Government

Chapter Outline ©2015 McGraw-Hill Education. All Rights Reserved. 2 Public Goods Private Provision of Public Goods Public Choice Income Distribution

Public Goods ©2015 McGraw-Hill Education. All Rights Reserved. 3 Pure public good: a good that has a high degree of nondiminishability and nonexcludability. –Each person consumes the same amount of it. Collective good: a good that is excludable and has a high degree only of nondiminishability.

Figure 18.1: The Aggregate Willingness- to-Pay Curve for a Public Good ©2015 McGraw-Hill Education. All Rights Reserved. 4

Figure 18.2: Equilibrium in a Market for Jointly Produced Products ©2015 McGraw-Hill Education. All Rights Reserved. 5

Figure 18.3: Optimal Provision of a Public Good ©2015 McGraw-Hill Education. All Rights Reserved. 6

Paying For Q* ©2015 McGraw-Hill Education. All Rights Reserved. 7 If the government is to produce Q* units of a public good, it must somehow raise sufficient tax revenue to cover the total production costs of that amount. The willingness to pay for public goods is generally an increasing function of income. –The rich, on the average, assign greater value to public goods than the poor do, not because they have different tastes but because they have more money.

Private Provision of Public Goods ©2015 McGraw-Hill Education. All Rights Reserved. 8 How can the good be paid for, if not by mandatory taxes? Funding by Donation –Free riding: choosing not to donate to a cause but still benefiting from the donations of others. Sale of By-Products Development of New Means to Exclude Nonpayers Private Contracts Clubs

Figure 18.4: The Trade-Off between Privacy and Cost ©2015 McGraw-Hill Education. All Rights Reserved. 9

Public Choice ©2015 McGraw-Hill Education. All Rights Reserved. 10 Majority voting: by this standard, projects favored by a majority—in either a direct referendum or a vote taken by elected representatives—are adopted and all others are abandoned.

The Median Voter Theorem ©2015 McGraw-Hill Education. All Rights Reserved. 11 The median voter theorem states that whenever alternatives can be ranked according to their closeness to each voter ’ s ideal outcome, majority voting will always select the alternative most preferred by the median voter. –Median voter: the voter whose ideal outcome lies above the ideal outcomes of half the voters. –Single-peaked preferences preferences that exhibit a single most-preferred outcome, with other outcomes ranked lower as their distances from their most- preferred outcome increases.

Figure 18.5: The Power of the Median Voter ©2015 McGraw-Hill Education. All Rights Reserved. 12

Cost-Benefit Analysis ©2015 McGraw-Hill Education. All Rights Reserved. 13 Cost-benefit analysis: an alternative to majority voting that attempts to take explicit account of how strongly people feel about each of the alternatives under consideration.

Local Public Goods and the Tiebout Model Even with a perfect mechanism for choosing between alternative public goods, it is difficult to escape the need for painful compromise. Professor Charles Tiebout suggested that at least some of these compromises can be avoided if people are free to form communities with others of similar tastes. – Those who favor high levels of public goods can group together in communities in which they accept the high tax rates necessary to finance these levels. – Those who favor a more limited menu of public goods and services can form groups of their own and have lower tax rates. ©2015 McGraw-Hill Education. All Rights Reserved. 14

Rent Seeking When there are large gains to be had from a project, private parties are willing to spend large sums in order to enhance their odds of being chosen as its beneficiaries. Pursuit of these gains is know as rent seeking. ©2015 McGraw-Hill Education. All Rights Reserved. 15

Income Distribution Determinate outcome: the theory of competitive factor markets tell us that each factor will be paid the value of its marginal product, and that in long-run competitive equilibrium, these payments will add up to the total product available for distribution. It rewards imitative, effort, and risk taking. The harder, longer, and more efficiently a person works, the more they will be paid. ©2015 McGraw-Hill Education. All Rights Reserved. 16

The Rawlsian Criticism Of The Marginal Productivity System ©2015 McGraw-Hill Education. All Rights Reserved. 17 The most common criticism to the marginal productivity system is that it often generates a high degree of inequality.

Rawls’ Thought Experiment ©2015 McGraw-Hill Education. All Rights Reserved. 18 “ What constitutes a just distribution of income? ” To answer using the following thought experiment: –Imagine that you and the other citizens of some country have been thrown together in a meeting to choose the rules for distributing income. This meeting takes place behind a “ veil of ignorance, ” which conceals from each person any knowledge of what talents and abilities he and others have. No individual knows whether he is smart or dull, strong or weak, fast or slow, and so on— which means that no one knows which particular rules of distribution would work to his own advantage The distribution of income chosen from behind this veil of ignorance constitutes what would be considered fair and just.

Fairness and Efficiency ©2015 McGraw-Hill Education. All Rights Reserved. 19 Inefficient solutions make the economic pie smaller for everyone, rich and poor alike. –If efficient solutions are adopted, it must be possible for everyone to receive a larger slice.

Figure 18.6: Charging for Directory Assistance ©2015 McGraw-Hill Education. All Rights Reserved. 20

Methods of Redistribution ©2015 McGraw-Hill Education. All Rights Reserved. 21 Our Current Welfare Programs The Negative Income Tax (NIT) Public Employment for the Poor (JOBS) A Combination of NIT and JOBS

Figure 18.7: Benefits versus Income for a Typical Welfare Program ©2015 McGraw-Hill Education. All Rights Reserved. 22

The Negative Income Tax ©2015 McGraw-Hill Education. All Rights Reserved. 23 Gives every man, woman, and child—rich or poor—an income tax credit that is large enough to sustain a minimally adequate standard of living. –Someone who earned no income would receive this credit in cash. People with earned income would then be taxed on their income at some rate less than 100 percent.

Figure 18.8: A Negative Income Tax Program ©2015 McGraw-Hill Education. All Rights Reserved. 24

Figure 18.9: Income Source in the NIT-JOBS Program ©2015 McGraw-Hill Education. All Rights Reserved. 25