1. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko “The Economic Way of Thinking” 11 th Edition Chapter 13: Markets and Government

2. © 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?

3. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 3 of 45 Chapter 13 Outline Excluding Nonpayers The Free-Ride Problem Positive Externalities and Free-Riders Law and Order National Defense Roads and Schools

4. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 4 of 45 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

5. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 5 of 45 Chapter 13 Outline Positive Externalities and Government Policies How Do People Identify the Public Interest? The Prisoner’s Dilemma The Limits of Political Institutions

6. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 6 of 45 Introduction Key questions in constitutional political economy –What should be left to the market? –What are the appropriate tasks for government?

7. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 7 of 45 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?

8. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 8 of 45 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

9. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 9 of 45 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.

10. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 10 of 45 Economic Theory and Government Action Question –Does the government make decisions in the same way?

11. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 11 of 45 Economic Theory and Government Action Governments: –Have limited resources. –Wants exceed the capacity of the resources. –Must allocate their resources. –Will use incentives to determine the optimal allocation.

12. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 12 of 45 Economic Theory and Government Action What is the role of property rights in government behavior?

13. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 13 of 45 The Right to Use Coercion Government possesses a generally conceded and exclusive right to coerce adults.

14. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 14 of 45 The Right to Use Coercion Coercion –To induce cooperation by threatening to reduce people’s options. Persuasion –To induce cooperation by promising to expand people’s options.

15. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 15 of 45 The Right to Use Coercion Examples of Coercion –Traffic laws –Easements –Code enforcement

16. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 16 of 45 The Right to Use Coercion 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.

17. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 17 of 45 Is Government Necessary? How much police protection did you consume last month? Would police protection be available without government?

18. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 18 of 45 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?

19. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 19 of 45 Excluding Nonpayers Positive Externalities and Free-Riders –Spillover benefits reduce the incentive to produce certain goods. Positive Externalities and Free-Riders –Government can create an incentive to produce goods through coercion which reduces the transaction cost.

20. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 20 of 45 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?

21. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 21 of 45 The Free-Rider Problem People are guided by the costs they expect to bear and benefits they expect to receive.

22. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 22 of 45 Positive Externalities and Free-Riders Positive Externalities –Exist alongside negative externalities. –Create a disincentive to produce. –Probably more prevalent than spillover costs.

23. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 23 of 45 Positive Externalities and Free-Riders Exchange entails transaction costs. Transaction Costs –Reduce exchanges if they exceed marginal benefits. Government Coercion –Reduces transaction costs.

24. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 24 of 45 Law and Order High transaction costs make it difficult to exclude free-riders. Government coercion forces everyone to pay involuntary contributions (taxes).

25. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 25 of 45 Law and Order Uniform and Consistent Rules –Increase planning confidence –Contribute to cooperating society Examples –Defining property rights –Enforcement of contracts

26. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 26 of 45 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.

27. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 27 of 45 Roads and Schools Question –Would the quantity and quality of roads be the same if coercion was not used to finance them?

28. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 28 of 45 Roads and Schools Transaction Costs –Would be high if tolls were relied on to finance roads. Question –Do others benefit from road development?

29. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 29 of 45 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.

30. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 30 of 45 Income Redistribution The government provides special benefits to the impoverished. Question –Why not rely on private philanthropy? Hint: Free-riders

31. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 31 of 45 The Regulation of Voluntary Exchange Reducing Transaction Costs –Licensing –Certification –Setting standards

32. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 32 of 45 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?

33. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 33 of 45 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?

34. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 34 of 45 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?

35. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 35 of 45 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.

36. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 36 of 45 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

37. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 37 of 45 Positive Externalities and Government Policies Government policies –tend to be dominated by special interests.

38. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 38 of 45 How Do People Identify the Public Interest? Scenario –How long should a new drug be tested by the FDA?

39. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 39 of 45 How Do People Identify the Public Interest? Costs and Benefits Time Spent in Testing Benefits to patients of additional testing Costs to patients of additional testing Cost = Benefit T1T1 Cost to the FDA for testing T2T2

40. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 40 of 45 The Prisoner’s Dilemma The Dilemma –Choosing whether to spend two hours/week working on a public policy issue or go bowling.

41. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 41 of 45 The Prisoner’s Dilemma Others Choose EachChooses DutyRecreation Duty Recreation GoodGovernment BadGovernment GoodGovernmentPlusBowlingBadGovernmentPlusBowling

42. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 42 of 45 The Limits of Political Institutions What do you think? –Are there limits to what political institutions can accomplish?

43. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 43 of 45 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.

44. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 44 of 45 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.

45. © 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 45 of 45 End of Chapter 13