© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko “The Economic Way of Thinking” 11 th Edition Chapter

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko

“The Economic Way of Thinking”

11th Edition

Chapter 13:

Markets and

Government

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 2 of 45

Chapter 13 Outline

• Introduction

• Private Versus Public?

• Competition and Individualism

• Economic Theory and Government Action

• The Right to Use Coercion

• Is Government Necessary?


Chapter 13 Outline

• Excluding Nonpayers

• The Free-Ride Problem

• Positive Externalities and Free-Riders

• Law and Order

• National Defense

• Roads and Schools


Chapter 13 Outline

• Income Redistribution

• The Regulation of Voluntary Exchange

• Government and the Public Interest

• Information and Democratic Governments

• The Interests of Elected Officials

• Concentrated Benefits, Dispersed Costs


Chapter 13 Outline

• Positive Externalities and Government Policies

• How Do People Identify the Public Interest?

• The Prisoner’s Dilemma

• The Limits of Political Institutions


Introduction

• Key questions in constitutional political economy

– What should be left to the market?– What are the appropriate tasks for government?


Private Versus Public?

• The market usually characterizes the private sector.

• Government agencies and officials comprise the public sector.

• Question

– Does individual self-interest play a role in the public sector?


Competition and Individualism

• The market sector is often referred to as the competitive sector.

• Question

– Is there competition in the government?

• Competition in the public sector

– Elections– Government agencies– Passing legislation


Economic Theory and Government Action

• Economic Theory

– All participants are concerned with self-interest and behave rationally.

– If the marginal revenue of an activity exceeds the marginal cost, the activity should be expanded.

– If the marginal cost of an activity exceeds the marginal revenue, the activity should be contracted.



• Question

– Does the government make decisions in the same way?



• Governments:

– Have limited resources.– Wants exceed the capacity of the resources.– Must allocate their resources.– Will use incentives to determine the optimal

allocation.



• What is the role of property rights in government behavior?


The Right to Use Coercion

• Government possesses a generally conceded and exclusive right to coerce adults.



• Coercion

– To induce cooperation by threatening to reduce people’s options.

• Persuasion

– To induce cooperation by promising to expand people’s options.



• Examples of Coercion

– Traffic laws– Easements– Code enforcement



• We may be able to achieve greater freedom and expanded options if we all accept some limitations of our freedom and some reduction in our options.


Is Government Necessary?

• How much police protection did you consume last month?

• Would police protection be available without government?


Excluding Nonpayers

• Without government

– People who wanted police and/or fire protection could pay for it.

– Could their neighbors be excluded?– How does this impact a person’s willingness to pay for

protection?


Excluding Nonpayers


– Spillover benefits reduce the incentive to produce certain goods.


– Government can create an incentive to produce goods through coercion which reduces the transaction cost.


The Free-Rider Problem

• Free-Riders

– People who accept benefits without paying their share of the cost of providing those benefits.

• Question

– Why don’t people do what would clearly make themselves and others better off?


The Free-Rider Problem

People are guided by the costs they expect to bear and benefits they expect to receive.


Positive Externalities and Free-Riders

• Positive Externalities

– Exist alongside negative externalities.– Create a disincentive to produce.– Probably more prevalent than spillover costs.


Positive Externalities and Free-Riders

• Exchange entails transaction costs.

• Transaction Costs

– Reduce exchanges if they exceed marginal benefits.

• Government Coercion

– Reduces transaction costs.


Law and Order

• High transaction costs make it difficult to exclude free-riders.

• Government coercion forces everyone to pay involuntary contributions (taxes).


Law and Order

• Uniform and Consistent Rules

– Increase planning confidence– Contribute to cooperating society

• Examples

– Defining property rights– Enforcement of contracts


National Defense

• National Defense

– A public good– A traditional role of government– Can’t be provided privately due to the free-rider

problem.– Does not have to be solely provided through coercion.


Roads and Schools

• Question

– Would the quantity and quality of roads be the same if coercion was not used to finance them?


Roads and Schools

• Transaction Costs

– Would be high if tolls were relied on to finance roads.

• Question

– Do others benefit from road development?


Roads and Schools

• Education

– People acquire education only as long as the marginal benefit exceeds the marginal cost.

– Positive externalities result.

• Education

– Less than optimal will be obtained when external benefits are not considered.

– Taxes to finance education lowers the cost and increases the demand.


Income Redistribution

• The government provides special benefits to the impoverished.

• Question

– Why not rely on private philanthropy?• Hint: Free-riders


The Regulation of Voluntary Exchange

• Reducing Transaction Costs

– Licensing– Certification– Setting standards


Government and the Public Interest

• Government attempts to address sources of market failure.

– Transaction costs– Positive externalities– Free-riders

• Question

– How would the lack of perfect information and incentives impact the government’s ability to act in the public interest?


Government and the Public Interest

• Why are government policies dominated by special interests?

• Why are governments more likely to oversupply than undersupply a public good?


Information and Democratic Governments

• Question

– Why don’t you take the time to learn more about the candidates running for various offices?

• Question

– Is an interest in being re-elected likely to lead elected officials to vote and act in the public interest?


The Interests of Elected Officials

• Observation

– The few who have much to gain invest vast resources in trying to influence the political process.

• Observation

– The many with more to gain in total, but less to gain individually, invest almost nothing.


Concentrated Benefits, Dispersed Costs

• Democratic political process

– Concentrate benefits on the • Well organized• Well informed• Who gain the most

– Disperse costs on• Unorganized• Ill-informed• With little to gain individually


Positive Externalities and Government Policies

• Government policies

– tend to be dominated by special interests.


How Do People Identify the Public Interest?

• Scenario

– How long should a new drug be tested by the FDA?


How Do People Identify the Public Interest?

Costsand

Benefits

Time Spent in Testing

Benefits to patientsof additional testing

Costs to patientsof additional testing

Cost =Benefit

T1

Cost to the FDAfor testing

T2


The Prisoner’s Dilemma

• The Dilemma

– Choosing whether to spend two hours/week working on a public policy issue or go bowling.


The Prisoner’s Dilemma

Others ChooseOthers Choose

EachEachChoosesChooses

Duty RecreationD

uty

Rec

reat

ion

GoodGoodGovernmentGovernment

BadBadGovernmentGovernment

GoodGoodGovernmentGovernment

PlusPlusBowlingBowling

BadBadGovernmentGovernment

PlusPlusBowlingBowling


The Limits of Political Institutions

• What do you think?

– Are there limits to what political institutions can accomplish?


Once Over Lightly

• Government actions follow decisions of citizens and government officials.

• They compare marginal costs and benefits of alternative actions.

• Governments have the right to use coercion.

• Thru coercion it is sometimes possible to secure goods not available thru voluntary cooperation.


Once Over Lightly

• Coercion may secure the supply thru lowering transaction costs.

• Government actions reduce transaction costs and overcome free-rider problems.

• Government coercion presupposes voluntary cooperation.

• Positive externalities permeate the political process in a democratic government.


End of Chapter 13

Documents

© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko “The Economic Way of Thinking” 11 th Edition Chapter