Twelfth Edition, Global Edition

Twelfth Edition, Global Edition
ECONOMICS Twelfth Edition, Global Edition Michael Parkin 1

16 PUBLIC CHOICES, PUBLIC GOODS, AND HEALTHCARE
Notes and teaching tips: 12, 22, 29, 34, 35, 60, and 69. To view a full-screen figure during a class, click the expand button. To return to the previous slide, click the shrink button. To advance to the next slide, click anywhere on the full screen figure. Applying the principles of economics to interpret and understand the news is a major goal of the principles course. You can encourage your students in this activity by using the two features: Economics in the News and Economics in Action. (1) Before each class, scan the news and select two or three headlines that are relevant to your session today. There is always something that works. Read the headline and ask for comments, interpretation, discussion. Pose questions arising from it that motivate today’s class. At the end of the class, return to the questions and answer them with the tools you’ve been explaining. (2) Once or twice a semester, set an assignment, for credit, with the following instructions: (a) Find a news article about an economic topic that you find interesting. (b) Make a short bullet-list summary of the article. (c) Write and illustrate with appropriate graphs an economic analysis of the key points in the article. Use the Economics in the News features in your textbook as models. PUBLIC CHOICES, PUBLIC GOODS, AND HEALTHCARE 2

After studying this chapter, you will be able to:
Explain why some choices are public choices and how they are made in a political marketplace Explain how the free-rider problem arises and how the quantity of public goods is determined Explain why governments provide healthcare and how our healthcare markets work 3

Public Choices A public choice is a decision that has consequences for many people and perhaps for an entire society. Examples of public choices include: Decisions by political leaders and senior public servants about price and quantity regulation, taxes, international trade, and government spending. 4

Public Choices Why Governments?
Governments exist for three reasons. They Establish and maintain property rights. Provide nonmarket mechanisms for allocating scarce resources. Implement arrangements that redistribute income and wealth. 5

Public Choices Replacing markets with government resource allocation decisions is no simple matter. Government failure is a situation in which government actions lead to inefficiency Government failure can lead to overprovision or under provision. 6

Public Choices Public Choice and Political Marketplace
Four groups of decision makers are Voters Firms Politicians Bureaucrats 7

Public Choices Political Marketplace
Voters express their demand via votes. Voters and firms express their demand for policies via campaign contributions. Politicians express their supply of policies with proposals which they hope will attract votes. 8

Public Choices Bureaucrats try to get the biggest possible budget for their departments and provide public goods and services. 10

Public Choices Political Equilibrium
In a political equilibrium the choices of voters, firms, politicians, and bureaucrats are compatible and no group can see a way of improving its position by making a different choice. 11

Public Choices What Is a Public Good?
What is the essential difference between: A city police department and Brink’s security? Fish in the Atlantic Ocean and fish in a fish farm? A live concert and a concert on television? These and all goods and services can be classified according to whether they are excludable or nonexcludable and rival or nonrival. Classroom activity Check out Economics in Action: Is a Lighthouse a Public Good? 12

Public Choices Excludable
A good is excludable if only the people who pay for it are able to enjoy its benefits. Brink’s security services, East Point Seafood’s fish, and a Coldplay concert are examples. A good is nonexcludable if it is impossible (or extremely costly) to prevent anyone from benefiting from it. The services of the LAPD, fish in the Pacific Ocean, and a concert on network television are examples. 13

Public Choices Rival A good is rival if one person’s use of it decreases the quantity available for someone else. A Brink’s truck can’t deliver cash to two banks at the same time. A fish can be consumed only once. A good is nonrival if one person’s use of it does not decrease the quantity available for someone else. The services of the LAPD and a concert on network television are nonrival. 14

Public Choices A Four-Fold Classification Private Goods
A private good is both rival and excludable. A can of Coke and a fish on East Point Seafood’s farm are examples of private goods. Public goods A public good is both nonrival and nonexcludable. A public good can be consumed simultaneously by everyone, and no one can be excluded from its benefits. National defense is the best example of a public good. 15

Public Choices Common Resources
A common resource is rival and nonexcludable. A unit of a common resource can be used only once, but no one can be prevented from using what is available. Ocean fish are a common resource. They are rival because a fish taken by one person isn’t available for anyone else. They are nonexcludable because it is difficult to prevent people from catching them. 16

Public Choices Natural Monopoly Goods
A natural monopoly good is nonrival and excludable. A special case of natural monopoly arises when the good or service can be produced at zero marginal cost. Such a good is nonrival. If it is also excludable, it is produced by a natural monopoly. The Internet and cable television are examples. 17

Public Choices Figure 16.2 shows this four-fold classification of goods and services. 18

Public Choices The Things Our Governments Buy
Of the things governments buy national defense, protection, and constructing and maintaining the transportation infrastructure fit the definition of a public good. They are nonrival and nonexcludable. But what about healthcare and education? They are rival and excludable, so aren’t they private goods? Why do governments provide them? 20

Public Choices Heathcare
Healthcare is two goods: healthcare service and health insurance. Governments provide both gods because, left to the market alone, they would be inefficiently underprovided and unfairly distributed. Education Governments provide public education because it brings benefits that spill over to others—called external benefits. Everyone benefits from living in an educated society. 21

Providing Public Goods
The Free-Rider Problem A free rider enjoys the benefits of a good or service without paying for it. Because no one can be excluded from the benefits of a public good, everyone has an incentive to free ride. Public goods create a free-rider problem—the absence of an incentive for people to pay for what they consume. Free-rider experiment. There are lots of free-rider experiments that you can get your students to do. An easy one from which the students learn quickly is the following. Each student has ten $10 tokens to invest Students instructed to choose the allocation between 1. A private account that provides a return to the student of 10 percent 2. A public account that provides a return to the class of 50 percent that is shared equally with everyone in the class Play the game for three rounds, permit no communication between rounds, and post the results after each round Permit discussion and communication and then repeat the game for another three rounds 22

The value of a private good is the maximum amount that a person is willing to pay for one more unit of it. The value of a public good is the maximum amount that all the people are willing to pay for one more unit of it. To calculate the value placed on a public good, we use the concepts of total benefit and marginal benefit. 23

Marginal Social Benefit from a Public Good Total benefit is the dollar value that a person places on a given quantity of a good. The greater the quantity of a good, the larger is a person’s total benefit. Marginal benefit is the increase in total benefit that results from a one-unit increase in the quantity of a good. The marginal benefit of a public good diminishes with the quantity of the good provided. 24

Figure 16.3 shows that the marginal social benefit of a public good is the sum of marginal benefits of everyone at each quantity of the good provided. Part (a) shows Lisa’s marginal benefit. Part (b) shows Max’s marginal benefit. 25

The economy’s marginal social benefit of a public good is the sum of the marginal benefits of all individuals at each quantity of the good provided. The economy’s marginal social benefit curve for a public good is the vertical sum of all individual marginal benefit curves. 27

The marginal social benefit curve for a public good contrasts with the demand curve for a private good, which is the horizontal sum of the individual demand curves at each price. What is “vertical” vs. “horizontal” summation? Whether we add marginal benefit curves together vertically or horizontally is sometimes a source of confusion for students. Tell them to focus on the unit of measurement on each axis. When we are looking at private goods, we want to know how many units should be produced to satisfy market demand at a given price. Because private goods are both rival and excludable, each buyer must have his or her own units, so we must add together the number of units demanded by each individual. In other words, we’re adding the horizontal coordinates (quantities) of individual demand curves to get the market demand curve, and we say we are adding the individual demand curves or marginal benefit curves “horizontally.” For public goods that are nonrival and nonexcludable, anyone who purchases a good is providing that good to everyone. If every consumer in the market demands one unit of a good, we can’t simply add together all of those units. Once one unit is provided to anyone, it is provided to everyone. The benefit of that unit will be determined by the sum of individual marginal benefits for that unit. An individual’s marginal benefit is measured as the y coordinate of an individual demand curve, so to find the marginal social benefit, we add all of the individual marginal benefits together. We say we are adding the individual demand curves or marginal benefit curves “vertically”. 29

The Marginal Social Cost of a Public Good The marginal social cost of a public good is determined in the same way as that of a private good. The Efficient Quantity of a Public Good The efficient quantity of a public good is the quantity at which marginal social benefit equals marginal social cost. 30

Figure 16.4 illustrates the efficient quantity of a public good. With fewer than 3 airplanes, MSB exceeds MSC. Resources can be used more efficiently by increasing the quantity. 31

With more than 3 airplanes, MSC exceeds MSB. Resources can be used more efficiently if fewer airplanes are provided. So only at the quantity at which MSB = MSC are resources used efficiently. Private production would produce 0 airplanes. 33

Inefficient Private Provision If a private firm tried to produce and sell a public good, almost no one would buy it. The free-rider problem results in too little of the good being produced by a private firm. Classroom activity Check out Economics in Action: Fighting Colorado’s Wildfires 34

Efficient Public Provision Because the government can tax all the consumers of the public good and force everyone to pay for its provision, public provision overcomes the free-rider problem. If two political parties compete, each is driven to propose the efficient quantity of a public good. A party that proposes either too much or too little can be beaten by one that proposes the efficient amount because more people vote for an increase in net benefit. Classroom activity Check out Economics in the News: Maintaining the Transportation Infrastructure 35

Figure 16.5 illustrates the efficient political outcome. Two parties, Hopes and Fears, agree on everything except the number of airplanes. If Hopes propose 2 airplanes and Fears propose 4, voters are equally unhappy and the election is too close to call. 36

If Hopes increase the number of airplanes to 3, it will win the election if Fears propose 4. If Fears decrease the number of airplanes to 3, it will win the election if Hopes propose 2. Both parties propose 3 airplanes and each party gets 50 percent of the votes. 38

Principle of Minimum Differentiation The attempt by politicians to appeal to a majority of voters leads them to the same policies—an example of the principle of minimum differentiation. The principle of minimum differentiation is the tendency for competitors (including political parties) to make themselves similar so as to appeal to the maximum number of clients (voters). (The same principle applies to competing firms such as McDonald’s and Burger King.) 39

Inefficient Public Overprovision If competition between two political parties is to deliver the efficient quantity of a public good, bureaucrats must cooperate and help achieve this outcome. Objective of Bureaucrats Bureaucrats want to maximize their department’s budget. A bigger budget increases their status and power. Bureaucrats might try to persuade politicians to provide more than the efficient quantity. 40

Rational Ignorance Rational ignorance is the decision by a voter not to acquire information about a policy or provision of a public good because the cost of doing so exceeds the expected benefit. For voters who consume but don’t produce a public good, it is rational to be ignorant about the costs and benefits. For voters who produce a public good, it is rational to be well informed. When the rationality of uninformed voters and special interest groups is taken into account, the political equilibrium results in overprovision of a public good. 41

Figure 16.6 shows bureaucratic overprovision. If rationally ignorant voters enable the bureaucrats to achieve their goal of maximizing their budget, … the public good might be overprovided and a deadweight loss created. 42

The Economics of Healthcare
The key reason why governments play a large role in healthcare is that It would be underprovided and unfairly distributed if left to the market alone. Healthcare Market Failure Three problems make healthcare a special good is that people Underestimate its benefit Underestimate their future needs Can’t afford the care they need 44

Underestimate Benefit People don’t have enough information to value the benefit of healthcare correctly. Many (especially healthy and young people) optimistically underestimate the health risks that they face. So they undervalue the insurance policies that can help them pay for healthcare and the healthcare resources that stand ready to help them when needed. 45

Underestimate Future Needs People take too short a view of the benefits of healthcare. The young and healthy don’t plan far into the future when they will be old and unhealthy. The end result is that many people perceive too small a marginal benefit from health insurance, and are not willing to pay what it is actually worth to them. 46

Can’t Afford For many people, the price of health insurance is beyond their ability to pay for it. Two groups of people are unable to afford adequate health insurance: those with a long-term health problem and the aged. But these are the people with the greatest need for healthcare. Most people want these people to have access to affordable healthcare. So there is an additional social benefit from healthcare. 47

Because the marginal social benefit of healthcare exceeds the marginal benefit perceived by its consumers, a competitive market in healthcare would underprovide it. The underprovision is Inefficient Unfair Figure 16.7 (next slide) illustrates the inefficient underprovision of a competitive market in healthcare. 48

Demand is determined by perceived marginal benefit. The curve D = MB shows the demand for healthcare. The curve S = MSC shows the supply of healthcare. The competitive market equilibrium is 0.3 billion patients a year. 49

The curve MSB shows the marginal social benefit from healthcare. The efficient quantity is 0.7 billion patients a year. Underprovision create a deadweight loss shown by the gray triangle. 51

Unfair The people who receive healthcare are only the ones who are willing and able to pay for it. The people who don’t receive healthcare bear the deadweight loss. They are the long-term sick and the aged who can’t afford the cost of healthcare. Because the market would deliver an inefficient and unfair outcome, healthcare is provided by the public choices of governments. 52

Alternative Public Choice Solutions There is a wide range of levels of public funding of healthcare. Healthcare paid by public expenditure are 83 percent in the United Kingdom 70 percent in Canada 46 percent in the United States But among these countries, public expenditure per person is highest in the United States. 53

Different public choices lead to different expenditures and different implications for efficiency and cost of healthcare. Three approaches to public choices are Universal coverage, single payer Private and government insurance Subsidized private insurance: Obamacare 54

Universal Coverage, Single Payer This system is used in Canada and the United Kingdom. Universal coverage means everyone is covered, no exceptions. Single payer means government buys the healthcare and chooses the quantity to supply. Patients access healthcare at zero (or low) price. Figure 16.8 (next slide) shows how this system works. 55

The demand curve D = MB, the supply curve S = MSC, and the curve MSB are the same as in Fig The quantity supplied is fixed at a level that exceeds the market equilibrium, … but less than the efficient quantity. A deadweight loss arises. 56

Patients face zero price, so the quantity demanded exceeds the quantity supplied. The available healthcare resources are allocated by doctors. Patients wait for treatment. 58

Defenders of this system say that inefficiencies are small and worth accepting because the outcome is fair. Everyone has equal access to services. But it isn’t exactly true that everyone has equal access. Some people are better at playing the system than others and are able to jump the line. 59

Private and Government Insurance In the United States, most healthcare services are produced by private doctors and hospitals that receive their incomes from three sources: Private health insurance (41 percent) Government (Medicare, Medicaid, etc 46 percent). Patients (13 percent) The quantity of healthcare provided is 1 billion patients per year. (3 physician visits per person per year.) Let the consumers determine the composition of public good to be provided. In the case of benefit externalities like education, the government has three policy choices: public provision, private subsidy, or vouchers. All three policies require the government to initially assess the social marginal costs and benefits to find the optimal level of education to be consumed. However, only the public provision policy forces the government to continually assess what type of education should be provided in a dynamic world of ever-changing technology. The policies of private education subsidies or educational vouchers force the students to determine what types of education would be best, because they now face an opportunity cost for their decisions as to what school to attend. An informed and motivated clientele, armed with vouchers or subsidies to allocate across the different qualifying educational institutions, would drive the composition of educational opportunities supplied by the different educational institutions. Classroom activity Check out Economics in Action: U.S. Heath-Care Expenditures in Global Perspective 60

Figure 16.9 shows how the system works. The quantity is determined by the quantity demanded by patients at the out-of- pocket price. Doctors supply the quantity demanded by patients. The quantity exceeds the efficient quantity and creates a deadweight loss. 61

Figure 16.9(b) illustrates the expenditure paid by: Patients Private insurers Government Government expenditure is determined by the quantity of care demanded, not by a fixed budget. 63

Obamacare The Patient Protection and Affordable Care Act, has created a Health Insurance Marketplace to provide subsidized insurance. The market quantity is 2 million insured at a price of $6,000 per family. 64

Figure illustrates how the Obamacare works. A subsidy of $5,000 per family puts a gap between the price paid of $4,000 and the price received by the insurer, $9,000. The total payment of $40 billion per year equals the area of the blue rectangle. Obamacare increases the number of people insured. 66

Does Obamacare achieve an efficient outcome? To know if it does or not, we would need to have an estimate of the extent to which the marginal social benefit of health insurance for the affected families exceeds their ability and willingness to pay. 67

Vouchers a Better Solution? When a market failure arises because marginal social benefit exceeds the ability and willingness to pay, economists say that vouchers should be used. A voucher is a token that can be used to buy only the item that the voucher specifies. So a healthcare voucher could be used to buy only health insurance. Laurence Kotlikoff suggests that every American be given a healthcare voucher. 68

Vouchers have four advantages over public provision and private subsidies: Vouchers can be used with public production, private provision, or competition between them. Governments can set the total value of vouchers to overcome bureaucratic overproduction. Vouchers spread the public contribution across millions of consumers. 4. By giving the buying power to patients, producers compete and provide quality service at the lowest attainable cost. Classroom activity Check out Economics in Action: Education Quality and Cost: Charter Schools Check out At Issue: Is Obamcare the Solution to U.S. Health-Care Problems? 69

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