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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
Chapter 3: Public Goods and Political Economy
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Introduction
Political economy
The concept of a public good
The behavior of the government
Chapter 3: Public Goods and Political Economy
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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
Chapter 3: Public Goods and Political Economy
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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?
Chapter 3: Public Goods and Political Economy
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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?
Chapter 3: Public Goods and Political Economy
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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
Chapter 3: Public Goods and Political Economy
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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
Chapter 3: Public Goods and Political Economy
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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!!
Chapter 3: Public Goods and Political Economy
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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
Chapter 3: Public Goods and Political Economy
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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?
Chapter 3: Public Goods and Political Economy
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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
Chapter 3: Public Goods and Political Economy
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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
Chapter 3: Public Goods and Political Economy
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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
Chapter 3: Public Goods and Political Economy
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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
Chapter 3: Public Goods and Political Economy
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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?
Chapter 3: Public Goods and Political Economy
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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
Chapter 3: Public Goods and Political Economy
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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
Chapter 3: Public Goods and Political Economy
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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…
Chapter 3: Public Goods and Political Economy
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Summary
The concept of a public good
The behavior of the government
Political economy
Chapter 3: Public Goods and 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