is necessary to prevent or
dismantle concentrations of market power.
- The distribution of goods and services generated by the
marketplace is not necessarily “fair”.
- Taxes and Transfer Payments - these are the
principal tools for transferring money from those who have “too much”
to those who have “too little”.
- Federal Taxes
State and Local Revenues
- Income Tax
- Social Security
- Corporate Taxes
- Excise Taxes
- Income Tax
- Property Tax
- Sales Tax
- Regressive Tax - a tax system in which tax rates fall
(in a relative sense) as incomes rise