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Policy Analysis

by: Alfredo Keebler

Policy Analysis 06E 119

Alfredo Keebler
GPA 3.81

Heath Spong

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Heath Spong
Class Notes
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This 6 page Class Notes was uploaded by Alfredo Keebler on Friday October 23, 2015. The Class Notes belongs to 06E 119 at University of Iowa taught by Heath Spong in Fall. Since its upload, it has received 29 views. For similar materials see /class/228101/06e-119-university-of-iowa in Economcs at University of Iowa.


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Date Created: 10/23/15
Topic 5 Problems and Solutions of Externalities Externalities arise from market failures and addressing these externalities could be left up to the private or public sectors Production externalities arise from the producer producing more ofa good without being compensated Positive externalities ofproduction benefit the producer and they under produce and negative production externalities benefit the consumer as there is an overproduction Consumption externalities arise from the society s benefit ofproducing a good without reimbursing the producer Positive externalities of consumption benefit the consumer and result in under produce and negative externalities of consumption benefit the consumers and result in over production The private can address these externalities through internalizing them and using the Coaese Theorem This theorem states that externalities can be fixed as long as one party is assessed property rights It doesn t matter who has the rights as long as they are present The government will establish this and the private sector enforce it Unfortunately there are several problems here Often times it is impossible to asses property rights thus making it impossible to determine who must internalize Other times if the solution involves several people one person may hold out and not contribute Transaction costs for this may be extremely high Freeriders may let others pay for their share and coast on the benefit of production The public sector can establish other means of correcting externalities They may set taxes provide subsidies or regulate production All of these would account for the marginal benefit or cost the externality sets forth Taxes would force reduction upon all firms and they will implement these changes as long as this cost is less than the tax This will however increase cost curve and the cost ofa product This is also difficult as it is impossible to determine the marginal damage and costs of all firms in a market Regulating may be difficult as it is impossible to find MD and MB Therefore several policies are present Quantity regulation sets a cap the entire market must hit Though this places some firms at a disadvantage as it may be cheaper for some to change methods ofproducing than others Regulation through taxes would offset the inefficiency by placing a tax equal to the marginal damage This raises input costs but gives plants exibility to reduce at their own rate Allowing permits that firms can trade allows a firm with high costs of changing production methods to firms who it is less expensive Though the costs of reduction in production are uncertain It is nearly impossible to find a cost and a benefit and who does the costing and benefitting There are also diminishing returns of production A large change in production now especially environmentally could mean little difference until later on creating a atter social benefit High taxes would make reduction expensive and bring market to inefficiency and wouldn t encourage further reduction It is essential to assume the goal of reduction Ifit is the goal to set production output goals one must set quantity regulations If the goal is to assure the same rate of taxation and costs to a firm then taxes should be implemented though production rates my vary Topic 6 Externalities and Governmental Policies The result of the industrialized nation we live in today causes what is known as acid rain The combination of sulfur and nitric acids produced by factories rise into the air where they cool and become acidic in nature They are taken by the wind and fall in places all over the world causing damages to property water supply and wildlife damage which has a significant impact on economies affected The government has implemented means of regulation to adjust for this Here the Coase theorem would not work largely because it is impossible to assign property rights The Clean Air Act of 1970 was a legislative movement that set the maximum standards for atmospheric harming chemicals They also set standards for new coalfueled plants requiring that their operation use low sulfur resources or installing scrubbers to remove these harmful emissions This did not work as well as hoped as it forced older plants who were not bound by these standards to operate well beyond their anticipated time Methods of abiding by these standards were expensive so the plants found loopholes to continue their standard operations In response the 1990 Amendments to Trading required all plants to reduce sulfuric acid emissions by half Each plant was given a certain amount of permitted emission based on previous usage These permits could be traded in the market to and from anyone who had a stake in the situation Those companies whose emission reduction incurred a high cost would purchase permits from those companies whose emission reduction incurred a low cost This policy came under extreme criticism from those against it Primary analyses estimated a huge monetary and job loss and some equated it to the middleages policy of buying and selling sins However in 2002 upon assessment costs were lowered 3367 15 years after it was estimated to cost only 600000 jobs and 75 billion in output much less than initial estimates The cost emissions posed were lowered significantly especially in regards to health This all boils down to the similar problem of global warming where greenhouse gases are taking a toll on the environmental health One of the largest issues is placing responsibility should we fix a problem and invest a lot of time and money into something that only the future will benefit from The Montreal Treaty of 1987 banned the use of CFCs which has reduced harmful ozonedestroying toxins significantly However it will take years until the ozone repairs itself The Kyoto Treaty was ratified by 35 of 38 industrialized countries though not the United States that aimed to reduce greenhouse gas emissions to 5 below 1990s levels The United States would incur 90 of the cost of this though they are only responsible for 25 of emissions It would cost them 11 trillion Ratifiers even added a trading allowance similar to the above though the United States still refused Congress has taken measures to reduce the rate of global warming at home though much less stingy and costly Plants could reduce emissions continue at the current level and buy permits from the government or use credit from previous years that would allow them to produce more in some years than in others This would potentially raise government revenue yet might raise the cost of energy for the consumer wouldn t benefit the consumer financially and could generate a monopoly To counter that the government proposed auctioning off these permits Regardless it is clear that politicians are in favor of doing something to combat global warming Topic 7 Public Goods The government should intervene only to provide national defense and fiX market failures In order to do the latter they must find a way to find consumer preferences and provide a good at this level Pure public goods are nonrival and nonexcludable meaning that one person s consumption does not hurt another s and there is no way to deny another from enjoying a good These are rare and most are impure public goods which satisfy one of these These can be excludable but nonrival cable TV rival but non excludable walking on the street or pure national defense The government would best provide goods at their optimal provision equilibrium where SMBSMC However consumer preferences demand different quantities ofa good at a different price As such the government must aggregate these preferences Consumer optimal rates are where utility and budget constraints meet meaning the price ofa good for one person should be the same relative to the price of another good for another person In private market equilibriums without failures the social efficient point is when the marginal rate of substitution equals marginal utility That is to say when consuming one more good utility does not increase Marginal value of consumption is equal to marginal cost ofproduction of one more unit because no matter how many of that good are produced everyone enjoys the good Private sectors should produce public goods when the marginal cost ofproduction is equal to the marginal rate of consumption for everyone If this occurs there is no need for governmental intervention However eXternalities result in underproduction on the private sector s side such as the freerider problem or when the consumer is faced with having to choose the enjoyment of one good that they enjoy for one good that all can enjoy Overcoming the freerider problem several ways Some people just want more ofa good and will thus be alright with funding it Others are altruistic feeling the need to provide for others in the society Warm glow may make them feel good about covering these costs and providing They may however overcome this by levying fees to users The public sector provides public goods to adjust for underproduction by taking over production or mandating certain levels ofproduction This could however result in the crowdingout affect The private sector provides less in response to the government providing more which offsets netgain ofpublic provision Assuming no warm glow that all individuals will be charged equal amounts for provision and that fewer goods are provided publically than are privately the government will replace private provision 11 and consumers will return to the original level of optimality Thus intervention left the market no better or worse off than under private provision The only way to avoid total crowdout is in the presence ofwarmglow societies or through forcing everyone to contribute It is then required to measure the costs and benefits ofpublic goods which is difficult to do because of the freerider problem and large costs assessed Issues in aggregating preferences arise from individuals not revealing their preferences out of fear of being charged individuals not knowing how much they value a good and how to add up these preferences to find the level that pleases all Though largely intervention in the provision ofpublic goods helps bring markets to efficient levels and the ability for the public to do so is assessed through measuring the costs and benefits to carry out their decision Topic 9 The Political Economy It is essential to reveal how the government operates in regards to economic decisions particularly public good provision Lindahl pricing requires unanimous conscent on public good levels Under the Lindahl pricing theory individuals will honestly reveal their willingness to pay and the government will charge each individual at that level To do this the government sets taX prices which is a share of the cost that each individual must bear for a public good Each individual says how much they would require at this price and this is repeated until a schedule of provision is revealed that re ects willingness to pay at various quantities Each willingness to pay at each quantity is added up and is added to the marginal cost curve Where the marginal cost for provision and the demand revealed by willingness to pay meet is the level at which the government will supply the good This creates efficient provision charges people based on what they ll use and what they value and makes the issue of aggregating utility unnecessary This comes with several problems Individuals may lie about their preferences and create the freerider problem They may not know what the value ofa good is and it may be difficult to add up everyone s preferences Thus voting has become an alternative to gauge consumer preferences Majority voting has been in place for the longest time though it only works to reveal preferences if the vote reveals dominance if transitivity is present and if the vote is independent of all other factors Majority voting would fail without these and especially if cycling when there are inconsistencies resulting from majority voting is present Arrow has described why majority voting is an impossible way of aggregating individual preferences If everyone were to pick only one option rather than rate their preferences it could result in a 3way tie Even if the results were weighted a 3way tie could result For Arrow in order for voting to work and for preferences to be aggregated voter preferences must be restricted or you must impose a dictatorship When there is a singlepeak revelation of preferences where utility falls in each direction that may give general aggregation ofpreferences However if there are multipeaks which occurs when adding multiple parties this does not work As such the median voter theory has come into play to account for these multi peaked woes It yields an outcome when tastes in the middle provide for preference revelation that are equal on both sides This assumes that it is only required to find one voter in the middle of an issue and does not re ect intensity of the voter s preferences That is to say perhaps one person is very much against an issue but one person lays in the middle of an issue and has no beef then median voter does not re ect preferences and results in social inefficiency The United States is a representative democracy where citizens vote for candidates who are to advocate for policies at the medianvoter level This relies on the fact that citizens vote on the person that represents their interests and not political parties and that the politician represents the median voter without other concerns This theory assumes singledimensional voting on one issue only only two candidates no politician ideology that everyone votes that money has no part and that everyone has full information Lobbying also makes voting difficult as a small group posing a large cost with small benefit may hinder the large group imposing a small cost with large benefit The government may not act in accordance with people resulting in government failures Topic 10 State and Local Government Expenditures The United States is one of the few and most decentralized governments distributing power at various levels Governments must address where federal governments must play a financial role a concept known as optimal fiscal federalism In the early days of the Union the federal government played a tiny role and has only recently arisen to levels similar to comparable countries Now federal revenue comes from taxes and is spent on social security health care and national defense State revenue comes from income taxes and property taxes spent on education health care and public safety The Tiebout model describes when the federal government should intervene in private markets He says what is missing in public markets that is present in private markets is shopping to adjust to preferences and competition to provide better affordable goods With many public goods individuals do not shop because of the public provision There are so many goods that individuals will not show their preferences based on one single good However this is different when public goods are provided at the national level At the local level goods will vary as opposed to uniformity across a nation This brings shopping and competition into play as consumers will search for provision at levels that meet their preferences In an ideal world each individual in a town has the same preferences and if they do not they vote on policies with their feet moving to a different area that has public provision at a level they are satisfied with This aggregates and reveals preferences There are of course problems with this model It assumes perfect mobility that everyone can move if and when they chose perfect information that other towns are providing at the perfect rate for individuals and efficient scales and economies to deal with the expansion and contraction ofindividuals It requires lumpsum taxes where individuals must pay taxes at the same rate as others regardless ofincome It also assumes that the provision has no spillovers and benefits ofpublic provision funded through taX money only affect the taxed individuals This could however be effective to some degree Residents of an area typically have the same desires thus drawing them to that area Only enough people must vote with their feet to show its effectiveness and house prices are capitalized to endure these costs Those who value a public good s provision to fund it so much will be drawn towards places they can afford to own a home and keep others out The eXtent to which public goods should be provided at the local level requires three things Taxbenefit linkages are required that show the relationship between taxes people pay and the benefits they reap When spillovers are low is also a time for local provision Lastly it should be provided locally with economies of scale benefitting only the number of people the economy could handle As such Tiebout suggests that local municipalities should focus on providing goods with few eXternalities that are broad in nature and that fit economies of scale When local funding is not enough governments may take advantage of cash transfers known as intergovernmental grants transferring funds from one government to another Matching grants are given in sums that match current funding for public goods Block grants give lump sums ofmoney that have no constraints on spending which could mean ineffective Conditional block grants require that the money be spent on a certain good though only effective when the grant is higher than current spending Topic 11 Education Education is the largest expenditure for state and local governments whose provision is constantly under scrutiny People often wonder why governments should provide funding There are public benefits to public provision of education An increase in productivity increases society s productivity While it may mean a direct benefit to an individual an increase in one person s productivity could mean an increase in group salary thus an increase in wages and taX revenue It may increase the workforce by providing opportunities to those who may be otherwise disadvantaged Public provision adjusts for private market failures as some people can t afford education and banks are wary about giving out loans without collateral Parents may not favor their child s education over other goods thus spending more on those than education or some families may not be able to afford education at all Thus the government intervenes and assists in the attainment level of education Free public education allows for the distinct possibility of crowding out People that may go to private school without public provision may choose the free option over the private to save money This can be solved by vouchers which give funds to parents that they may use for a child s education These vouchers allow the individual to choose and be sovereign and forces schools to compete to be better as a means of attracting these voucher s revenue These vouchers may also however lead to specialization that reduces overall quality of schools increase segregation increase public costs do not necessarily cover costs of special education and may not make education a competitive market


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