Economics for Leaders Lesson 8: Costs & Benefits Of Government Action

Economics for Leaders Institutions Shape Incentives Rule of Law Private Property Rights Open, Competitive Markets Interaction & Exchange (information & competition) Entrepreneurship and Innovation Having the RIGHT INSTITUTIONS in place.

Economics for Leaders Institutions Shape Incentives Institutions are the formal and informal rules of the game that shape incentives and outline expected and acceptable forms of behavior in social interaction. Incentives are the rewards and penalties that influence people’s choices and behavior.

Economics for Leaders Institutions Shape Incentives The rules of the game shape decisions. Decisions result in outcomes. People respond to incentives in predictable ways. INSTITUTIONS MATTER!

Economics for Leaders How do we evaluate government’s role in the economy? Use economic reasoning to… INVESTIGATE! Data Knowledge Evidence

limit power of central government life, liberty, pursuit of happiness (self interest, profit, well-being – not selfish) establish and enforce the protection of private property rights government should do what citizens cannot do! The Role of Government (Founding Fathers)

The Role of Government

Economics for Leaders The opportunity cost of government spending is private spending. The opportunity cost of government spending on a particular program is the foregone benefit of the other program where the money could have been spent. What else could we do? Layered Opportunity Cost of Government Spending?

Economics for Leaders When is this most likely to be the case? public goods externalities monopolies Government should act when: MB ≥ MC

Public Goods Non-rivalrous in consumption Non-exclusive in consumption Guns or Butter

Negative Externalities

Economics for Leaders Positive Externalities

Price Discrimination ???

YearDefense Health & Medicare Inc. & Soc. Security Net Interest on Debt % 15%11% % 11%13% %2%20%9% %7%22%9% %9%35%9% %12%32%15% %20%37%15% 2008*23%25%37%10% Source: Economic Indicators, Council of Economic Advisors

Source: US Office of Management & Budget

The Mix of Government Expenditure

budget deficit: gov’t spending > tax revenue Source: (millions of dollars)

budget deficit: gov’t spending > tax revenue Source: (millions of dollars)

budget deficit: gov’t spending > tax revenue Source:

Economics for Leaders National Debt = Debt Clock: MB vs. MC? What else could we do? Investment or Consumption Party?

Economics for Leaders Public Choice Theory: Like private individuals, elected officials act in their best interests. Elected officials’ abilities to accomplish their goals depend on being elected (and re-elected). Elected officials have an incentive to pay more attention to those constituents who are able and likely to influence the election. The power of Special Interest Groups derives from the distribution of benefits and costs

Economics for Leaders Concentrated Benefits and Diffuse Costs? Big benefit to a small but organized group of voters Small cost to a large number of unorganized, sometime voters

Economics for Leaders Rational Ignorance Do you know your US Senators? Do you know your US Congressional representative? What did they do today? What will they do tomorrow? They spend your (our) money!

Economics for Leaders Big Ideas Government facilitates wealth-producing voluntary exchange by establishing and enforcing the rules of the game that secure property rights and provide incentives. The opportunity cost of government spending is private spending/what else could have been done.

Economics for Leaders The marginal benefit of government involvement in the economy may outweigh the marginal costs when significant externalities exist or in the case of public goods and monopolies. The incentive to expand government activities beyond the point where MB = MC is explained by public choice theory and rational ignorance. Big Ideas

U.S. Injects $30 Billion & Will Own 60% of GM “The sale likely will save more than 3,000 U.S. jobs in manufacturing and engineering, and at various Hummer dealerships.”

“This is a great opportunity for US agriculture and would also mean more food for the Cuban people.” Not to mention the cigars!

I can’t believe I have to breathe their smoke. There should be a law! A law banning smoking will hurt my business!

Economics for Leaders ERP-5: Understanding based on knowledge and evidence imparts value to opinions. Opinions matter and are of equal value at the ballot box. But on matters of rational deliberation the value of an opinion is determined by the knowledge and evidence on which it is based. Statements of opinion should initiate the quest for economic understanding, not end it.