ECON201 week 9 & 10 Ch15 & 18 w/ Prof. Haynes
ECON201 week 9 & 10 Ch15 & 18 w/ Prof. Haynes ECON201 Online, Stephen Haynes
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Week 9 Econ 201 Chapter 15 Public Goods and Public Choice Free riders people who bene t from public goods but don t pay for them Government intervenes to make public goods available Individual preference affects elections and decision making in the public sector 9 Figure 51 Spending Programs for Local State and Federal Governments pg 340 Shows budget break downs for three levels of government 9 152 Revenue Sources for Local State and Federal Governments About 23 of local government revenue comes from higher levels of government the next largest source of revenue is income tax At the federal level the major source of incomes are income taxes and employment taxes including social security and Medicaid 151 External Bene ts and Public Goods External bene t a bene t from a good experienced by someone other than the person who buys the good A market with external bene ts is inef cient government intervention may help to promote ef ciency in these markets Let s illustrate this concept with a dam built for ood control 0 One thousand people would bene t 0 Each person would get 50 of bene t 0 If one person builds the dam private bene t is 50 while external bene t is 49950 50 for each of the 999 people 0 The cost of building the dam is 20000 because the price well exceeds the private bene t we can t expect one person to build the dam 0 Where there are external bene ts to a good collective decision making yields more ef cient results Public Goods and the FreeRider Problem 0 Public good available for everyone to utilize regardless of who pays for it and who doesn t 1 It is a nonrival consumption one person bene ting from a good does not prevent another person from bene ting from the same good 2 Nonexcludable it is impractical to exclude people who don t pay ex National defense law enforcement environmental protection ect 0 Private good consumed by a single person or household ex Hot dog or anything you eat NOT ALL GOODS PROVIDED BY THE GOVERNMENT ARE PUBLIC GOODS If the government hands out free Week 9 Econ 201 cheese anyone can get in line but only one person can consume the cheese The same applies for public housing only one household can consume the good and therefore though it is provided by the public sector it is not by de nition a public good 0 Most public goods are supported by taxes 0 If taxes were eliminated and we counted on donations to fund our government projects do you think we would have enough revenue to support our current output Hell to the no 0 Put more eloquently because of the free rider problem each person has an incentive to avoid payment and still yield the bene t Overcoming the Free Rider Problem 0 How some organizations manage to overcome the free rider problem public radio and television religious organizations charities ect I Giving contributors private goods as an incentive to contribute gt More likely to contribute if they are given something I Matched contributions gt More likely to contribute if their contribution will be matched by another person rm or employer I Appealing to moral civic responsibility gt More likely to contribute when reminded they will bene t from the service 9 Application 1 Free Riders and ThreeClock Tower How can we respond to the freerider problem gtllt 96 Clock towers the days before time pieces Funded by the voluntary contributions of citizens One time in a US town one wealthy citizen refused to pay The town decided to only put 3 faces on the clock tower the side without the face was in the direction of the wealthy citizens home The citizen was unsuccessful in trying to get a free ride Other citizens suffered from this too Putting only 3 faces was inef cient because the cost of the fourth face was much less than the forgone bene t of the excluded citizens 9 Application 2 Global Weather Observation What happens when external bene ts spill across international borders gtllt Global weather observation Information gathered by one country bene ts other countries No single organization gathers all the information to reveal the big weather picture Uninhabited pars of the world are barely monitored US has taken the lead in encouraging cooperation in sharing and collecting data Early warnings of weather conditions can save lives and the economy a lot of damage Week 9 Econ 201 152 Private Goods with External Bene ts 96969696 If I paint my house Others bene t by the improved look of the neighborhood If I buy a re extinguishers Others bene t by a re being less likely to spread to their home External Bene ts from Education 0 Let s talk about the external bene ts of education 1 Workplace externalities educated people increase productivity 2 Civic externalities a welleducated person is more likely to vote intelligently resulting in external bene ts for other citizens 3 Crime externalities educated people tend to earn higher income and therefore are less likely to commit crime Increasing the highschool graduation rate decreases the crime rate External Bene ts and the Marginal Principle 0 A parent s decision on how much time and education to spend on child s education Bases of the decision of her private cost and the child s private bene t 9 Figure 153 External Bene ts and the Marginal Principle 0 O In the graph education is measured by of books read Bene t is measured as increase in future income You would expect the parent to buy 9 books where the marginal cost the marginal bene t Marginal social bene t exceeds marginal private bene t Point b on the graph shows the socially ef cient choice where social bene t marginal cost The marginal social benefit marginal private benefit marginal external bene t When the external bene ts decisions made based on the private bene t will yield an inef ciently small quantity of the good in this case education Government uses policies to encourage education Local government provide free education through high school States subsidize students at public colleges the federal government provides nancial aid to public or private school students Other Private Goods that Generate External Bene ts 0 Government subsidies for onthej ob and education are put in place to encourage workers and rms to invest in human capital and increase productivity Subsidize training and education because some of that bene t is taken to other rms or markets when the employee switches jobs University research nonpro ts generate external bene t as well government intervenes to increase ef ciency and make transactions happen Week 9 Econ 201 9 Application 3 External Bene ts from LoJack What private goods generate external bene t 9696969696 9696 A system used to recover stolen vehicles It is an effective deterrent to car theft Car thieves can t tell if a car has LoJack so criminals steal fewer cars in general Decrease in car theft in general is an external benefit of the product Annual cost of LoJack is 100 The benefit from a LoJack consumer is the discount offered by hisher insurance which is typically way lower than 100 For every 3 installed car theft decreases by one car per year The external benefit from fewer vehicle theft is 1300 per year The benefits are reap by those who don t install the system rather than those who do 9 Application 4 The Private and External Benefit of Trees What happens when neighbors benefit 969696969696 Mature trees in neighborhoods have private cost but private and social benefit Initial cost of purchasing a seedling is very low The cost of upkeep is high time and money The social benefits are imporved air quality shade it looks nice Trees add about 7000 to the value of the owner s home It also increases the collective benefit of the neighbors houses by 13000 To address the issue that the equilibrium number of trees to be less than the socially efficient amount local governments sometimes subsidize trees 153 Public Choice and the Median Voter O 0 Public Choice Economics a field of economics that uses models of rational choice to explore decision making in the public sector Voting and the MedianVoter Rule The basic idea of a democracy is that the government will take actions that are approved by the majority of citizens If governments are responsive to their voters their actions should re ect the desires of the voters The medianvoter rule the choices made by the government will match the preferences of the median voter What is the median voter The voter whose preferences lie in the middle of the set of all voter s preferences Consider a state with two candidates for govemor Penny and Buck I The only issue discussed is how much to spend on education 9 Figure 154 The Median Voter Rule page 348 I As long as Penny s budget remains less than Buck she won t loose votes as she increases her budget as long as it stays under his Week 9 Econ 201 budget she can steal some of his voters the same for Buck but vice versa I The result is that by election day the two candidates have almost the same proposed budget for education I People can also vote with their feet what communities they decide to live in I Two sources of citizen power ballots and feet limit government ability to take actions that are inconsistent with the majority of voters The Median Voter and the Median Location 0 The medianvoter logic also applies to certain types of competition 0 Ice cream cone stands on a one mile stretch of beach with 120 swimmers each willing to walk a max of one mile to get ice cream 0 The most ef cient arrangement is for the vendors to locate themselves a half mile apart 9 Figure 155 Competition on a Beach Leads to a median Location for Both Sellers pg 350 0 At 12 mile apart each vendor would get 60 patrons o Is this an equilibrium choice I No the sellers do have an incentive to unilaterally dissent I If Lefty moved his shop to the 12 mile mark splits the location in half the vendor would keep all of their customers and take some of Righty s customers I The equilibrium is the median location both vendors will serve half the market they will set up right next to each other Alternative Models of Government SelfInterest and Special Interests 0 According to James Buchanan politicians pursue their own individual interests which may very well con ict with the interests of the public 0 Example Politicians might gain prestige from starting a new government program the social benefit might be less than the cost for the program voters don t have enough information to know this and vote accordingly 0 The selfinterest theory explains why voters sometimes approve explicit limits on taxes and government spending I Example state limits on property tax and total revenue government spending limits 0 According to the theory limitations on taxes and spending are necessary to protect against officials that benefit from big budget projects 0 Another model of government has to do with special interest groups I Based on the idea that small groups of people manipulate government for their own gain I Say a total benefit of a dam was less than its cost it is therefore an inefficient project I A few farmers reap a large benefit from the dam Week 9 Econ 201 I The farmers have a strong incentive to spend both time and money convincing policy makers to build the dam I If politicians listens to people who express their preferences and contribute nancially to campaigns inefficient projects may get passed 39 When a few people share the bene t of a project and a large number of people share the cost the government is likely to approve the ine icient project 9 Application 5 The Median Voter in the NBA What is the median voter rule NBA uses labor agreements between players and owners to control player salary Without these agreements market equilibrium would generate very high salaries for a small number of really remarkable players The salary caps are used to shift salary away from superstar players in favors of the less famous and awesome ones Which theory is correct 0 We don t really know 0 There is evidence supporting both theories 0 It is probably safe to assume that both theories show some truth 0 Public choice is an active area of study for economists and political scientists Chapter 18 lntemational Trade and Public Policy Many view trade as a zero sum game if one country gains from trade the other must lose This belief advocates trade restrictions US restricts trade to protect jobs 181 Benefits from Specialization and Trade Imagine you lived in a nation that could produce everything it consumed and didn t depend on other countries for economic livelihood If you were in charge would you pursue selfsuf ciency 0 Actually more beneficial to specialize and trade with other nations Let s say there are two nations Shirtland and Chipland haha 0 Each nation produces shirts and computer chips wish they were tortilla chips lol 9 Table 181 Output and Opportunity Cost page 410 Production Possibilities Curve 0 What happens if the two nations are selfsufficient 9 Figure 181 Production Possibilities Curve page 411 Week 9 Econ 201 o Shirtland s has the following options I All shirts and no chips point a 108 shirts pday I All chips and no shirts point d 36 chips pday I Equal division of both point I 54 shirts amp 18 chips pday o If Shirtland chose to be selfsuf cient it would be a case of autarky self sacri ce because self suf ciency yields a nation less bene t than trade Comparative Advantage and the Terms of Trade 0 To decide which nation should produce which good we must gure out which nation has the lower opportunity cost of producing it 0 Comparative advantage matters for trade NOT absolute advantage I Chipland has a comparative advantage in producing chips The opportunity cost of production of one chip in chipland is one shirt compared to shirtland s threeshirt opportunity cost therefore Chipland should produce chips I Shirtland has a comparative advantage in producing shirts The opportunity cost of producing one shirt in Shirtland is onethird of a chip compared to Chipland s opportunity cost of one chip therefore Shirtland should produce shirts 0 At what rate will the two nations exchange chips and shirts I Terms of trade the rate at which units of one product can be exchanged for units of another product A nation is not going to trade one good for less than the amount of the desired good they could have produced themselves Shirtland will be willing to pay up to three shirts for one chip If it was forced to pay more than that it would make more sense for Shirtland to produce chips themselves because they wouldn t be gaining from the trade If they agree to trade two shirts for one chip Shirtland will have the same amount of chips it would have had on it s own but it will retain one more shirt than it would have before In order for Chipland to be willing to give up one chip they must be offered any quantity of shirts above one the opportunity cost of producing one chip for Chipland If they agree to exchange one chip for two shirts Chipland will have the same number of chips and one more shirt The Consumption Possibilities Curve 0 The consumption possibilities curve a curve showing the combinations of two goods that can be consumed when a nation specializes in a particular good and trades with another nation 9 Figure 182 Consumption Possibilities page 413 Week 9 Econ 201 0 Panel A I Shows Chipland producing chips the good for which they have a comparative advantage I At point g Chipland produces 120 chips and no shirts I With the terms of trade established earlier one chip for two shirts Chipland can trade 40 of it s computer chips for 80 shirts bringing Chipland to point h where it consumes 80 of each good 0 Panel B I Shows Shirtland producing shirts the good for which they have a comparative advantage I At point A Shirtland produces 108 shirts and no chips I With the terms of trade established earlier one chip for two shirts Shirtland can trade 80 of its 108 shirts for 40 chips bringing it to point k where it consumes 28 shirts and 40 chips 0 Autarky essentially when a nation doesn t interact with the rest of the world perhaps a few neighbors but largely cuts out the rest of the world 0 Knowing that how do the specialization via trade outcomes compare to the autarky ones I Trade increases consumption of 20 each good by 20 unites I The trade curves lie above the nation s PPC meaning each nation has more options on the curve when trade is present I In most cases nations pick the point on the curve that produces more of each good but this is a simpli cation of course in real life there are many goods and many factors Supply Demand Price How Free Trade Affects Employment 0 In Chipland the chip industry doubles with trade but the shirt industry disappears altogether o In Shirtland this is of course the opposite o Is free trade good for everyone I On average people will benefit from free trade I People will also be harmed in both nations I Where you stand on an issue depends on where you sit a worker in Chipland working with sewing machines will oppose free trade because they are likely to lose their job 182 Protectionist Policies Common importrestriction policies Import Bans 9 Figure 183 Effects of an Import Ban page 414 Week 9 Econ 201 The graph shows the free trade and the domestic supply equilibriums If imports are banned the price for shirts in Chipland will be 23 compared to the 12 price with free trade What happens when Chipland bans imports I The total supply of shirts in Chipland will be the domestic supply I The decrease in supply in result of the ban will increase price for consumers Quotas and Voluntary Export Restraints 0 Import quota a govemment imposed limit on the quantity of a good that can be imported 0 With an import quota imports are cut but not eliminated o The price for consumers would lie between the domestic supply price and the free trade price 0 Import quotas are illegal under international trading rules 0 Voluntary export restraints VER a scheme under which an exporting country voluntarily decreases its exports One way to get around the illegality of import quotas o Quotas and VER s have the same effect I They both increase the price of the restricted good making it more feasible for domestic firms to participate in the market 9 Figure 184 Market Effects of Quotas page 416 0 An import quota or VER will shift the entire supply curve to the left At each point there will be a smaller amount of quantity supplied because foreign supplier s aren t allowed to supply as many The total supply curve with a VER will lie between domestic supply curve and the free trade supply curve VER s generate winners and losers I Winners the domestic and foreign producers and their workers Foreign firms according to our example can sell at a price of 20 each and the price will be high enough for domestic participation I Losers the consumers will have to pay higher prices for the good Import Licenses Rights issued by the government to import goods I Granted to some I Import licenses provide profits to the holder they are often awarded politically people have an incentive to bribe for them We can reach the same point on the supply curve with a tariff as we do with VER Tariff a tax on imported goods There is one fundamental difference between a VER or quota and a tariff under the tariff the government gets the money from the tariff I Citizens in Chipland will prefer the tariff to the quota because the government can use the revenue on their behalf I Tariffs have been major consequences on the world economy I Decrease in tariffs increases world output Week 9 Econ 201 I Tariffs also appear to disproportionately affect the poor Responses to protectionist Policies 0 Restrictions on imports leads to increased trade restrictions ie retaliation Application 1 The Impact of Tariffs on the Poor Do tariffs taxes on imported goods hurt the poor disproportionately In the US tariffs are high on textiles apparel amp footwear These goods represent a higher fraction of consumption among lower income than higher income households The highest tariffs fall on the cheapest products In general tariffs are highest on labor intensive goods which tend to be lower priced bringing the burden of the tariff to the poor 0 Protecting one industry in a nation is likely to effect another 0 Many import restrictions have led to retaliation resulting in substantially lessened trade 0 Import restrictions also increase incentive to smuggle goods 183 What are the Rationales for Protectionist Policies Three possible reasons for protectionist policy 1 To shield workers from foreign competition 2 To nurture infant industries until they mature 3 To help domestic firms establish monopolies in world markets To Shield Workers from Foreign Competition 0 Politicians have an incentive to protect their constituents from short term unemployment by supporting textile tariffs even if it comes at a loss to the economy as a whole 0 The effects will be less efficient production higher prices and lower consumption for the US 0 Think of the US and the far east in production of textiles o If the US lowered tariffs on textiles from the far east US producers would not be able to compete and companies would shut down and people would be laid off To Nurture Infant Industries until they Mature 0 Learning by doing knowledge and skills workers gain during production that increases productivity and lower cost I As more and more liberty ships were built they each required fewer hours for construction due to learning by doing 0 Infant industries industries that are at an early stage of development I These industries can benefit from learning by doing I Tariffs protect these young industries from mature competitors I In practice infant industries rarely become competitive with their foreign rivals Latin American countries that tried this suffered Week 9 Econ 201 I Once government has given an industry protection it is dif cult to take that away To Help Domestic Firms Establish Monopolies in World Markets 0 If an industry requires huge economies of scale a nation will support few or one rm 0 In this case a nation might want to take on policies that help ensure it s nations company will be the monopoly of the world market 0 Consider commercial airline industry if two companies are in the industry both will lose money so the government could agree to support a rm to ensure pro t so that it will enter the market 0 Foreign competitors won t be able to enter the market and the country will bene t from higher production and more jobs Application 2 Chinese Imports and Local Economies What have been the local effects of Chinese Imports The pace of Chinese import growth was so rapid between 1990 and 2007 that it often had a strong negative effect on local economies in the US Communities more exposed to Chinese imports felt an increase in workers receiving unemployment food stamps disability ect The burden of imports varies with region Bene ts of increased export opportunities for the US to China was not measured in the study 0 What can go wrong with monopoly creation policies I If both nations subsidize their domestic rms both enter the market and both lose money I Taxpayers would then have to pay for subsidies I Nation may pick the wrong industry to subsidize 184 A Brief History of International Tariff and Trade Agreements General Agreement on Tariffs and Trade GATT An international agreement established in 1947 that has lowered trade barriers between the US and 23 other nations Multiple GATT negotiations have taken place over the years resulting in lower tariffs and increasing membership Now there are 149 members of GATT World Trade Organization WTO An organization established in 1995 that oversees GATT and other international trade agreements resolves trade disputes and holds forums for further rounds of trade negotiations Under GATT a nation that reduces tariffs for one nation must do so for all members helping to reduce tariffs throughout the world The most recent trade negotiations took place in Qatar in 2001 and focused on reducing agricultural subsidies in developed countries in order to foster competitiveness in developing countries who also wanted there own industrial tariffs lowered as well These negotiations were unsuccessful Week 9 Econ 201 Best known trade organizations I The North American Free Trade Agreement NAFTA eliminated trade tariffs between Canada Mexico and the United States for a period of 15 years implemented in 1994 II The European Union designed to remove all trade barriers in Europe in order to form one market initially consisting of 6 countries Belgium Germany France Italy Luxembourg and the Netherlands More countries have joined since including Denmark Ireland the United Kingdom Greece Spain Portugal Austria Finland and Sweden III Asian Paci c Economic Cooperation APEC was a nonbinding agreement between 18 nations to reduce trade barriers established in 1994 IV The Dominican Republic Central America Free Trade Agreement DR CAFTA modeled after NAFTA designed to promote free trade between the US Dominican Republic Costa Rica El Salvador Guatemala Honduras and Nicaragua Economists worry that though regional trade negotiations reduce trade barriers within a region they don t do much to promote free trade on a global scale 185 Recent Policy Debates and Trade Agreements Are Foreign Producers Dumping their Products 0 O Dumping a situation in which the price a rm charges in a foreign market is lower than either the price it charges in it s home country or the production cost Dumping is illegal under international trade agreements According to WTO a nation can impose antidumping duties a tax on products that are being dumped in to it s borders Dumping is a form of price discrimination If a rm has a natural monopoly in home country it will charge a high price there and a low price in foreign markets in order to get more customers and gain more pro t Another reason for dumping is predatory pricing pricing lower than production cost to drive rivals out of the market Once rival is out of business the remaining rm increases their prices It is dif cult to distinguish dumping for price discrimination and dumping for predatory pricing Economists speculate that antidumping duties are put in place of protectionist policies Antidumping duties are a potent weapon for protecting domestic industry Do Trade Laws Inhibit Environmental Protection 0 0 Starting in the early 90 s environmentalists began to question if free trade policies harm the environment Example dolphin deaths at the hands of tuna shers Week 9 Econ 201 0 Under current WTO a nation can adopt environmental standard as long as it doesn t discriminate against foreign producers 0 US boycott on Tuna was against WTO rules because the killing of dolphins does not harm US environment directly 0 In recent years congress has been lobbied to disapprove bilateral trade deals if it does not include adequate environmental standards 0 At what point do we allow national policy concerns to override the principle of free trade This is a new challenge facing the global economy Do Outsourcing and Trade Cause Income Inequality o Inequality in wage has been growing since 1973 0 World trade has also increased since 1973 is there a connection Trade theory suggest a link between increased trade and increased wage inequality If the US has a comparative advantage in goods utilizing skilled labor than it will trade with developing countries who have a comparative advantage in unskilled labor Demand for skilled labor will increase and so will the wages for these positions Demand for unskilled labor will decrease and so will the wages for these jobs Companies that need unskilled labor will outsource overseas where there is a comparative advantage in production and demand for unskilled labor in the US will continue to fall It is hard to determine a de nite cause for increased wage inequality there are too many factors to consider however we do know that trade has contributed to increased wage inequality to some extent On the other hand trade also may decrease the prices of goods so it is hard to determine if increased trade is worth the cons Responses to increased wage inequality with increased trade Trade restrictions Facilitate transition from unskilled labor to skilled labor through education and training assistance In recent years technical jobs have been transferred over seas causing a new problem it is not only unskilled labor being transferred overseas Why do People Protest Free Trade 0 Important policy issues surrounding free trade Country cannot dictate the terms under which another country actually produces a good or service remember the dolphins Possible for free trade to increase income inequality although reduced prices slightly offset this affect 0 But are these the reasons people protest free trade Dependence on others for trade Decreased independence and sovereignty Feared loss of cultural identity Week 9 Econ 201