1. Chapter 9 Political Economy
Public Finance and Public Policy
Author: Jonathan Gruber
Instructor: Yigang Zhang

2. Introduction Alaska, bridge to nowhere project Small states advantage;
Logrolling: the process by which politicians trade support for one issue or piece of legislation in exchange for another politician’s support, especially by means of legislative votes;
Logrolling within a Direct Democracy
Implicit Logrolling
Distributive Logrolling

3. Introduction
Economists do not get to decide whether public policies are undertaken or not.
Decisions are made in the context of a complex political system.
Understand the political mechanisms to evaluate whether the intervention is optimal.

4. Arrangement Best case scenario: Realistic case I: direct democracy;
unanimous consent; perfectly measures and aggregates citizens’ preferences; Lindahl pricing;
Realistic case I: direct democracy;
Realistic case II: representative democracy;
Public choice; Government Failure;

5. Lindahl Pricing Lindahl Pricing Problems with Lindahl Pricing
Aggregating individuals’ marginal willingness to pay to form marginal social benefit;
Tie tax prices to individuals’ willingness to pay;
Charging every individual by the willingness to pay;
Benefit taxation;
Problems with Lindahl Pricing
Individuals underreport the valuation to free ride on others;
Individuals have no knowledge about their own valuation on public goods;
Preference aggregation is problematic.

6. Mechanisms for Aggregation
Majority voting;
Single-peaked .vs. non-single-peaked preferences;
When there is other alternatives;
Private school option at choice for public school funding;
Backyard option at choice for sizes of park;
Etc.

7. Majority Voting
TABLE 9-1: Majority Voting Delivers a Consistent Outcome
Types of Voters
Parents
Elders
YoungCouples
First H L M
Second
Third
TABLE 9-2: Majority Voting Doesn't Deliver a Consistent Outcome
Types of Voters
PublicParents
PrivateParents
YoungCouples
First H L M
Second
Third

8. Arrow’s Impossibility Theorem
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:
unrestricted domain
non-dictatorship
Pareto efficiency
independence of irrelevant alternatives

9. Arrow’s Impossibility Theorem
No rank-order voting system can be designed that satisfies these three "fairness" criteria:
If every voter prefers alternative X over alternative Y, then the group prefers X over Y.
If every voter's preference between X and Y remains unchanged, then the group's preference between X and Y will also remain unchanged (even if voters' preferences between other pairs like X and Z, Y and Z, or Z and W change).
There is no "dictator": no single voter possesses the power to always determine the group's preference.

10. Median Voter Theory Assumption: single-peaked preferences
Majority voting will yield the outcome preferred by the median voter if preferences are single-peaked.
The median voter is the voter whose tastes are in the middle of the set of voters, so an equal number of other voters prefer more and prefer less of the public good.

11. Mechanisms for Aggregation
Median Voter Theory;
Difference between mean and median;
Intensity of preferences isn’t reflected;
Lobbying;
Recall the question in quiz #02;
MC/3=30; SMB= ;
Monument Example;
SMC/1001=40; SMB=500* *0=50000;

12. Representative Democracy
Median Voter Theory in Representative Democracy;
Vote maximizing politicians
Location model by Hotelling;
Example: Obama .vs. McCain in national defense;
B0=10, J0=40; B1=20, J1=40;
B2=20, J2=28; B3=25, J3=25;

13. Problems facing Median Voter
Assumptions of the Median Voter Model
Single-dimensional voting;
Bundle issues (less national defense, more education spending, more health care spending, more unemployment benefit, etc.)
Only two candidates;
Location model with 3 shops;
No ideology or influence;
Self-interest politicians;
No selective voting;
Turn-out rate; only voters with intense preferences vote;
No money;
Full information;

14. Public Choice Sources of Government Failure:
Size-Maximizing Bureaucracy;
Problems with Privatization;
Leviathan Theory;
Corruption; (Is lobbying the same?)
Government failure: the inability or unwillingness of the government to act primarily in the interest of its citizens.