Economics for Leaders Lesson 8 Setting the Rules

Economics for Leaders Lesson 8: Setting the Rules Costs and Benefits of Government Action Economics for Leaders

ERP-4: Institutions are the “rules of the game” that influence choices. Economics for Leaders

The Rules……… Under the Rule of Force, people own what they can defend. Rule of Man exists when laws are applied at the discretion of the governing. Rule of Law exists when rules that govern behavior and interactions among individuals and groups of individuals apply to both the governed and the governing. Economics for Leaders

Freedom House: Rule of Law Is there an independent judiciary? Does the rule of law prevail in civil and criminal matters? Are police under direct civilian control? Is there protection from political terror, unjustified imprisonment, exile, or torture, whether by groups that support or oppose the system? Is there freedom from war and insurgencies? Do laws, policies, and practices guarantee equal treatment of various segments of the population? Economics for Leaders

Free Economics for Leaders Partly Free Not Free

Review: income of nations Economics for Leaders

Free Economics for Leaders Partly Free Not Free

How do we evaluate government’s role in the economy? Start with Opportunity Cost Economics for Leaders

What is the opportunity cost of government spending to do something? At the margin, the opportunity cost of public spending is private spending or some other public expense. Government spending is paid for by taxation, which is involuntary. Therefore, (some) citizens undertake actions to minimize their tax burden – using more resources! Does that mean gov’t spending is “bad”? Economics for Leaders

Public or Private Production: The Guideline Is the Same Private Production should take place when the marginal benefit exceeds the marginal cost ≥ Economics for Leaders Government Production should take place when the marginal benefit exceeds the marginal cost.

Government Production should take place when the marginal benefit exceeds the marginal cost. ≥ Economics for Leaders When is this most likely to be the case? 1. externalities 2. Monopolies 3. Public Goods

Externalities The MB of government providing goods or services may exceed MC if considerable externalities (negative or positive) accompany production Economics for Leaders

Monopoly Cable TV Electricity Economics for Leaders When monopoly conditions exist, the MB of government regulation or provision of goods and services may exceed MC by helping to prevent the accumulation of market power.

1. Public Goods or just “publically-provided” goods? True public goods are” 1. Non-rivalrous in consumption 2. Non-exclusive in production “free rider problem” Economics for Leaders

Public Goods or Just Goods Provided by/for the Public? Is it possible to exclude people who don’t pay? Are there examples of this good or service being provided privately? Economics for Leaders Is it possible to exclude people who don’t pay? examples of private production? Would people be motivated to pay for the service if it was only provided privately?

Example: National Defense Would you pay? Economics for Leaders

The free-rider problem A free-rider experiment You have the choice to vote “me” or “us” I will pay everyone $. 05 for each “us” vote In addition I will pay $. 25 to each person who votes “me” Put your name and vote on a piece of paper Economics for Leaders

Government coercion is necessary to ensure all beneficiaries bear part of the cost Economics for Leaders

How do we pay for government? Taxes Economics for Leaders

ONLY? Economics for Leaders

Debt and Deficits What is a Deficit – Government Spending > Tax Revenue Run a deficit – Borrow What is Debt – National debt = Sum of Previous deficits and surpluses Economics for Leaders

How Does The Government Borrow? Treasury responsible Bills – days to 52 weeks Notes – 2, 3, 5, 7 & 10 years Bonds – 30 years Economics for Leaders

The cost of Government 2009 Federal Expenditures=$3. 6 Trillion 2009 Federal revenues=$2. 1 Trillion 2009 Deficit=$1. 5 Trillion Federal Debt as of 12/31/2009= $13. 5 ($7. 54 public) Trillion Debt as of 2005= $8. 1 ($4. 7 public) Trillion. Economics for Leaders

So why does is feel like all that spending still does not get us what we want? How are government choices made? Incentives matter! Economics for Leaders

Public Choice Theory: The power of Special Interest Groups derives from the distribution of benefits and costs Like private individuals, elected officials act in their best interests. Elected officials’ abilities to accomplish their goals depend on being elected (and re-elected). Elected officials have an incentive to pay more attention to those constituents who are able and likely to influence the election. Economics for Leaders

Concentrated Benefits and Diffuse Costs? Vote “For!” Big benefit to a small but organized group of voters Economics for Leaders Small cost to a large number of unorganized, sometime voters

The “Big Ideas” from Lesson 8: 1. Government facilitates wealth-producing voluntary exchange by establishing and enforcing the rule of law that secures property rights. 2. At the margin, the opportunity cost of government spending is private spending. 3. The incentive to expand government activities beyond the point where MB = MC is explained by public choice theory. Economics for Leaders

ERP-4: Institutions are the “rules of the game” that influence choices. Obama Signs Health Care Overhaul Bill, With a Flourish Economics for Leaders

ERP-4: Institutions are the “rules of the game” that influence choices. President Signs Wall Street Reform Bill Arizona Immigration law faces federal challenge today Economics for Leaders

Frédéric Bastiat (1801 – 1850). “Government is the great fiction through which everybody endeavors to live at the expense of everybody else. ” Economics for Leaders