PPA 220A Applied Economic Analysis I Fall 2003 P rofessor Rob Wassmer Meeting 11 Public Choice/Externalities Regulatory

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PPA 220A Applied Economic Analysis I Fall 2003 P rofessor Rob Wassmer Meeting 11 Public Choice/Externalities Regulatory Reform. HW. Questions 1-3, pp. 234-35 in Munger 1. a. Income = \$1,000, P pizza = \$3, P caviar = \$65 Max Pizza = 1,000 / 3 = 333.3 Max Caviar = 1,000 / 65 = 15.4

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PPA 220A Applied Economic Analysis IFall 2003Professor Rob WassmerMeeting 11Public Choice/ExternalitiesRegulatory Reform

HW
• Questions 1-3, pp. 234-35 in Munger
• 1. a. Income = \$1,000, Ppizza = \$3, Pcaviar = \$65
• Max Pizza = 1,000 / 3 = 333.3
• Max Caviar = 1,000 / 65 = 15.4
• Budget line: horizontal pizza, vertical caviar
• Intercepts above
• Caviar = (1000 / 65) – (3 / 65) pizza
• 1. b. Draw indifference curves
• 2. Show change if Ppizza = \$2.50, Ppizza = \$4.00
• 3. Draw demand curve

Voting Results

• Choice 1, Choice 2,Choice 3

Wessels Chapter 13: Public Choice and Externalities

• Externality
• Negative: activity imposes uncompensated costs on others
• Positive: activity offers benefits to other that do not pay to enjoy them
• Causes
• Tragedy of commons
• Absence of property rights
• High transaction and information costs
• Solutions
• Coase
• Pigou (see my handout)
Wessels Chapter 13: Public Choice and Externalities
• Optimal level of pollution
• Total cost = Hurt imposed upon others + abatement cost
• Figure 13.4
• Public choice theory
• Median voter model
• Logrolling
• Vote trading: results in legislation not majority favored
• Rational voter ignorance
• Voting is costly, cost to learn about issue > benefit
• Ideological voting
• Tiebout hypothesis
Munger Chapter 8: Choice of Regulatory Reform
• “Economist’s view of the world”
• Gov’t regulation driven by efficiency
• Reality in policy world
• Figure 8.1: Three conflicts
• Markets vs. experts (efficiency concerns)
• Mediated by politics
• Markets vs. politics (equity concerns)
• Mediated by experts
• Politics vs. experts (institutional concerns)
• Mediated by markets

Figure 8.1:

Three conflicts

Markets

• Equity Policies
• Income Redistribution
• Resource Distribution
• Control Externalities
• Efficiency Policies
• Market structure
• Control Externalities
• Public Goods
• Information Asymmetry

Politics

Experts

• Institutional Reform Policies
• Information
• Values (Efficiency v. Equity
• Institutional Design

Munger Chapter 8: Choice of Regulatory Reform

• Markets vs. experts
• Concern over institutional environment
• Market: trading without central planning
• Organizations: consumers and firms
• Institutions: rules that guide/constrain trading
• Market failures extend beyond (1) classic list already learned
• Info asymmetries, externalities, public goods, natural monopolies

Munger Chapter 8: Choice of Regulatory Reform

• Important, also fail due to
• (2) Impediments to market process
• Non-externality based taxes/subsidies/regulations/info restrictions
• (3) Market process infrastructure missing
• Property rights, money, law/order, etc.
• Market not working? Is it reason 1, 2, or 3?
• Economists default to (1) classic list
• Need to consider institutional framework
• Why politics mediate market vs. expert conflict

Munger Chapter 8: Choice of Regulatory Reform

• Markets vs. politics
• Tradeoff between efficiency and equity
• Everyone agrees upon Pareto improvement
• Most agree upon Kaldor-Hicks improvement
• Little agreement on vertical equity improvement
• Experts mediate
• Concepts of “Fair” distribution of resources
• Total equality
• Property is theft: “fruits of the earth belong to no one”
• Share equal to what needed
• Equalize happiness (disabled)
• Share equal to what produced

Munger Chapter 8: Choice of Regulatory Reform

Figure 8.2 Inequality in Income Distribution in the United States.

Percentiles of income

100

Perfect equality

80

80

60

60

53

40

40

Actual U.S.(1996)

29.7

20

20

4.2

14.2

0

80

100

0

20

40

60

Percentiles of population

Munger Chapter 8: Choice of Regulatory Reform

• Actual distribution of resources in U.S.
• Disparity at each percentile of population
• Poorest 20% population, 4.2% of income
• Wealthiest 20% population, 47% of income
• Problem?
• Rawls and Marx: Yes
• Smith: Not so certain (work harder, more productive, resource control)
• Final distribution can be policy choice
• Things to consider when making
• Ant and Grasshopper: Forgo today for better tomorrow
• But what if never learned, unwilling to do, or done it wrong

Munger Chapter 8: Choice of Regulatory Reform

• More than virtue: Fundamental injustice in capitalism
• Marx (labor theory of value, primitive accumulation)
• Productivity rewards flawed (asymmetric info, discrimination, education opportunities, genetics)
• Three reasons for poverty in market economy
• Lack of skill
• Lack of effort
• Market of output and accumulated wealth low
• Amount of redistribution supported depends on belief in relative importance of each
• Actual redistribution in economy
• Table 8.1

Munger Chapter 8: Choice of Regulatory Reform

• Politics of redistribution
• Figure 8.3: Median income < mean income
• Median voter’s income even greater (turnout)
• Transfers from rich to median voter
• Experts vs. politics
• “The way we decide affects what we decide”
• Preferences x institutions = outcomes
• (What people want) x (rules and practices)
• If both change, multiplicative result
• Desire different outcome, change the institution

Munger Chapter 8: Choice of Regulatory Reform

• \$ and political process
• Marx: economic power translates to political power
• But can \$ be excluded entirely from politics?
• Contribution as way to get voice heard
• Restrictions on special interests hard
• We are all a special interest
• Thus conflict between experts and politics mediated by markets in capitalistic system

Social Security Reform

• Consider facts and define policy problem
• Issue here: What is the problem?
• Facts
• Public support for retirement safety net
• Ratio of receivers to contributors falling
• Payroll financed (6.2% up to \$72k)
• 2/3 seniors receive over ½ income from
• Poverty status of seniors low because of it
• By 2034, only 2/3 covered by payroll taxes
• Consensus that reform needed

Social Security Reform

• Equity or efficiency based reform?
• Equity