Part III: Economic Progress and the Role of Government - Lecture Notes
Slide 1-3: Intro to Section
We are still climbing up that economic mountain. This section starts off talking about the role of government and market failure. It then goes into the problems with government solutions (known as public choice economics). When looking at the costs vs. the benefits of these government solutions, you can decided what side you are on (that really does not matter to me, as I am completely devoid of any political agenda).
Show Debt Clock
Slide 4: Size and Growth of Government (1)
This graph shows how federal spending has increased steadily regardless of congressional leadership.
Slide 5: Size and Growth of Government (2)
This graph shows U.S Federal Government spending by the political party of the president
Slide 6: Size and Growth of Government (2)
Watch 1000 Pennies clip (1:37): This movie clip put in perspective proposed budget cuts and how hard it is for the government to cut spending.
Slide 7: #1 Government promotes economic progress by protecting the rights of individuals and supplying goods that cannot be provided through markets (1)
· In 1930, government spending as a share of Gross Domestic Product (GDP) is 9.4%. By 2008, government spending as a share of GDP is about 35.3% (over one third of our economy is government production. (this often naturally happens: when an economy grows, government grows with it. This is known as Wagners Law).
· You may have noticed that when the government gets involved, things tend to get messed up. Although this is very debatable, the appropriate actions of the government have been boiled down to these two things (However, some would believe the government should not do any of these things).
· When the government was originally conceived it was done in order to give us the power to protect us from foreign aggressors and criminals. However, it has evolved to do a lot more.
Slide 8: #1 Government promotes economic progress by protecting the rights of individuals and supplying goods that cannot be provided through markets (2)
There are four sources of market failure (four things that cause the market to work less perfectly that otherwise thought):
1. Lack of Competition
2. Lack of Information
3. Externalities
4. Public Goods
Slide 9: #1 Government promotes economic progress by protecting the rights of individuals and supplying goods that cannot be provided through markets (3)
- non-rival:
· Ex. radio signals: one persons consumption does not interfere with another person’s consumption (unlike beer or ice cream).
· Ex. Out door fireworks display: one person watching does not necessarily stop someone else from watching
- non-excludable:
· Ex. national defense: can’t protect everybody except the Thompson home because they did not pay taxes. To protect the country you can’t exclude anybody.
· Ex. Out door fireworks display: its difficult to exclude someone else from watching once fireworks are provided
**Please Note** Being produced by the government does not make a good a public good. To be a public good, the good must have these two characteristics.
Slide 10: #1 Government promotes economic progress by protecting the rights of individuals and supplying goods that cannot be provided through markets (4)
· If someone comes around and asks you how much you value national defense, you will probably lie and say not so much to avoid paying for it because you expect others to pay for it. However, when a lot of people do this the good will be underrepresented.
· The government can force people to pay so that nobody is free-riding.
· The market tends to be able to provide public goods by tying them to private goods. For example, radio broadcasts is a public good but it is tied to advertising. Lighthouses often have fees paid at the docking sight so that people don’t free-ride of their use.
Slide 11: Voting is different than market allocation (1)
· Do market Vs. Voting Allocation Example in Class
· Just because a government project passes a majority vote does not mean that the government project will be a productive one. Whenever there is a disconnect between who pays for something and who receives it then problems tend to arise.
· When people pay a flat amount then productive projects may not get passed (and unproductive projects may get passed), but when people pay in proportion to the benefits that they receive then all productive projects will be passed and unproductive ones will not. (example of unproductive project being passed is on page 84). Do Plan A for both examples on this slide
· Lets say this group of individuals want to vote on a new government sponsored English literacy course. It generates more benefits then costs and therefore should be undertaken, but if everyone pays the same amount then it will fail majority vote. If people pay in proportion to the benefits they received then it will pass unanimously.
Voter / Benefits Received / Plan A / Plan BJackie Chan / $20 / $5 / $12.50
Jet Li / $12 / $5 / $7.50
Jason Statham / $4 / $5 / $2.50
Jean-Claude Van Damme / $2 / $5 / $1.25
Chuck Norris / $2 / $5 / $1.25
Total / $40 / $25 / $25
lose 3 to 2 / win 5 to 0
· Lets say this group of individuals want to vote on a new hospital where they want to send all the people they beat up. It generates more costs then benefits and therefore should not be undertaken, but if everyone pays the same amount then it will pass majority vote. If people pay in proportion to the benefits they received then it will fail unanimously.
Voter / Benefits Received / Plan A / Plan BJackie Chan / $15 / $12 / $18.00
Jet Li / $15 / $12 / $18.00
Jason Statham / $15 / $12 / $18.00
Jean-Claude Van Damme / $3 / $12 / $3.60
Chuck Norris / $2 / $12 / $2.40
Total / $50 / $60 / $60
wins 3 to 2 / Loses 5 to 0
Slide 12: #2 Voting is different than market allocation (2)
· When people pay in proportion to the benefits they receive then productive projects will be passed and unproductive projects will fail. Do plan B for both examples on this slide.
· Gasoline Tax: Those who are using the roads are those who are paying for the roads.
Slide 13: #2 Voting is different than market allocation (3)
Many economists think the best voting mechanism for passing government projects is:
· People pay in proportion to the benefits that they receive. We have seen how effective this is, however, it may be difficult to gather that information so:
· A program should only pass if a supermajority (80 or 90%) of the voters supported the program. This would limit the amount of legislation passed where the costs outweigh the benefits, and increase the probability that passing the legislation means the benefits outweigh the costs.
Slide 14: The Costs of Government are not only Taxes (1)
· Remember that there is no such thing as a free lunch. All of the resources that go into police protection, highways, missiles, and anything else that gets produce by the government has alternative uses.
· These resources don’t come from thin air, so its never the case that the government is giving us something. Only if the government uses resources better than the private sector is it adding something (but most of the time the government is less efficient than the private sector).
Slide 15: The Costs of Government are not only Taxes (2)
· Its not the case that when you pay your taxes, the exact amount of money you owe just magically transfers from you to the government. In addition to the actual cost of taxes to you, there are additional costs involved.
1. In the U.S., it takes businesses and individuals approximately 5.5 billion worker hours (2.7 million full-time workers in a year) just to complete the taxation paperwork every year.
2. In the United States this amounted to $495 billion in 2000 (about $4,800 per household). This is just the amount to figure out and send in what you owe, this does not include the tax amount. (it has been estimated that every dollar paid in taxes cost around $1.20).
· An additional $348 billion dollars are spent lobbying for and against regulation
· This is why so many economists are in favor of less complicated taxing procedures
Slide 16: The Costs of Government are not only Taxes (3)
· Remember that taxes reduce the amount of transactions that otherwise would have happened. This means that the value that would have increased due to these transactions will not happen (remember the candy game). This is the deadweight loss we referred to earlier in the supply and demand section
Slide 17: #4 Unless Restrained by Constitutional Rules, Special-Interest Groups Will Use the Democratic Political Process to Fleece Taxpayers and Consumers
· Special interest effect: An issue that generates substantial benefits for a small group by generating minimal costs to a large group. (in aggregate, losses may exceed benefits but the project will still be passed because the benefits are concentrated, but the costs are widespread).
· Ex. I could get rich by convincing the government to tax everybody in the state $1 a year and have that money given to me. I would lobby the government enough to get it passed because it would be worth my time. Nobody else would lobby against it because it is not worth their time.
· Ex. You are taxed $1 a week if you work in Charleston.
· Ex. Tariffs and Quotas: Groups will convince the government to tax or limit imports to keep prices high. (costs each consumer a little more, but generates a lot of revenue for the group). Special Interest Groups are organized, others are not. Special interest groups may repay politicians in the form of large campaign contributions.
1. For Example: For example the government uses trade restrictions (quotas) to keep sugar prices in the U.S. high to benefit the sugar farmers. The domestic price of sugar in 2004 is 20 cents per pound while the world price is 6 cents per pound. As a result sugar growers gain about $1.9 billion dollars more ($30,000 more per grower) per year, while it costs the average American household $20 per year more in the form of higher prices (on sugar and everything that sugar makes). There are 105,480,101 households according to the 2000 census so this translates into over 2.1 billion dollars
2. The sugar lobby contributed about $13 million in campaign contributions in the 2000 election.
Slide 18: #5 Unless Restrained by Constitutional Rules, Legislators Will Run Budget Deficits and Spend Excessively
· Politicians want to do things that provide immediate benefits, like increase spending and government projects, but nobody wants to impose taxes. So they have the incentive to run a budget deficit and spend now while letting the next guy worry about raising taxes to repay the debt).
· Before the Great Depression, the government was good at balancing the budget, but Keynes suggested running budget deficits during economic recessions in order to help pull the economy out of a recession, the government has been running them ever sense.
· Since 1960, the government has been in deficit 42 times with only 5 surpluses.
· Imagine going out to dinner with 9 of your closest friends and you agree ahead of time to split the bill evenly. You see a dessert that costs $10. You would only be willing to pay $2 for it (Possible Extra Credit Activity).
- From a socially economic efficient standpoint, should you get it? (No, the dessert costs $10, you only value it at $2)
- Will you get it? (yes, it is worth $2 to you, you only pay $1)
- Everybody has this incentive so everybody spend more then they should. Now imagine the same thing, only there are 535 people there (435 representatives and 100 senators).
· Please understand that it is not the people rather it is the incentives they face. At a job interview at Penn St. they took me out to dinner at the Quaker Steak and Lube where the University (tax payers) paid for our dinner. An economist ordered a dessert even though he was full and only ate half. Another economist said that because they were not paying for it, if you only enjoyed even one bite of the dessert then it was worth it.
Slide 19: #6 Government Slows Economic Progress When It Becomes Heavily Involved in Providing Favors to Some People at the Expense of Others (1)
· William Baumol (1990) talked about productive vs. unproductive entrepreneurship. Productive entrepreneurship involves creating and improving goods and services so that people can have better and cheaper goods. We talked before bout how this increases the size of the economic pie because in order for people to make money this way that have to get people to voluntarily agree to the exchange so that it makes both individuals better off.
· Unproductive entrepreneurship involves taking the wealth of others. If you steal $10 dollars from someone, you have not increased the economic pie, but rather taken someone’s piece. The same is true if you use the government as an intermediary to take someone else’s wealth.
Slide 20: #6 Government Slows Economic Progress When It Becomes Heavily Involved in Providing Favors to Some People at the Expense of Others (2)