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© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko
“The Economic Way of Thinking”
11th Edition
Chapter 13:
Markets and
Government
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 2 of 45
Chapter 13 Outline
• Introduction
• Private Versus Public?
• Competition and Individualism
• Economic Theory and Government Action
• The Right to Use Coercion
• Is Government Necessary?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 3 of 45
Chapter 13 Outline
• Excluding Nonpayers
• The Free-Ride Problem
• Positive Externalities and Free-Riders
• Law and Order
• National Defense
• Roads and Schools
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 4 of 45
Chapter 13 Outline
• Income Redistribution
• The Regulation of Voluntary Exchange
• Government and the Public Interest
• Information and Democratic Governments
• The Interests of Elected Officials
• Concentrated Benefits, Dispersed Costs
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 5 of 45
Chapter 13 Outline
• Positive Externalities and Government Policies
• How Do People Identify the Public Interest?
• The Prisoner’s Dilemma
• The Limits of Political Institutions
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 6 of 45
Introduction
• Key questions in constitutional political economy
– What should be left to the market?– What are the appropriate tasks for government?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 7 of 45
Private Versus Public?
• The market usually characterizes the private sector.
• Government agencies and officials comprise the public sector.
• Question
– Does individual self-interest play a role in the public sector?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 8 of 45
Competition and Individualism
• The market sector is often referred to as the competitive sector.
• Question
– Is there competition in the government?
• Competition in the public sector
– Elections– Government agencies– Passing legislation
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 9 of 45
Economic Theory and Government Action
• Economic Theory
– All participants are concerned with self-interest and behave rationally.
– If the marginal revenue of an activity exceeds the marginal cost, the activity should be expanded.
– If the marginal cost of an activity exceeds the marginal revenue, the activity should be contracted.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 10 of 45
Economic Theory and Government Action
• Question
– Does the government make decisions in the same way?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 11 of 45
Economic Theory and Government Action
• Governments:
– Have limited resources.– Wants exceed the capacity of the resources.– Must allocate their resources.– Will use incentives to determine the optimal
allocation.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 12 of 45
Economic Theory and Government Action
• What is the role of property rights in government behavior?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 13 of 45
The Right to Use Coercion
• Government possesses a generally conceded and exclusive right to coerce adults.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 14 of 45
The Right to Use Coercion
• Coercion
– To induce cooperation by threatening to reduce people’s options.
• Persuasion
– To induce cooperation by promising to expand people’s options.
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The Right to Use Coercion
• Examples of Coercion
– Traffic laws– Easements– Code enforcement
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 16 of 45
The Right to Use Coercion
• We may be able to achieve greater freedom and expanded options if we all accept some limitations of our freedom and some reduction in our options.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 17 of 45
Is Government Necessary?
• How much police protection did you consume last month?
• Would police protection be available without government?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 18 of 45
Excluding Nonpayers
• Without government
– People who wanted police and/or fire protection could pay for it.
– Could their neighbors be excluded?– How does this impact a person’s willingness to pay for
protection?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 19 of 45
Excluding Nonpayers
• Positive Externalities and Free-Riders
– Spillover benefits reduce the incentive to produce certain goods.
• Positive Externalities and Free-Riders
– Government can create an incentive to produce goods through coercion which reduces the transaction cost.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 20 of 45
The Free-Rider Problem
• Free-Riders
– People who accept benefits without paying their share of the cost of providing those benefits.
• Question
– Why don’t people do what would clearly make themselves and others better off?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 21 of 45
The Free-Rider Problem
People are guided by the costs they expect to bear and benefits they expect to receive.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 22 of 45
Positive Externalities and Free-Riders
• Positive Externalities
– Exist alongside negative externalities.– Create a disincentive to produce.– Probably more prevalent than spillover costs.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 23 of 45
Positive Externalities and Free-Riders
• Exchange entails transaction costs.
• Transaction Costs
– Reduce exchanges if they exceed marginal benefits.
• Government Coercion
– Reduces transaction costs.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 24 of 45
Law and Order
• High transaction costs make it difficult to exclude free-riders.
• Government coercion forces everyone to pay involuntary contributions (taxes).
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 25 of 45
Law and Order
• Uniform and Consistent Rules
– Increase planning confidence– Contribute to cooperating society
• Examples
– Defining property rights– Enforcement of contracts
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 26 of 45
National Defense
• National Defense
– A public good– A traditional role of government– Can’t be provided privately due to the free-rider
problem.– Does not have to be solely provided through coercion.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 27 of 45
Roads and Schools
• Question
– Would the quantity and quality of roads be the same if coercion was not used to finance them?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 28 of 45
Roads and Schools
• Transaction Costs
– Would be high if tolls were relied on to finance roads.
• Question
– Do others benefit from road development?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 29 of 45
Roads and Schools
• Education
– People acquire education only as long as the marginal benefit exceeds the marginal cost.
– Positive externalities result.
• Education
– Less than optimal will be obtained when external benefits are not considered.
– Taxes to finance education lowers the cost and increases the demand.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 30 of 45
Income Redistribution
• The government provides special benefits to the impoverished.
• Question
– Why not rely on private philanthropy?• Hint: Free-riders
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 31 of 45
The Regulation of Voluntary Exchange
• Reducing Transaction Costs
– Licensing– Certification– Setting standards
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 32 of 45
Government and the Public Interest
• Government attempts to address sources of market failure.
– Transaction costs– Positive externalities– Free-riders
• Question
– How would the lack of perfect information and incentives impact the government’s ability to act in the public interest?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 33 of 45
Government and the Public Interest
• Why are government policies dominated by special interests?
• Why are governments more likely to oversupply than undersupply a public good?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 34 of 45
Information and Democratic Governments
• Question
– Why don’t you take the time to learn more about the candidates running for various offices?
• Question
– Is an interest in being re-elected likely to lead elected officials to vote and act in the public interest?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 35 of 45
The Interests of Elected Officials
• Observation
– The few who have much to gain invest vast resources in trying to influence the political process.
• Observation
– The many with more to gain in total, but less to gain individually, invest almost nothing.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 36 of 45
Concentrated Benefits, Dispersed Costs
• Democratic political process
– Concentrate benefits on the • Well organized• Well informed• Who gain the most
– Disperse costs on• Unorganized• Ill-informed• With little to gain individually
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 37 of 45
Positive Externalities and Government Policies
• Government policies
– tend to be dominated by special interests.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 38 of 45
How Do People Identify the Public Interest?
• Scenario
– How long should a new drug be tested by the FDA?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 39 of 45
How Do People Identify the Public Interest?
Costsand
Benefits
Time Spent in Testing
Benefits to patientsof additional testing
Costs to patientsof additional testing
Cost =Benefit
T1
Cost to the FDAfor testing
T2
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 40 of 45
The Prisoner’s Dilemma
• The Dilemma
– Choosing whether to spend two hours/week working on a public policy issue or go bowling.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 41 of 45
The Prisoner’s Dilemma
Others ChooseOthers Choose
EachEachChoosesChooses
Duty RecreationD
uty
Rec
reat
ion
GoodGoodGovernmentGovernment
BadBadGovernmentGovernment
GoodGoodGovernmentGovernment
PlusPlusBowlingBowling
BadBadGovernmentGovernment
PlusPlusBowlingBowling
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 42 of 45
The Limits of Political Institutions
• What do you think?
– Are there limits to what political institutions can accomplish?
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 43 of 45
Once Over Lightly
• Government actions follow decisions of citizens and government officials.
• They compare marginal costs and benefits of alternative actions.
• Governments have the right to use coercion.
• Thru coercion it is sometimes possible to secure goods not available thru voluntary cooperation.
© 2006 Prentice Hall Business Publishing The Economic Way of Thinking, 11/e Heyne/Boettke/Prychitko 44 of 45
Once Over Lightly
• Coercion may secure the supply thru lowering transaction costs.
• Government actions reduce transaction costs and overcome free-rider problems.
• Government coercion presupposes voluntary cooperation.
• Positive externalities permeate the political process in a democratic government.