ECON 1100 Global Economics (Fall 2013) Government Failure

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1 ECON 11 Global Economics (Fall 213) Government Failure Relevant Readings from the Required extbooks: Economics Chater 11, Government Failure Definitions and Concets: government failure a situation in which otal Social Surlus is decreased by government intervention in a market. wo broad causes of Government Failure: (1) government fails to erform a necessary task efficiently and (2) government fails to do only those tasks that it should do seven secific sources of government failure: (1) informational roblems, (2) costs of comlying with government bureaucracy, (3) corrution or kletocracy, (4) rentseeking, (5) logrolling, (6) regulatory cature, and (7) deadweight-loss from taxes economic calculation roblem the argument that a system of lanning will never be able to achieve efficient outcomes, recisely because under such a system the lanners do not have the information generated by market activities available to them first made by Ludwig von Mises and later refined by Friedrich von Hayek costs of comlying with government bureaucracy when governments imose rules/regulations, individual households and firms need to exend resources to comly with the olicies use of resources for comliance imoses a cost => the greater the bureaucracy, the higher are these costs => if the costs are sufficiently large, they will outweigh any benefits of the regulation Permit Raj in India: a comlex, irrational, almost incomrehensible system of controls and licenses under which everything needed (government) aroval and a stam. Recall the Ease of Doing Business study. Costs of starting a new business in o Chad: 11 rocedures, 66+ days, costing 28.5% of annual er caita income o New Zealand: 1 rocedure, as little as 1 day, costing.4% of annual er caita income corrution an environment in which regulations are not enforced and decisions are not made evenly and without bias => corrution leads to inefficient decisions kletocracy an environment of extreme corrution in which government officials unabashedly seek ersonal gain at the exense of the ublic interest resent day Russia: an ill-governed kletocracy in which corrution is not a hay side effect of ower, but the core of the system and as a consequence a small grou of eole wholly above the law has, in the ast decade, become rich beyond the wildest dreams of the tsars.

2 ublic choice the academic subfield which uses the tools and framework of economics to analyze issues that historically fall within the domain of olitical science rent seeking attemts by individuals and firms to use government action to make themselves better off at the exense of others e.g., U.S. trade restrictions on imorted eanuts very beneficial to owners/workers of U.S. eanut farms (who therefore have a strong incentive to lobby hard to kee the restrictions in lace) => eanut roducers have an incentive to exend resources to secure these rents costly to consumers, foreign eanut roducers, and U.S. roducers of any goods which use eanuts as an inut logrolling the rocess by which a legislator votes to arove one bill in exchange for favorable votes from other members on other bills not necessarily a bad thing => logrolling can be otentially beneficial, since it allows for an exression of intensity of reference but, articularly when voters are rationally ignorant, the rocess can give rise to inefficient outcomes rational ignorance since becoming informed on an issue is costly and the benefits of being informed are tyically very small, it is rational for many voters to remain uninformed aroximate average annual er erson costs of trade rotection for dairy roducts: $5.25; machine tools: $2.41; softwood lumber: $2.3; canned tuna: ; eanuts: => even though trade restrictions on eanuts are a small net loss for the average erson in the U.S., they aear to be a net gain for voters in GA, AL, and X => voters in GA become informed about and recognize the local benefits of the trade rotection for eanuts but remain rationally ignorant of the costs of all the other trade rotections James Buchanan (1919 ; George Mason University; Noble Prize in 1986) argued that oliticians in a democracy often act so as to maximize their robability of reelection => it is in the best interest of the reresentative from GA to engage in logrolling (i.e., vote trading) with others to ensure assage of trade rotection for eanuts (even if it means assing all the other rograms as well) regulatory cature a situation in which firms in a regulated industry influence a regulatory agency to the oint where the agency makes decisions that are in the best interest of the firms being regulated (even if the decisions are not in the best interest of the ublic)

3 incidence of a tax a measure of who bears a burden of a tax in terms of decreased welfare Equivalence between er unit tax imosed on buyers and er unit tax imosed on sellers. Consider either a er unit tax of $ imosed on buyers or a er unit tax of $ imosed on sellers he outcomes of these two alternative olicies are identical in terms of: level of trade; er unit rice ultimately aid by buyers; er unit rice ultimately received by sellers; decrease in Consumers Surlus; decrease in Producers Surlus; tax revenue generated by the government; magnitude of resulting Deadweight-Loss. hat is, the two olicies are equivalent to each other from the ersective of buyers, from the ersective of sellers, and from the ersective of society. hus, if the government were to imose an additional $1 of taxes on gasoline, consumers should not care whether they are resonsible for aying the tax or if gas station owners are resonsible for aying the tax.

4 Per unit tax of $ imosed on Buyers: Effect on Demand => at the oint of sale any buyer is now willing to ay exactly $=$1 less than before => Demand curve shifts down by $=$1 $ B 4.2 Suly = (Seller s Res. Price) M 3.8 a d b e f c Demand = (Buyer s Res. Price) S 3.2 (Buyer s Res. Price)-() quantity q 4,2 q M 5, Outcome with tax in lace: Outcome at oint of sale determined by focusing on green curve and red curve 4,2 units are traded (less than the efficient level of 5,) <= unique quantity at which buyer s reservation rice (height of blue curve) is exactly $=$1 greater than seller s reservation rice (height of red curve) Price at the oint of sale is $3.2 Sellers receive $3.2 on each of the 4,2 units sold Buyers must ay $=$1 on to of the $3.2 urchase rice, for a total of $4.2 on each of the 4,2 units urchased CS decreases by (a)+(b)+(c) <= Incidence of ax for buyers PS decreases by (d)+(e)+(f) <= Incidence of ax for sellers Government generates tax revenue of (a)+(b)+(d)+(e) (equal to ($1)(4,2)=$4,2). Note that the government collects less than $5, in tax revenue, since they only collect the $1 of tax on the units which are traded when the tax is in lace. DWL of (c)+(f)

5 Per unit tax of $ imosed on Sellers: Effect on Suly => at the oint of sale any seller must now be aid exactly $=$1 more than before => Suly curve shifts u by $=$1 $ (Seller s Res. Price)+() B 4.2 Suly = (Seller s Res. Price) M 3.8 d a e b f c Demand = (Buyer s Res. Price) S 3.2 quantity q 4,2 q M 5, Outcome with tax in lace: Outcome at oint of sale determined by focusing on orange curve and blue curve 4,2 units are traded (less than the efficient level of 5,) <= unique quantity at which buyer s reservation rice (height of blue curve) is exactly $=$1 greater than seller s reservation rice (height of red curve) Since the same quantity is traded with the tax imosed on sellers as when the tax was imosed on buyers, it follows that all other asects of the two outcomes are identical as well! hat is: Sellers receive $3.2 while buyers ay $4.2 on each of the 4,2 units traded he decrease in CS, decrease in PS, amount of government tax revenue, and magnitude of DWL are all the same as when the tax was imosed on buyers instead of sellers It makes NO DIFFERENCE in terms of welfare (to buyers, sellers, or society) if this er unit tax is imosed on buyers or imosed on sellers!

6 Multile Choice Questions: 1. If a er unit tax is laced on sellers of a roduct, the rice ultimately aid by buyers, while the rice ultimately received by sellers. A. increases; remains unchanged. B. remains unchanged; decreases. C. increases; increases. D. increases; decreases. 2. Which of the following is NO one of the seven sources of government failure discussed in lecture? A. Corrution. B. Regulatory Cature. C. Logrolling. D. Externalities. 3. In the textbook, was described as an ill-governed kletocracy in which corrution is not a hay side-effect of ower, but the core of the system. A. resent day India B. resent day Russia C. the United States during the 193s D. Great Britain during the 198s 4. he Economic Calculation Problem osits that A. a system of lanning will never be able to achieve efficient outcomes, recisely because under such a system the lanners do not have access to the information generated by market transactions. B. in order for economic outcomes to be fair, it is necessary to redistribute wealth through a highly rogressive tax structure. C. it is imossible to come u with any estimate of the costs of comlying with government bureaucracy. D. calculating the true economic value of a worker can only be done under a socialist system. 5. Within our discussion of Logrolling, we noted that argued that oliticians in a democracy often act to maximize the robability of their own reelection. A. Ronald Coase B. Gordon ullock C. James Buchanan D. Jeremy Bentham

7 6. he trade rotections for dairy roducers which are resently in lace in the U.S. rovide er erson er year over society as a whole. A. net benefits of aroximately $1,24.37 B. net benefits of aroximately $4.89 C. net costs of aroximately $5.25 D. net costs of aroximately $ is the rocess by which a legislator votes to arove one bill in exchange for favorable votes from other members on other bills. A. Rent Seeking B. Logrolling C. Rational Ignorance D. Regulatory Cature 8. he Incidence of a ax refers to A. which level of government is imosing the tax. B. the frequency with which an individual has to ay the tax. C. which individual is legally resonsible for writing a check to ay the tax. D. who bears the burden of the tax in terms of decreased welfare. 9. refers to a situation in which total social surlus is decreased as a result of government intervention in a market. A. Market Failure B. Government Failure C. he Free Rider Problem D. An Externality 1. In advance of the election for County Sheriff, Edward and Mike are discussing the different candidates. Edward states: I haven t really researched the ositions and backgrounds of the two eole running. In order to do so roerly I would have to invest a great deal of time, and, after all, the chance of my vote deciding the election is very small and I don t think things will be very different for me regardless of who wins. His statement is closely related to the issue of A. the incidence of a tax. B. regulatory cature. C. rational ignorance. D. the Economic Calculation Problem. 11. Regulatory Cature refers to a situation in which A. a government regulatory is thrown in jail for unethical behavior. B. legislators trade votes in order to have multile olicies enacted (each of which would otherwise not garner a majority of suort). C. firms in a regulated industry influence a regulatory agency to the oint where the agency makes decisions which are in the best interest of the firms (even if the decisions are not in the best interest of the ublic). D. government regulators collect bribes from the firms being regulated.

8 For questions 12 through 15, consider a market with Suly and Demand as illustrated below. $ a Suly d b c e f g Demand quantity 1, 15, 21, 12. Imosing a er unit tax of $2.6 on buyers in this market would generate tax revenue of A. less than $26,. B. exactly $26,. C. more than $26, but less than $39,. D. exactly $39,. 13. In comarison to the free market outcome, imosing a er unit tax of $4. on sellers in this market would A. decrease Producers Surlus by areas (e)+(f). B. decrease Producers Surlus by areas (c)+(f). C. increase Producers Surlus by area (g). D. not have any imact on the value of Producers Surlus. 14. In comarison to the free market outcome, imosing a er unit tax of $1.4 on sellers in this market would generate a Deadweight-Loss A. larger than areas (e)+(f). B. exactly equal to areas (e)+(f). C. smaller than areas (e)+(f). D. exactly equal to area (g). 15. Consider the following two roosed taxes: ax A is a $3 er unit tax imosed on buyers; ax B is a $2 er unit tax imosed on sellers. We can infer that A. Deadweight-Loss would be exactly the same under ax A and ax B. B. consumers would refer ax B over ax A. C. roducers would refer ax A over ax B. D. More than one (erhas all) of the above answers is correct.

9 Answers to Multile Choice Questions: 1. D 2. D 3. B 4. A 5. C 6. C 7. B 8. D 9. B 1. C 11. C 12. C 13. B 14. C 15. B