1. 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

2. Government Spending as a Share
of the Economy,
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.

3. The Size of Government
Government Expenditures as a Share (%) of GDP
3.0
6.5
9.4
1930
Federal
8.4
15.7
7.3
State & local
1940
21.1
14.7
6.3
1950
24.1
16.5
7.6
1960
30.2
19.4
10.9
1970
32.8
21.0
11.8
1980
34.2
21.6
12.6
1990
31.9
19.0
12.9
2000
34.3
20.6
13.7
2003
As is shown here, government expenditures as a share of GDP have risen over time.

4. How the Federal Government Spends
Defense
18.8%
Social Security
22%
Net Interest
7.1%
Transportation
3.1%
Income Security
Other
Medicare and health
15.5%
11.8%
21.7%
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.

5. How State & Local Government Spends
Insurance trusts
Public welfare & Health
Public welfare & Health
Education
7.7%
32.2%
22.3%
Police & Fire Protection
Transportation
Utilities & liquor stores
Interest on debt
Administration & other
7.9%
12.2%
6.3%
7.1%
4.3%
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

6. The Growth of Government Transfer Payments
Transfer payments as a % of national income
13.4%
State & local governments
11.8%
Federal government
11.1%
11.3%
7.7%
5.1%
5.2%
2.6%
1.1%
1930
1940
1950
1960
1970
1980
1990
2000
2002
Sources: Bureau of Economic Analysis,
Government transfer payments have grown rapidly in the last 75 years.

7. Differences and Similarities Between Government and Markets
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

8. 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

9. 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.

10. 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

11. 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.

12. 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”

13. 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.

14. When The Process Works

15. Benefits and Costs Among Voters
Distribution of benefits among voters
Widespread
Concentrated
Type 1
Type 2
Widespread
Distribution of costs among voters
Type 4
Type 3
Concentrated
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.

16. 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.

17. Benefits Derived by Voters from Hypothetical Road Project
Tax payment
Voter
Benefits received
Plan A
Plan B
Adams
$ 20 12 4 2
$ 5 5
$ 12.50
7.50
2.50
1.25
Chan
Green
Lee
Diaz
Total
$40
$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.

18. Voter
Benefit
Equal Tax
Benefit Tax
Adam
$140
$50
$105 $5
$40 $6
Bob 40 50 30 60
Cathy 20 15 45 54
Totals
$200
$150
$100
$120
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?

19. Voter Benefit Equal Tax Benefit Tax
Adam
$140
$50
$105 $5
$40 $6
Bob 40 50 30 60
Cathy 20 15 45 54
Totals
$200
$150
$100
$120
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?

20. When It Does Not work well

21. Benefits and Costs Among Voters
Distribution of benefits among voters
Widespread
Concentrated
Type 1
Type 2
Widespread
Distribution of costs among voters
Type 4
Type 3
Concentrated
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.

22. 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.)

23. Classify each of the following as type 1, 2, 3 or 4 according to Table
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
Type 1
Type 2
Widespread
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
Type 4
Type 3
Concentrated
c. For which types of action is government likely to have a bias against adopting actions even if they are efficient? a b c

24. 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.
Distribution of benefits among voters
Widespread
Concentrated
e. A 10 percent tax on the profits of major gasoline retailers (BP, Shell, Exxon, etc.) to finance government-funded research on solar energy.
Type 1
Type 2
Widespread
Distribution of costs among voters
Type 4
Type 3
f. An increase in the income tax to finance an increase in national defense spending.
Concentrated
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).

25. Classify each of the following as type 1, 2, 3 or 4 according to Table
Distribution of benefits among voters
Widespread
Concentrated
h. A 1 percent increase in Social Security taxes on current workers to finance large benefit increases for those currently receiving Social Security payments.
Type 1
Type 2
Widespread
Distribution of costs among voters
Type 4
Type 3
Concentrated
i. Reductions in subsidies to sugar farmers to finance the increases in Social Security benefits.

26. 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.

27. 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 *
in A
in B
in C
Total 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
Assume the districts are of equal size. *
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.

28. Net Benefits (+) or Costs (-) to District Representative of District
New Road in District A
New Park in District B
New Dam in District C A
$+10
$-5
$-2 B -6 +9 -2 C -5
+13
Totals -1
By looking at the Totals row at the bottom of the table, which of these projects are efficient?
- Which are inefficient?
If each project was put up for vote individually (by majority rule), which would pass?
- Which would fail?

29. Net Benefits (+) or Costs (-) to District Representative of District
New Road in District A
New Park in District B
New Dam in District C A
$+10
$-5
$-2 B -6 +9 -2 C -5
+13
Totals -1
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?

30. 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).

31. with Economic Efficiency
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.

32. 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:
More taxes, less fun working.
More taxes, more resources flow into rent-seeking.
More taxes induces tax payers to focus less on income-producing activities, and protecting their income.

33. Consider the supply and demand for public sector action, and decide whether each of the following illustrates
rent-seeking behavior by private parties,
vote-seeking behavior by elected officials, or the
rational ignorance effect.
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.

34. 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.

35. Economic Organization:
Who Produces, Who Pays,
and Why It Matters
Many major economic problems, including rising health- care costs and dissatisfaction with schools, reflect the structure of economic organization.

36. Who Pays? and Who Produces?
Good is paid for by:
Consumer purchaser
Taxpayer or third party
Quadrant 1: Apples, oranges, TV sets, food, housing, & most other goods
Quadrant 2:
Health care, food purchased with food stamps
Private enterprise
Good is produced by:
Quadrant 3: Post Office, water & electricity in many cities, toll roads, and many hospitals
Quadrant 4: Public schools, roads, national defense, and law enforcement
Government
enterprise or
contracting
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.

37. Economic Organization & Incentives
Good is paid for by:
Consumer purchaser
Taxpayer or third party
Quadrant 1
Quadrant 1: Apples, oranges, TV sets, food, housing, & most other goods
Quadrant 2:
Health care, food purchased with food stamps
Private enterprise
Good is produced by:
Quadrant 3: Post Office, water & electricity in many cities, toll roads, and many hospitals
Quadrant 4: Public schools, roads, national defense, and law enforcement
Government
enterprise or
contracting
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.

38. Economic Organization & Incentives
Good is paid for by:
Consumer purchaser
Taxpayer or third party
Quadrant 2
Quadrant 1: Apples, oranges, TV sets, food, housing, & most other goods
Quadrant 2:
Health care, food purchased with food stamps
Private enterprise
Good is produced by:
Quadrant 3: Post Office, water & electricity in many cities, toll roads, and many hospitals
Quadrant 4: Public schools, roads, national defense, and law enforcement
Government
enterprise or
contracting
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.

39. Economic Organization & Incentives
Good is paid for by:
Consumer purchaser
Taxpayer or third party
Quadrant 3:
Quadrant 1: Apples, oranges, TV sets, food, housing, & most other goods
Quadrant 2:
Health care, food purchased with food stamps
Private enterprise
Good is produced by:
Quadrant 3: Post Office, water & electricity in many cities, toll roads, and many hospitals
Quadrant 4: Public schools, roads, national defense, and law enforcement
Government
enterprise or
contracting
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.

40. Economic Organization & Incentives
Good is paid for by:
Consumer purchaser
Taxpayer or third party
Quadrant 4:
Quadrant 1: Apples, oranges, TV sets, food, housing, & most other goods
Quadrant 2:
Health care, food purchased with food stamps
Private enterprise
Good is produced by:
Quadrant 3: Post Office, water & electricity in many cities, toll roads, and many hospitals
Quadrant 4: Public schools, roads, national defense, and law enforcement
Government
enterprise or
contracting
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.

41. The Economic Way of Thinking about Government

42. 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.

43. 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.

44. 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?
Public choice analysis applies the principles of economics to political science topics
Public choice analysis takes the principles of political science and applies them to the traditional topics of economics.
Public choice analysis uses the principle of majority rule to determine the efficiency of an action.
Public choice analysis indicates there is a sharp distinction between economic and political topics.

45. 3. The rational-ignorance effect is a result of
externalities that lead to an excess supply of information.
the limited incentive of the news media to cover political campaigns.
the expectation of individual voters that their vote will not be decisive
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,
efficient projects will tend to be opposed by a majority of voters.
inefficient projects will often be favored by a majority of voters.
projects that are efficient will tend to be favored by an overwhelming majority of voters
democratic political decision making can be expected to work poorly.

46. 5. Most voters will likely be concerned with
most issues since most issues have some impact, however slight, on each citizen.
only a few special issues (those that exert the most impact on the voters’ personal welfare)
most issues since information on most issues can be obtained at a low cost.
the views of a particular political candidate on all issues.
6. Special-interest programs are highly attractive to vote-seeking 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

47. 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.

48. 9. Which of the following explains why managers of government agencies have little incentive to achieve operational efficiency?
Public-sector managers need not fear bankruptcy when operational efficiency is not achieved.
Public-sector managers seldom receive personal benefits if they find ways to improve the efficiency of their operations.
Public-sector agencies typically do not face competition.
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,
consumers have a strong incentive to search out those firms offering them the best deal.
private producers of such goods will have little incentive to control costs and provide them at low prices
goods and services will only be supplied if consumers are willing to pay an amount sufficient to cover their production costs.
the invisible hand will direct consumers and producers toward an efficient level of output.