Public Finance (MPA405) Dr. Khurrum S. Mughal

Lecture 9: Public Choice and the Political Process Public Finance

Public Choice Public Choice is when decisions are made through political interaction of many persons according to pre-established rules. Public choice vs. private choice Taxes Vs Voluntary Cost-Sharing

Political Equilibrium A political equilibrium is an agreement on the level of production of one or more public goods given the specified rule for making the collective choice and the distribution of tax shares among individuals.

III - Unique and cyclical equilibria

Uniqueness and Cycling A unique political equilibrium may not emerge under majority rule Two or more public good outputs may recieve majority vote The outcome can depend on factors other than cost vs benefits order in which alternatives are presented Inclusion or exclusion of alternatives Disturbing possibility

Uniqueness and Cycling of Outcomes Under Majority Rule Voter Rankings For Fireworks Displays per Year Voter First Choice Second Choice Third Choice A 3 2 1 B C

Preferences Single-peaked preferences a unique optimal outcome exists   Multi-peaked preferences as a person moves away from their most preferred outcome they become worse off until a certain point when moving further away from their most-preferred outcome makes them better off.

Figure 5.3 Voter Rankings of Alternatives Multiple Peaks Single Peak Net Benefit for A Net Benefit for B 1 2 3 1 2 3 Fireworks Displays per Year Single Peak Net Benefit for C 1 2 3 Fireworks Displays per Year

Pairwise Cycling Pairwise cycling is the phenomenon in which each outcome can win a majority depending on how it is paired for voting.

Pairwise Cycling A 3 2 1 B C A X B C Totals 1 vote 2 votes Voter First Choice Second Choice Third Choice A 3 2 1 B C Election 1 1 display per year 2 displays per year A X B C Totals 1 vote 2 votes Result : 2 displays per year wins

Pairwise Cycling A 3 2 1 B C A X B C Totals 1 vote 2 votes Voter First Choice Second Choice Third Choice A 3 2 1 B C Election 2 3 displays per year 1 display per year A X B C Totals 1 vote 2 votes Result :1 display per year wins

Pairwise Cycling A 3 2 1 B C A X B C Totals 1 vote 2 votes Voter First Choice Second Choice Third Choice A 3 2 1 B C Election 3 2 displays per year 3 displays per year A X B C Totals 1 vote 2 votes Result : 3 displays per year wins

Implications Arbitrary results Results are order dependent – any can emerge winner – phenomena of Cycling Disturbing: No rhyme or reason explains the emerging choices Public Choices can be influenced by Order in which issues are placed on the agenda Elimination of one alternative can change the way others are ranked

Arrow's Impossibility Theorem It is impossible to devise a voting rule that meets a set of conditions that can guarantee a unique political equilibrium for a public choice. when voters have three or more distinct alternatives (options), no rank order voting system can convert the ranked preferences of individuals into a community-wide (complete and transitive) ranking while also meeting a specific set of criteria criteria are called unrestricted domain, non-dictatorship, Pareto efficiency, and independence of irrelevant alternatives

Conditions of Arrows Impossibility Theorem All voters have free choice; no dictator. Unique political equilibrium is obtained We cannot rule out multi-peaked preferences. If all voters change their rankings of a particular alternative, the public choice that emerges must not move in the opposite direction. Public choices must not be influenced by the order in which they are presented.  Public choices must not be affected by the elimination or addition of an alternative to the ballot. Public choice should be transitive.

Cause of Cycling: Multi-peaked preferences Voter Rankings For Fireworks Displays per Year: All Voters with Single Peaked Preferences Voter First Choice Second Choice Third Choice A 3 2 1 B C

Figure 5.3 Voter Rankings of Alternatives Single Peak Net Benefit for A 1 2 3 Fireworks Displays per Year Single Peak Single Peak Net Benefit for B’ Net Benefit for C 1 2 3 1 2 3 Fireworks Displays per Year

Pairwise Cycling A 3 2 1 B’ C A X B’ C Totals 1 vote 2 votes Voter First Choice Second Choice Third Choice A 3 2 1 B’ C Election 1 1 display per year 2 displays per year A X B’ C Totals 1 vote 2 votes Result : 2 displays per year wins

Pairwise Cycling A 3 2 1 B’ C A X B’ C Totals 1 vote 2 votes Voter First Choice Second Choice Third Choice A 3 2 1 B’ C Election 2 3 displays per year 1 display per year A X B’ C Totals 1 vote 2 votes Result :1 display per year wins

Pairwise Cycling A 3 2 1 B’ C A X B’ C Totals 1 vote 2 votes Voter First Choice Second Choice Third Choice A 3 2 1 B’ C Election 3 2 displays per year 3 displays per year A X B’ C Totals 1 vote 2 votes Result : 2 displays per year wins

The Median Peak as the Political Equilibrium under Majority Rule Medium Peak (Voter C ) Peak for Voter B' Peak for Voter A Net Benefit 1 2 3 Fireworks Displays per Year

Existence of Multiple-Peaked preferences Multiple Peaked Preferences are inconsistent with declining Marginal Benefit

Net Benefit Marginal Benefit and Tax per Unit t MB Q * Declining Marginal Benefit of a Pure Public Good Meaning That Preferences are Single Peaked Q * Net Benefit MB Marginal Benefit and Tax per Unit t Output of a Pure Public Good

Existence of Multiple-Peaked preferences Multiple Peaked Preferences are inconsistent with declining Marginal Benefit Can exist in real life: Example: Public vs Private schooling Budgets Vietnam War

IV – Political Process

Political Processes Constitutions Minority Rule Majority Rule

Political Processes Constitutions Accepted set of rules by which decisions are made Evolve over time Are generally accepted Some decisions require rules some doesn’t Choice of apparel vs choice of war Viable constitutions have social contracts inherent in their rules Uncertainty of skills and future opportunities

Political Processes Minority Rule Might not satisfy majority of community Political externalities imposed by minority of citizens Decisions by minority – oligarchy One single individual – dictatorship (monarchy) No population involvement – colonial rule

Political Processes Majority Rule Simple majority rule 51% Number of dissatisfied voters declines to 33%