WELFARE ECONOMICS AND PUBLIC CHOICE THEORY

City & Metropolitan Economics Week 04 – Assignment 1 and Spatial Sorting January 30, 2018

Assignment 1 Demand Side Analysis

Question 1 – the price of public goods • Focuses on a key debate in public governance—

• what constitutes a public good • should government pay for it • and if so how whether costs should be shared with the public (and how)?

Demand curves • Tells us the quantity of a good that consumers are willing to buy at different prices.

• Law of Demand: holding all other factors that influence demand fixed, there is an inverse relationship to price and quantity.

• As prices fall, demand rises • As prices rise, demand falls

Individual Demand Curve- Opera Tickets

Individual demand curve -- opera tickets

0

50

100

150

200

250

0 1 2 3 4 5 6 7 8 9

quantity

pr ic

e marginal benefit

quantity

Pr ic

e

@$200, quantity demanded = 1

@$150, quantity demanded = 3

Assignment 1 Public Choice Theory

Question 2 – median voter theory • Application of why we discuss “centrist” viewpoints in policy

• Some key issues emerge: • can people really know their willingness to pay for public goods?

• those who “can pay,” do they want to pay? • for those who can’t pay, is there an equity argument to be made?

Public choice theory

• Resource allocation decisions in the public sector in a democratic society are made through voting

The Median voter

• The outcome of majority voting corresponds to the preferences of the median voter.

• Median voter determines the level of expenditure on public goods.

The Median voter • The median voter is that voter for whom it is true that exactly half of the rest of the people in the jurisdiction prefer the government to spend less than it does and exactly half prefer the government to spend more than it does.

Problems • Preference revelation (so easy in the market, so hard in the politial arena) • Elections of representatives convey limited information about voters’ attitudes toward specific public goods

• Representatives must be motivated to ascertain the preferences of their constituents

Assignment 1 Price Elasticity of Demand

Question 3 – price elasticity of demand • Focuses on the efficacy of policies related to taxes, regulations, incentives, etc.

• To really understand whether a policy decision has the desired effect, we need to analyze the public response.

How much of a fine? Price elasticity of demand

Elasticity of demand = % change in quantity demanded % change in price

If Ed is 1, demand is unit elastic (goes up or down in exact proportion to price chance)

If Ed is between 0 and 1, demand is inelastic (goes up or down but at a lesser proportion than the price change)

If Ed is > 1, demand is elastic (goes up or down at a greater proportion than price change)

Metro Solutions // Wasatch Choice 2050 What happened?

For those attending Metro Solutions

• What are the panelist’s positions (what do they think is going on, and what will happen)?

• Are you convinced by their statements? Why, or why not?

Spatial Sorting

The Tiebout hypothesis The existence of multiple local jurisdictions provides an elegant solution to the problem of pricing goods provided by local governments.

Voting with your feet “The consumer voter may be viewed as picking that community which best satisfies his preference pattern for public goods… moving or failing to move replaces the usual market test of willingness to buy and reveals the consumer-voter’s demand for public goods.”

“Just as the consumer may be visualized as walking to a private market place to buy his goods, the prices of which are set, we place him in the position of walking to a community where the prices (taxes) of community services are set… spatial mobility provides the local public-goods counterpart to the private market’s shopping trip.”

Corollaries “There is an optimal community size…defined in terms of the number of residents for which this bundle of services can be produced at the lowest average cost.”

• “Movement will take place out of the communities of greater than optimal size into the communities of less than optimal size.”