Chapter 5 Economic Efficiency 07 21 2013 Economists use the standard of economic efficiency to asses the desirability of economic outcomes o Occurs when All activities generating more benefit than cost that are No activities are undertaken for which the cost exceeds undertaken the benefit o Economic efficiency is when marginal cost is equal to marginal benefit If it s worth doing it s worth doing imperfectly The gains from doing something even better will not be worth the cost o Think about both marginal benefits and marginal costs and recognize that there are alternative ways of pursuing objectives o Perfection is never worth the cost o Economics is about trade offs Economic Role of Government Protective function by other o Protection of individuals and their property against invasions Maintenance of a framework of security and order Infrastructure of rules within which people can interact peacefully with one another Productive function o The production of goods and services that cannot easily be provided through private markets Stable monetary and financial environment is vital Shortcoming of the market Market shortcomings raise the possibility that government intervention beyond the protective function might improve things Invisible hand may fail because o Lack of competition Sellers may gain by restricting output and raising price Too few units will be produced Exists when the market fails to register fully costs and o Externalities benefits External costs Present when the actions of a group harm the property of others without their consent Problem arises because property rights are imperfectly defined and or enforced THIRD PARTY S ARE AFFECTED NEGATIVELY The supply curve understates the true cost of Units may be produced that are valued less than Too many units are produced from viewpoint of production their cost efficiency Pollution problems are often a side effect External benefits Present when the actions of a group generate benefits for nonparticipating parties THIRD PARTY S ARE AFFECTED POSITIVELY Demand curve understates the true cost of production Units are more highly valued than their costs may not be produced Too few units are produced o Public goods Jointly consumed individuals can simultaneously enjoy the consumption Non excludable it is not possible to restrict consumption of the good to those who pay for it Those who don t pay but still receive the public good is called a free rider When a lot of people do this too little of the o Poor Information good is produced Information problem is minimal if the item is purchased regularly Problems of conflicting interests and unhappy customers can arise if goods are Difficult to evaluate on inspection and seldom repeatedly purchased from the same producer Potentially capable of serious and lasting harmful side effects that cannot be predicted Responses to Poor Information Consumer information publications Provide expert evaluation Brand names and franchises Warranties Chapter 6 The Size and Growth of Government 07 21 2013 Total government spending accounted for only 9 4 of GDP in 1930 and only 1 3 of this spending was at the federal level Government spending soared from 1930 to 1970 o Particularly at the federal level o Rose from 9 4 in 1930 to 30 2 in 1970 Since 1970 government spending has been relatively constant at about 1 3 of the U S economy o Major categories of federal spending Healthcare social security national defense and o Major categories of state and local spending Education health and welfare programs and welfare administration Transfer payments tax income from some and transfer it to others Differences and Similarities Between Government and Markets Competitive behavior is present in both the market and public sectors Public sector organization can break the individual consumption payment link o When decisions are made politically sometimes goods are allocated to people when they paid little or nothing to cover the cost o Individuals are required to pay for a government program even though they derive little or no benefit from it Private sector action is based on mutual agreement public sector is based on majority rule o Mutual gain is the foundation for the market exchange o In the government sector it is based on majority rule Minority must accept policy and help pay for it Scarcity imposes the aggregate consumption payment link in both sectors Income and power are distributed differently in the two sectors Public Choice Analysis The tools of economics to the political process in order to provide insight concerning how the process works Applies the principles of methodology of economics to the operation of the political process political sectors o Self interested behavior is present in both market and Political process can be viewed as a complex interaction among o Voter taxpayers politicians and bureaucrats Voter Consumer Voters tend to support candidates that will provide them with the most benefits and services Rational Ignorance Effect Recognizing their vote is unlikely to be decisive they will not obtain information on candidates and issues Voters will only rely on information provided freely by the candidates o Incentives confronted by the politician Politician Supplier Interested in winning elections Uninformed voters often must be convinced to want the candidate o Incentives of the bureaucrats Interests of bureaucrats are complementary with those of the interest groups they serve Larger budgets and extension programs serve as general interests Benefits and Costs among voters o When benefits or costs are either both widespread or concentrated representative government tends to undertake projects that are productive and reject those unproductive Type 1 and 3 o When benefits are concentrated and costs widespread representative government is biased towards the adoption of counterproductive activity Type 2 o When benefits are widespread but the costs are concentrated the political process often rejects productive products Type 4 Special Interest Effect o Large personal benefit for a small group while imposing a small individual cost on a large number of others Interest group members feel strongly about issues and it will dominate their political choices o Logrolling the exchange between politicians of political support on one issue for political support on another Gets necessary support to pass desired legislation o Pork barrel legislation the bundling of unrelated projects benefiting many
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