After reading the material in this chapter, you should be able to: Compare simple interest with compound interest, calculate the compound amount and interest manually and by table lookup, explain and compute the effective rate (APY), compare present value (PV) with compound interest (FV), compute present value by table lookup, check the present value answer by compounding.
Chapter 12 Government Imperfections McGrawưHill/Irwin Copyrightâ2009byTheMcGrawưHillCompanies,Inc.AllRightsReserved Learning Objectives ã ã • • • What is public choice theory? How government officials behave? How politicians take away from the weak? How politicians destroy the wealth of society? How does corruption affect the wealth of society? • What can reduce corruption? • What are the problems with democracies? 12-2 Public Choice Theory • Public choice theory is the economic study of government • It examines how government officials and voters choose 12-3 A Fictional Tale • • • • • Decisions for a congressman: Which tariff to vote for? Which group of population to choose to cut funding from? How to allocate licenses? How to protect jobs in your district? Every congressman tends to favor powerful interest groups and puts his voters interest above the needs for the country 12-4 Government Officials • Economists assume that government officials act in their own interests • Government officials are as self-interested as businesspeople • However, there is no invisible hand guiding politicians 12-5 Taking From the Weak in Dictatorships To maintain power many dictators follow a threestep formula: Take wealth from some disfavored group Build support among some favored group by giving them the wealth acquired through the earlier step Suppress or kill the disfavored group so they can’t harm the dictator 12-6 Taking From the Weak in Democracies • • • • In modern democracies, even disfavored groups can vote Politicians in democracies use a similar formula Take wealth from politically inactive groups Build support among politically active groups by giving them the wealth acquired through the earlier step Politically active groups always vote and contribute to campaigns In the U.S., the elderly vote is a much higher percentage than other demographic groups 12-7 Concentrated vs Diffused Interest Groups • Generally, producers are the members of concentrated groups like dairy farmers, truck drivers, lawyers, doctors, etc • It is easy for industry-wide organizations to contribute and affiliate with friendly politicians • The interests of consumers are almost always diffused • Hence, the producers of goods often organize to promote their interests while the consumers of goods rarely • Governments are often pushed to enact pro-producer, anti-consumer laws 12-8 Destruction of Wealth • When politicians transfer resources, they distort the market by raising taxes, imposing tariffs, mandating prices or restricting entry into professions • These market distortions reduce the wealth of society • Transferring money among groups also creates deadweight loss because it encourages rentseeking • “Rents” are money a person receives beyond what the marketplace would ordinarily give him 12-9 Spending Other People’s Money • Politicians spend taxpayers’ money in a way that it benefits themselves • Much of public choice theory concerns the incentives of self-interested politicians have to gather and spend other people’s money • It creates a Prisoners’ Dilemma for taxpayers Voters from every state want their congressmen to get federal funding for local projects But when all states this, taxes go up 10 12-10 Corruption • Corruption is probably as old as government itself • Usually, the more powerful a government official is, the more opportunity he has for corruption • One means of reducing corruption is to reduce the power of government, e.g the Mexico city police, Indian bureaucrats, etc 11 12-11 Corruption: Wealth Creation and Destruction • Corruption can sometimes help the economy by allowing businesspeople to circumvent harmful economic regulations, e.g Soviet Union • Corruption usually destroys wealth by discouraging economic activities • Corruption is a tax and it discourages wealth creation 12 12-12 Corruption Unstable vs stable dictatorship: • Dictatorships with strong central governments tend to have less corruption than ones with decentralized power centers • In unstable or weak dictatorships, all government officials are in a decentralized Prisoners’ Dilemma Abundant natural resources increase corruption: • The lack of natural resources force countries to have honest governments in order to survive 13 12-13 Corruption Competitive politics reduce corruption: • Political candidates benefit by exposing wrongdoing committed by their opponents • Fear of exposure surely prevents some politicians from engaging in corruption A free press reduces corruption: • News organizations benefit from exposing corruption because doing so attracts customers • As the Internet is transnational, it can aid people fighting corruption in nations lacking a free press 14 12-14 Corruption • Corruption breeds corruption • Countries can get into a corruption trap in which past corruption causes future corruption 15 12-15 Problems With Democracies Voting is irrational: • Each voter has an extremely small chance of deciding the election • Further, a voter has no incentive to become informed about the candidates before voting since his vote would almost certainly have no effect on the outcome Politicians have short time horizons: • Politicians have little incentive to think beyond their political term • Individual voters have minimal incentives to analyze the long range consequences of politicians’ actions 16 12-16 Problems With Democracies Government programs don’t always have to satisfy consumers • Consumers usually have no political power • Government officials have greater incentives to satisfy political powerful politicians Incumbents rarely lose • Politicians write election rules Acting in their own self-interest, politicians pick these rules to make it difficult for them to lose reelection 17 12-17 Famines and Democracies • “No functional democracy has ever had a substantial famine,” Amartya Sen • Avoiding famines strongly serves the selfinterest of politicians in democracies 18 12-18 Do You Know? • What is public choice theory? Public choice theory is the economic study of government It examines how government officials and voters choose • Why democratic politicians often pass pro-producer, anti-consumer laws? The producers of goods often have concentrated interest groups and organize to promote their interests The consumers of goods often have diffused interests and rarely organize themselves 19 12-19 Do You Know? • How can corruption destroy wealth? Corruption usually destroys wealth by discouraging economic activities • Why is it often irrational to vote? Each voter has an extremely small chance of deciding the election 20 12-20 Summary • Public Choice Theory examines how government officials and voters choose • Government officials usually act in their own interests • Politicians take away from the weak or politically inactive groups in dictatorships as well as democracies • Governments are often pushed to enact pro-producer, anti-consumer laws • The producers of goods often organize to promote their interests while the consumers of goods rarely • By distorting markets politicians reduce the wealth of society • Politicians spend taxpayers’ money in a way that it benefits themselves • Corruption is a tax and it discourages wealth creation 21 12-21 Summary • Usually, the more powerful a government official is, the more opportunity he has for corruption • Dictatorships with strong central governments tend to have less corruption • Abundant natural resources increase corruption • Competitive politics and a free press reduce corruption • Voting is often irrational • Politicians have short time horizons • Government programs don’t always have to satisfy consumers • Incumbent politicians rarely lose reelection • No functional democracy has ever had a substantial famine 22 12-22 Coming Up What is the challenge of externality ? 23 12-23 ... politicians often pass pro-producer, anti-consumer laws? The producers of goods often have concentrated interest groups and organize to promote their interests The consumers of goods often have... above the needs for the country 1 2- 4 Government Officials • Economists assume that government officials act in their own interests • Government officials are as self-interested as businesspeople... problems with democracies? 1 2- 2 Public Choice Theory • Public choice theory is the economic study of government • It examines how government officials and voters choose 1 2- 3 A Fictional Tale • •