2. Congestion and political economy Today: An application of externalities using congestion; Direct democracy; Indirect democracy

3. Today A real-life example with externalities  Automobile congestion  Some economic tools to analyze the situation Equilibrium Market failure Chapter 6  Political economy Direct democracy Representative democracy

4. Congestion externalities Congestion is a big problem in urban areas Possible solutions to the problem  Tolls on congested routes  Building our way out of congestion  HOV lanes  Private highways and express lanes Monopoly power?  Public transit and city design

5. A simple example Choose between a highway and a bridge

6. More information on this example Travel time on the highway is 20 minutes, no matter how many other cars travel on this route The bridge is narrow, and so travel time is dependent on the number of other cars on the bridge If 1 car is on the bridge, travel time is 10 minutes; 2 cars, 11 minutes; 3 cars, 12 minutes; etc.  Travel time is 9 + T minutes if T represents the number of cars on the bridge

7. Route choice and externalities Without tolls, equilibrium occurs with equal travel times on both routes  11 cars on the bridge However, there are negative externalities involved whenever an additional car travels on the bridge  Imposition of a one-minute negative externality to cars already on bridge

8. Why charging a toll is useful Without tolls, the bridge and highway have the same travel times in equilibrium  Take away the bridge and nobody’s travel time changes  No social value to the bridge With tolls, some people can have shorter travel times  Lower overall travel time improves efficiency

9. Aren’t tolls costs too? If bridge tolls go to government, these are just transfers of money Toll revenue can offset tax money that has to be collected  Remember that taxes have DWL, except in a case like this where negative externalities are present In this case, an optimal tax (which is a toll in this case) can reduce DWL

10. Equilibrium with tolls Suppose each minute has $1 in time costs, and a $5 toll is charged  Cost to travel on HW  $20  Cost to travel on bridge  time cost + $5 What is equilibrium?  Each person on the bridge has $15 in time cost  travel time of 15 minutes  6 cars on the bridge

11. In the following analysis… …we assume 30 cars that must travel from A to B How many cars should travel on the bridge to minimize total travel time?

12. For efficiency, see the right column # on bridgeTravel time on bridge Total minutes for bridge travelers Total minutes for highway travelers Total minutes for all drivers 110 580590 21122560582 31236540576 41352520572 51470500570 61590480570 716112460572 817136440576 918162420582 1019190400590 1120220380600

13. What is efficient? 5 or 6 on bridge # on bridgeTravel time on bridge Total minutes for bridge travelers Total minutes for highway travelers Total minutes for all drivers 110 580590 21122560582 31236540576 41352520572 51470500570 61590480570 716112460572 817136440576 918162420582 1019190400590 1120220380600

14. The above example with calculus Total travel time for all cars  20 (30 – T) + (9 + T) T  600 – 11T + T 2 First order condition to minimize travel time  – 11 + 2T = 0  T = 5.5  Is this a minimum or maximum? Try second order condition

15. The above example with calculus Second order condition to check that this is a minimum  2 > 0 Positive second order condition  Minimum Since fractional numbers of cars cannot travel on a route, we see that 5 or 6 cars minimizes total travel time

16. Real traffic problems Los Angeles metro area Some refer many of these freeways to be parking lots during rush hours

17. Can we build our way out? Some people believe that we can build our way out of congestion Let’s examine this problem in the context of our example

18. Increased capacity on bridge New technology leads to bridge travel time at 9 + 0.733T Equilibrium without tolls: T = 15, 20 minute travel times for all once again

19. Increasing bridge capacity Increased capacity leads more people to travel on the bridge Increasing freeway capacity creates its own demand  Some people traveling during non-rush hour periods will travel during rush hour after a freeway is expanded Freeway expansion often costs billions of dollars to be effective during peak travel periods

20. HOV lanes HOV lanes attempt to increase the number of people traveling on each lane (per hour) These attempts have limited success  Benefit of carpool: Decreased travel time, almost like a time subsidy  Cost of carpool: Coordination costs  Problem: Most big cities on the west coast are built “horizontally”  sprawl  limits effective carpooling

21. Private highways Uses prices to control congestion Private financing would prevent tax money from having to be used More private highways would decrease demand for free roads

22. Problems with private highways Monopoly power  Positive economic profits if not regulated  Clauses against increasing capacity on parallel routes Loss of space for expansion of “free” lanes Contracts are often long (30-99 years) Private highways are often built in places with low demand  Tollways in Orange County

23. Public takeover of a private highway This is what happened on the 91 Express Lanes in Orange County (eventually)  Privately built Monopoly problems  Public buy-out of the privately-built lanes With public control, more carpooling has been encouraged

24. Pricing public roads Pricing based on time of day and day of week can improve efficiency by decreasing congestion Recall that these measures increase efficiency Why are these “congestion pricing” practices not used more?  Feasibility  Political resistance

25. Benefits of congestion pricing Gasoline taxes can be reduced in congested areas to offset congestion pricing Pricing increases efficiency  Taxes may increase efficiency in this context Non-commuting traffic has an economic incentive to travel during times of little or no congestion Trips with little economic value can be avoided  Remember: With externalities, these trips have Social MB lower than Social MC

26. Example: 91 Express Lanes toll schedule $10 toll going eastbound on Fridays, 3 pm hour

27. Public transit and city design People often hope that public transit is the solution  However, many people hope that “someone else” takes public transit Why? Slow, inconvenient, lack of privacy  Public transit can only be a long-term solution if it is faster and less costly than driving Public transit will almost always be less convenient than driving

28. Public transit and city design City designs usually make public transit difficult for many people to use effectively  Sprawl leads to people originating travel in many different places  Express buses are difficult to implement  Local buses are slow, used mostly by people with low value of time

29. Public transit and city design City planners can make public transit more desirable  Increased population density near public transit  Areas with big workplace density, especially near bus routes and rail lines  Designated bus lanes to make bus travel faster than driving solo

30. Public transit and city design The problem with these potential solutions  People in these cities want their single family homes, low density neighborhoods  People value privacy highly This leads to the externality problems of congestion

31. Summary: Congestion externalities Congestion is a major problem in urban areas  Especially in cities built “horizontally” Congestion pricing has been implemented on a limited basis in recent decades in California  Feasibility and political resistance has limited further implementation Many other methods are used to try to limit congestion  Mixed success

32. Democracy Political decision making is important for public finance Two types of democracy in this “mini-lecture”  Direct  Indirect, or representative

33. Direct democracy There are different ways to make decisions in a direct democracy  Unanimity, especially of public goods purchases Lindahl prices  Majority voting rules Possible cycling with three or more choices Median voter theorem  Arrow’s impossibility theorem

34. Unanimity with public goods Suppose there are two people trying to find the efficient level of public goods purchases Each person could decide on a quantity to purchase  Free-rider problem Each person could decide on a quantity to purchase, given what fraction he or she would pay  The share paid is known as a Lindahl price

35. Direct democracy: Unanimity rules r per year 0 0’ Adam’s share (S A ) Eve’s share (S E ) DrADrA The Lindahl Model DrEDrE r* S* Notice that by construction of graph, shares add up to one at each point

36. Feasibility of unanimity rules Reaching equilibrium  Time and negotiation costs are usually very high when many people are involved Strategic behavior  One person could react to how he or she thinks the other will behave  Strategic behavior can prevent efficient results from occurring

37. Majority voting rules Majority voting relies on all voters having single-peaked preferences With single-peaked preferences…  The person with median preferences can essentially make the decision (under certain conditions) Trading votes may or may not increase welfare  Programs that lower overall welfare are known as “pork”

38. Jen: Double-peaked preferences Missiles Utility A BC Brad Jen Angelina Single-peaked preferences Double-peaked preferences

39. Preferences When at least one person does not have single-peaked preferences, we can get cycling  Cycling occurs when no clear winner can be established

40. Single-peaked preferences Each person has single-peaked preferences here  Brad’s peak is at A  Jen’s peak is at C  Angelina’s peak is at B A vs. B: B wins A vs. C: C wins B vs. C: B wins B is the clear winner Voter ChoiceBradJenAngelina FirstACB SecondBBC ThirdCAA

41. Back to Jen’s two peaks This example is different from the previous one  Jen now has double-peaked preferences A and C are both peaks We now get cycling  A vs. B: A wins  A vs. C: C wins  B vs. C: B wins  No clear winner  This inconsistency is part of a voting paradox Voter ChoiceBradJenAngelina FirstACB SecondBAC ThirdCBA This example is the same as in the graph a few slides ago

42. Suppose Angelina is in charge Agenda manipulation: Someone can decide on the order of votes to get her or his first choice  Suppose Angelina decides the order of votes to get her most- desired choice  First, A vs. C: C wins  Second, B vs. C: B wins  B is implemented Voter ChoiceBradJenAngelina FirstACB SecondBAC ThirdCBA

43. The median voter theorem When preferences of each person are single peaked, we can assign a “median voter” Relative to the median voter  Half of the people want more  Half of the people want less Under certain conditions, the median voter’s preferences will be approved

44. The median voter theorem VoterMost desired expenditure on breast cancer research Abby$50 Betty$1,000 Christine$1,100 Doris$2,500 Elaine$50,000 Median voter theorem predicts that $1,100 will be voted on

45. Six reasonable criteria for decision making Kenneth Arrow studied six criteria that many people would consider “ethically acceptable” Unfortunately, there is no guarantee that all six criteria can be followed  This proof is known as Arrow’s Impossibility Theorem What are the six criteria? Kenneth Arrow, 2004

46. The six criteria that Arrow proposed It can produce a decision whatever the configuration of voters' preferences  No problems due to multipeaked preferences It must be able to rank all possible outcomes It must be responsive to individuals’ preferences  Example: If everyone prefers A to B, then society does too Preferences must be transitive  If A is at least as good as B, and B is at least as good as C, then A is at least as good as C Independence of irrelevant alternatives  Relative rankings of two goods do not depend on a third good Dictatorship ruled out  Social welfare is a function of more than one person

47. Representative democracy In a representative democracy, a subset of the population votes to determine who our elected politicians are  Median voter theorem applies here also, assuming single-dimensional rankings and exactly two candidates  Ideology, personality, and leadership abilities of the politician may matter to voters  If no candidate appeals to a voter he or she may not vote

48. Median voter theorem in one dimension Number of Voters LiberalConservative Median voterS If a candidate takes position S, the opponent can take the median voter stance and get a majority of votes

49. Implications of the median voter model Based on the median voter model…  Two-party systems tend to be stable  Replacement of direct referenda by representative system has no effect on outcomes

50. Logrolling Logrolling is the act of politicians trading votes in order to pass legislation that is beneficial to their district  Some logrolling improves welfare  Some logrolling does not improve welfare An example  Suppose that Waldo, Xavier, and Zach each live in a different congressional district  Note that this example uses a different approach than in the book

51. Logrolling In each case, Waldo, Xavier, and Zach’s representatives can get together to try to pass each other’s projects If all three projects are passed together, Waldo, Xavier, and Zach are each better off Whether or not the logrolling leads to welfare improvements depends on the cost to others

52. Welfare-improving logrolling ProjectWaldoXavierZachothersTotal net benefits Park500-200-250-3020 Beach restoration -200750-300-100150 Tree planting -200-300750-75175

53. Bring on the pork ProjectWaldoXavierZachothersTotal net benefits Park500-200-250-130-80 Beach restoration -200750-300-350-100 Tree planting -200-300750-275-25

54. Public employees Public employees fulfill legislated mandates and operate many government operatives  Bureaucrats sometimes have interpretive power  Red tape criticism Unresponsive to reasonable requests  No market-oriented incentives Some bureaucrats want to maximize the size of their departments  Niskanen’s model of bureaucracy

55. Niskanen’s model of bureaucracy Q per year $ 0 V C Q* Efficient output Q bc Bureaucrat’s suggested output

56. What can the politician do? A politician can change the quantity to Q* if he or she knows what Q* is  Sometimes, only the bureaucrat knows what Q* is Make bureaucrats’ pay dependent on quality of work  Requires costly oversight Hire bureaucrats that are reliable in determining what Q* is  Probably difficult

57. Special interests “Special interests” has become a politically- charged term in today’s political arena What are some special interest groups?  Labor groups  Groups that favor the rich, poor, young, or old  Groups that favor tax breaks for an industry  Groups that want to enhance social and religious goals  Rent-seeking behavior Attempts for a firm to have positive economic profits

58. Rent-seeking behavior tons of peanuts per year $ S=MC D MR Rents Competitive outcome Cartel price and quantity Deadweight loss with a cartel

59. Other people involved Other people help to carve the political landscape  Judges have control to enforce and interpret laws  Media influence Providing information Political leanings  Experts  Former politicians Example: Al Gore

60. Summary: Democracy Democracies can be direct or indirect Both types of democracies have their own sets of problems  Direct democracies Time consuming to people Cycling Arrow’s Impossibility Theorem  Indirect democracies Bureaucrats Special interests