1. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 1 ECON Designed by Amy McGuire, B-books, Ltd. McEachern 2008-2009 16 CHAPTER Public Goods and Public Choice Micro

2. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 2 Private, Public Goods, and in Between LO 1 1.Private goods –Rival in consumption –Exclusive –Provided by private sector 2.Public goods –Nonrival in consumption –Nonexclusive –Provided by government

3. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 3 Private, Public Goods, and in Between LO 1 3.Natural monopoly –Nonrival but exclusive –With congestion: private goods –Provided by private sector or government 4.Open-access good –Rival but nonexclusive –Regulated by government

4. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 4 Exhibit 1 LO 1 Categories of Goods

5. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 5 Optimal Provision of Public Goods LO 1  Nonrival in consumption –Once produced: available to all consumers  Market demand curve –Vertical sum of individual demand curves –Marginal benefit  Efficient level of public good –Market D curve intersects MC curve

6. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 6 Exhibit 2 LO 1 Market for Public Goods Because public goods, once produced, are available to all in identical amounts, the demand for a public good is the vertical sum of each individual’s demand. The efficient level :MC of mosquito spraying equals its marginal benefit; at point e, where the marginal cost curve intersects the market demand curve. The market demand for mosquito spraying (D) is the vertical sum of Maria’s demand, D m, and Alan’s demand, D a.

7. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 7 Paying for Public Goods LO 1  Tax = marginal valuation –Free-rider problem People try to benefit from the public goods without paying for them –Ability to pay

8. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 8 Public Choice in Representative Democracy LO 2  Public choices –Government decisions Public goods Taxes  Median-voter model –The preference of the median voter will dominate other choices

9. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 9 Special Interest and Rational Ignorance LO 2  Elected officials: Maximize political support –Special interest rather than –Public interest Asymmetry Voters ‘rational ignorance’

10. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 10 Distribution of Benefits and Costs LO 2 1.Widespread benefits; widespread costs –Traditional public-goods legislation –Positive impact on economy Total benefits > total costs 2.Concentrated benefits; widespread costs –Special-interest legislation –Harms the economy Total costs > total benefits –Pork-barrel spending

11. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 11 Distribution of Benefits and Costs LO 2 3.Widespread benefits; concentrated costs –Populist legislation –Beneficiaries: rationally ignorant 4.Concentrated benefits; concentrated costs –Competing-interest legislation –Fierce political battles

12. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 12 Exhibit 3 LO 2 Categories of Legislation Based on the Distribution of Costs and Benefits

13. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 13 LO 2 Case Study Farm Subsidies  The Agricultural Marketing Agreement Act, 1937  Prevent ‘ruinous competition’  One in four Americans: farm  Floor prices  2007  One in fifty Americans: farm  $18 billions a year

14. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 14 LO 2 Case Study Farm Subsidies  To subsidize farmers, consumers pay  Higher product price  For the surplus (taxpayers)  For storage (the government buys the surplus)  E.g. milk  Free market p=$1.50  Subsidized p=$2.50+$2.50+$0.50  Farmers: normal profit

15. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 15 Exhibit 4 LO 2 Effect of Milk Price Supports 075100150 Millions of gallons per month $2.50 1.50 Dollars per gallon S D Excess quantity supplied No government intervention: market price = $1.50 per gallon, and 100 million gallons are sold per month. Government: floor price = $2.50 per gallon, quantity supplied increases and the quantity demanded decreases. To maintain the higher price, the government must buy the excess quantity at $2.50 per gallon.

16. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 16 Rent Seeking LO 2  Activity interest groups undertake –Secure special favors from government  Political action committees  Shift resources from production  No incentive for economic efficiency

17. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 17 LO 2 Case Study Campaign Finance Reform  Special-interest money  Soft money  Hard money  Money matters more to challengers  Efforts to limit campaign spending

18. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 18 The Underground Economy LO 3  Unreported market activity –To avoid taxes –Illegal  Tax avoidance –Legal –Pay least possible tax  Tax evasion –Illegal –No or fraudulent tax return

19. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 19 The Underground Economy LO 3  Underground economy grows more –Government regulation increase –Tax rates increase –Government corruption widespread  Estimated: $1.4 trillion in 2007

20. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 20 Bureaucracy in Representative Democracy LO 4  Bureaus –Government departments, agencies  Ownership –Taxpayers  Funding –Government appropriation  Less incentive to eliminate waste and inefficiency

21. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 21 Bureaucracy in Representative Democracy LO 4  Bureaucratic objectives –Serve the public –Maximize budget Larger budget than desired by median voter

22. Chapter 16Copyright ©2009 by South-Western, a division of Cengage Learning. All rights reserved 22 Bureaucracy in Representative Democracy LO 4  Private vs. public production –Private production – may be more efficient –Public production – preferred by public officials