Graded Project Research Project Grad

Study Guide

Introduction to Public Policy By

Robert G. Turner, Jr., Ph.D.

About the Author

Robert G. Turner, Jr., Ph.D., has more than 20 years of teaching experience. He has taught seventh grade, worked as a curriculum developer for the Upward Bound Program, and taught sociology, anthropology, and honors seminars at the university level. As a professional writer, he has written nonfiction books, journal and magazine articles, novels, and stage plays.

Copyright © 2013 by Penn Foster, Inc.

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INSTRUCTIONS TO STUDENTS 1

LESSON ASSIGNMENTS 9

LESSON 1: PUBLIC POLICY: WHY WE DO WHAT WE DO 11

LESSON 2: MARKETS AND GOVERNMENT 45

LESSON 3: TOOLS FOR ANALYSIS 75

LESSON 4: MAKING POLICY 117

RESEARCH PROJECT 127

SELF-CHECK ANSWERS 133

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INTRODUCTION

Welcome to your course in public policy. For many thousands of years, the concept of public policy was essentially nonexistent. Most of us lived in tribal societies composed of relatively small populations. There was no concept of “public” in tribal worlds. Daily life was largely face-to-face and, quite often, the name people had for their society simply meant “the people” or the “human beings.” The word Cheyenne, for example, simply means “human beings.” The face of the world for indigenous people like the Inuit of the Arctic, the Kwakiutl of the Pacific Northwest, or the Navajo (Dine) was the natural world itself. Understanding and cooperating with nature was the name of the game when it came to survival.

However, the rise of civilizations changed all of that in signifi- cant ways. As population densities and numbers increased in the first urbanized civilizations, the mode of production was intensive, organized agriculture that produced food surpluses. The food surpluses, in turn, permitted a far more complex division of labor. While most people in the early civilizations were peasant farmers, food surpluses permitted the rise of whole categories of people who weren’t peasant farmers. Among the new social classes of people there were artisans, soldiers, merchant traders, priests, and bureaucrats. The lat- ter class represented the interests and policies of social elites, such as imperial or monarchial dynasties and their ministers or agents. In general, policies were made at the top and outcomes were often problematic for all those folks trying to make a living day by day—a number of whom were slaves. Today, in light of the powerful forces of advancing technology, ideals of dem- ocratic governance, and sophisticated modes of communication, social orders are imposed on natural environments, sometimes in rather destructive ways. In our world of glass, steel, inter- nal combustion engines, asphalt, and electric power plants, our environments are essentially artificial. Meanwhile, the division of labor is so complex that most of us have little understanding of what others do to make a living. Physicists talk to physicists, and cops talk to cops. Journalists hop about in search of a story. Factory-work environments are a far cry from country club environments. And the people who inhabit these environments aren’t likely to comprehend

Instructions to Students2

the life of a Maine lobster fisherman or a West Virginia coal miner. And so, we begin to grasp the baffling complexity that faces public policy makers.

Today, the word public is still an abstract concept, but it can be loosely defined as all those people in a complex soci- ety who either benefit from or are negatively impacted by policy decisions. For in our world, public policies frame and organize all of our social institutions—economic, political, and social. Education, health care, sports, the military, law enforcement, and the many other fields of human action and discourse require communal dialogue, sorting out differences, and reaching compromises on just how our lives should be conducted and organized.

OBJECTIVES

When you complete this course, you’ll be able to

n Define public policy, and explain the five steps in the policy-making process

n Describe and contrast the characteristics of for-profit, nonprofit, and government institutions

n Describe and explain issues related to balancing private and public concerns in a world characterized by scarcity and uncertainty

n Explain and describe 10 factors that may challenge collective efforts to reconcile differences regarding public policy

n Explain how the complexities of the real world are sim- plified through the use of conceptual models, such as the law of supply and demand or the idea that individuals seek to maximize their utility

n Describe the concept of moral hazards given that infor- mation is often incomplete and that human behavior isn’t necessarily rational

n Explain and discuss the characteristics of externalities— negative or positive—as these may be affected by property rights, transaction costs, and other factors

Instructions to Students 3

n Explain concepts of strategic interaction as these are expressed in game theory as exemplified by the prisoner’s dilemma

n Explain what’s meant by dynamic human behavior as illustrated by things like runs on banks or collective- action problems wherein accepted individual behaviors result in negative group outcomes

n Discuss and explain how indicators, like the poverty threshold, or indexes, like the human development index (HDI), are used to assess levels of social welfare

n Describe and explain conceptual tools for making inferences about social welfare, including efficiency, deadweight loss, equity, and distinguishing absolute from relative poverty

n Differentiate between parliamentary and presidential systems with respect to the legislative process

n Discuss and explain societal approaches to allocating scarce resources and, in particular, the characteristics of markets

n Describe the characteristics of market failure in relationship to enforcing property rights, lowering transaction costs, promoting competition, and ameliorating externalities

n Explain and compare redistribution and paternalism in respect to providing a social safety net

n Describe, explain, and apply descriptive statistics in the context of gathering and measuring information related to public policy

n Describe, explain, and apply principles of probability sampling and statistical inference in the context of public policy decision making

n Describe, explain, and apply linear regression analysis in the context of assessing information related to public policy

n Discuss and describe stakeholder analysis, mechanisms for changing behavior, and the elements of the policy process as aspects of effective public policy

COURSE MATERIALS

This course includes the following materials:

1. This study guide, which contains an introduction to your course, plus

n A lesson assignments page with a schedule of study assignments you’ll complete during the course

n Assignment introductions emphasizing the main points in the textbook

n Self-checks to help you assess your understanding of the material

n A research project and instructions for completing it

2. Your course textbook, Introduction to Public Policy, which contains the assignment reading material

YOUR TEXTBOOK

Your textbook, Introduction to Public Policy, by Charles Wheelan, contains the material on which you’ll be tested. Success in your course depends on your knowledge of the textbook. For that reason, you should take some time to look through the textbook from front to back to get a sense of how the material is arranged. Here are some of the key features of your textbook:

Front Matter

n Brief Contents are found on pages vii–viii.

n Contents are found on pages ix–xix. Studying the contents of the five sections of the textbook will give you a quick overview of the learning challenges you’ll encounter in this course.

n The Preface, found on pages xxi–xxiii, will give you an overall sense of the author’s approach to understanding the challenges and promises of forging effective public policies.

Instructions to Students4

Instructions to Students 5

Chapter Features

n Each chapter begins with an engaging exploration of a topic related to the contents of the chapter.

n A chapter outline follows the introductory essay. Read it carefully to understand the learning goals of the chapter.

n Within the text, key terms appear in bold type.

n Supplements under the heading “Policy in the Real World” offer case studies covering specific public policy issues. They’re found in every chapter.

n A Conclusion ends the main text of each chapter. You’ll want to read it carefully as you review your understand- ing of the chapter.

n A “For Discussion” feature follows the conclusion. It will challenge you to think about a specific public policy issue in considerable detail.

n Questions follow the discussion feature. They can help you think critically and creatively about specific public policy concerns.

n Lastly, a list of Key Concepts is found at the end of each chapter.

End Matter

n A Glossary is found on pages 549–568. This course will introduce you to a great number of concepts and terms. So, beyond using the glossary as a reference when you’re in mid-read and fuzzy about a term, you may also find it useful to simply scan the glossary once or twice as a form of review.

n An Index, found on pages 569–582, can help you pinpoint names, concepts, and topics.

Instructions to Students6

A STUDY PLAN

Think of this study guide as a blueprint for your course. You should read it carefully. To receive the maximum benefit from your studies, follow this procedure:

1. In this study guide, read the introduction to Assignment 1. This is the first reading assignment of Lesson 1. Pay attention to the new ideas and concepts introduced, and carefully note the pages in your textbook where the reading assignment begins and ends.

2. Skim the assigned pages in your textbook to get a general idea of their contents.

3. Then, read the assigned pages in the textbook. Try to see the “big picture” of the material during this first reading.

4. Next, go back and carefully study the assigned pages in your textbook. Pay careful attention to all details, includ- ing the illustrations, charts, and diagrams included in the textbook. Take notes on the important points and terms in a notebook, if you wish.

5. At the end of the reading assignment, review what you’ve learned by completing the self-check questions in this study guide. Write the answers on a separate piece of paper, if you wish. Try to answer the questions on your own without looking them up in the textbook. Don’t worry about making a mistake. The purpose of answering these questions is to review the material and to help you recognize the areas that you may need to study again. After you’ve answered the self-check questions, check your answers with the answers in the back of this study guide to confirm that you answered the questions correctly. If you answered any questions incorrectly, review the material for that topic until you’re sure that you understand it. Note that these questions are provided only for you to review your learning. You won’t be graded on them in any way. Don’t send your self-check answers to the school.

6. Repeat Steps 1 through 5 for each of the remaining reading assignments in the lesson.

Instructions to Students 7

7. When you’ve finished reading all of the assigned textbook pages for the lesson and you’re sure that you’re comfort- able with the material, complete the examination for that lesson. The examination contains a number of multiple- choice questions. You may go back to your textbook to review material at any time when you’re working on the examination. When you’re finished with each lesson, take the examination as soon as you’re ready. Don’t study another lesson until you’ve completed the examination.

8. Repeat these steps until all lessons have been completed.

9. Complete the Research Project and submit it for grading.

Remember that you may ask your instructor for help whenever you need it. Your instructor can answer your questions, provide additional information, and provide further explanation of your study materials. E-mail your questions to your instruc- tor, and he or she will see to it that you receive the needed information.

Now you’re ready to begin Lesson 1.

Good luck with your course!

Remember to regularly check “My Courses” on your student homepage. Your instructor may post additional resources that you can access to enhance your learning experience.

Instructions to Students8

NOTES

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Lesson 1: Public Policy: Why We Do What We Do

For: Read in the Read in the study guide: textbook:

Assignment 1 Pages 11–15 Chapter 1, pages 3–31

Assignment 2 Pages 16–20 Chapter 2, pages 32–66

Assignment 3 Pages 21–27 Chapter 3, pages 69–105

Assignment 4 Pages 28–35 Chapter 4, pages 106–138

Assignment 5 Pages 36–43 Chapter 5, pages 139–174

Examination 501783 Material in Lesson 1

Lesson 2: Markets and Government

For: Read in the Read in the study guide: textbook:

Assignment 6 Pages 45–55 Chapter 6, pages 177–213

Assignment 7 Pages 56–64 Chapter 7, pages 214–249

Assignment 8 Pages 65–73 Chapter 8, pages 250–287

Examination 501784 Material in Lesson 2

Lesson 3: Tools for Analysis

For: Read in the Read in the study guide: textbook:

Assignment 9 Pages 75–85 Chapter 9, pages 291–327

Assignment 10 Pages 86–93 Chapter 10, pages 328–363

Assignment 11 Pages 94–99 Chapter 11, pages 364–404

Assignment 12 Pages 100–107 Chapter 12, pages 405–443

Assignment 13 Pages 108–116 Chapter 13, pages 444–475

Examination 501785 Material in Lesson 3

Lesson Assignments10

Lesson 4: Making Policy

For: Read in the Read in the study guide: textbook:

Assignment 14 Pages 117–123 Chapter 14, pages 479–510

Assignment 15 Pages 124–125 Chapter 15, pages 511–547

Examination 501786 Material in Lesson 4

Research Project 50178700

Note: To access and complete any of the examinations for this study guide, click on the appropriate Take Exam icon on your “My Courses” page. You should not have to enter the examination numbers. These numbers are for reference only if you have reason to contact Student Services.

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Public Policy: Why We Do What We Do

ASSIGNMENT 1 Read Assignment 1 in your study guide. Then, read Chapter 1 on pages 3–31 of your textbook, Introduction to Public Policy.

Imagine yourself living near a national park that gets lots of snow during the winter. You’re a fan of outdoor camping and backpacking; you respond to the “call of the wild.” So, how might you feel about snowmobiles? Would you adore riding them across snowy wastes? Would their noise bother you? Would you view their riders as barbaric invaders of nature’s precious solitude?

If you’re responsible for crafting public policy, how would you go about reconciling the range of attitudes about snowmobiles in national parks? Of course, at this point, that’s not a fair question. But this scenario does tell you one thing: Making public policy is intensely challenging. Understanding how and why is the whole point of this course.

Defining Public Policy

To quote your textbook, “Public policy is the process by which a society makes and enforces decisions on what behavior is acceptable and what is not” (page 7). Basically, this formalism tells us that public policy is all about what we, collectively, are willing to allow other people to do. Consider these questions: Are you in favor of legal abortion? Are you in favor of a livable minimum wage? Do you feel your tax burden is too high, about right, or too light? Do you agree that America has the right to wage preemptive wars against foreign states, such as Iraq and Afghanistan, in pursuing a global fight against terrorism?

You’ll notice two kinds of questions here. The issues of abortion and same-sex marriage may involve communal discourse and debate that might lead to legislative actions. Such debates can have a lot to do with how, collectively, we may decide on what we think other people should be allowed to do. On the

Introduction to Public Policy12

other hand, the issues related to raising revenue (taxes) and waging war are pretty much beyond the control of ordinary citizens. Regardless of how people feel about tax rates, they’ll still have to pay national, state, and local taxes. Regardless of how people feel about preemptive wars, government foreign policy will be what it will be, except for the possibility of mas- sive, organized dissent. That said, it’s still the case—in every case (at least in principle)—that public policies should aim at making things better for people.

The Policy Process

Familiarize yourself with the five steps of the policy process:

1. Identify a social goal. Improving public education, reducing poverty, or improving public infrastructure could be a few, among the many, social goals you might imagine.

2. Diagnose the problem. If the issue is poverty, we’ll seek data that helps us identify possible causes of poverty.

3. Identify the appropriate institution for action. Having iden- tified a key cause, like unemployment, we might decide on ways agencies of the government might offer incentives to business for hiring more workers.

4. Evaluate the substance and politics of competing policy options. Is it better to expand public welfare services (like Medicaid or the food stamps program) or cut funding for such programs in the name of balancing the budget?

5. Implement, enforce, and monitor the policy change. During the Clinton administration, public policy programs— national, state, and local—called for increasing the number of cops on the beat to reduce crime and enhance public safety. With such programs in place, enforced by government mandates, public policy experts went about monitoring the results, such as looking at changes in crimes rates.

Note: Refer to the graphic on page 11 for an overview of the five steps in the policy-making process.

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For-Profit, Nonprofit, and Government Institutions

The key idea to keep in mind here is that all of the institu- tions mentioned in your textbook, for-profit firms, nonprofit firms, and the government, influence and are influenced by public policy.

For-profit firms exist to make money. They aim to keep their expenses lower than their revenues. Most of our daily needs and jobs come from the private sector, and private sector operations can thrive only when they’re meeting the needs of the people they employ and the customers they serve.

Nonprofit firms offer goods and services to people that aren’t provided by the private sector. In this way, they contribute to the overall social welfare. For example, university endow- ments can be used to finance the education of students who can’t afford to pay tuition costs.

Government institutions are unique in that they can compel people to do what they would prefer not to do. This is true of local, state, and national governments because, in general, governments maintain a monopoly on force. Western states embrace representative democracies. Too much government can squelch and limit free enterprise and human freedom in general. Too little government can lead to a “war of all against all,” civil corruption, and the unraveling of the social order.

Balancing Private Life and Public Policy

With respect to the economic face of public policy, here’s the key idea: Our collective decisions, expressed as public policy, create the framework for the private and corporate production of goods and services. In short, we need public policy. On the other hand, policy makers must always try to find the balance between liberated human expression and the collective good. Private, individual freedom must be balanced against the rights and welfare of communities and society as whole.

Introduction to Public Policy14

The Art of the Possible: Life in a World of Scarcity and Uncertainty

Most people who’ve lived on planet Earth for a while under- stand this: Much of what we value is scarce and life is full of unforeseen contingencies hidden in clouds of uncertainty. A blizzard arrives, people get snowed in, and the power bill goes through the roof.

On a larger scale, it’s simply a fact that many amenities peo- ple might want are beyond their financial means. That’s why families need budgets: Incomes are finite, and we can never buy everything we might want. Yet, even our budget estimates may be hedged about with uncertainty.

Fields of uncertainty noted in your textbook include

n Scientific uncertainty. Scientists must deal with a great swarm of data to figure out just how climate change will affect conditions like sea-level rise and spreading desertification.

n Human unpredictability. Humans can be identified by their fingerprints, because each of us has a distinctive fingerprint pattern. In the same sense, actual individual responses, for example, to a new zoning policy, are inherently subject to uncertainty.

n Deliberately hidden information. As your textbook points out, the invasion of Iraq was based on the assumption that Saddam Hussein’s government was harboring and producing weapons of mass destruction. In fact, no such weapons were ever found. So the questions arise: Was the intelligence faulty or was information deliberately with- held from the public to carry out a preconceived plan?

n The sheer complexity of life. Your textbook discussion here focuses on the immense complexity of economic outcomes in the context of financial meltdowns and international trade agreements. But you’ve probably guessed that life is bafflingly complex simply from trying to figure out why you bought a car you couldn’t afford or why your boss failed to smile while passing your cubicle.

Take some time now to review what you’ve learned by completing Self-Check 1.

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Self-Check 1

At the end of each section of Introduction to Public Policy, you’ll be asked to pause and check your understanding of what you’ve just read by completing a “Self-Check” exercise. Answering these questions will help you review what you’ve studied so far. Please complete Self-Check 1 now.

Indicate whether each of the following statements is True or False.

1. In the world of public policy, adverse effects are more likely to be significant when an intervention has a profound effect on people’s lives.

2. The private sector is composed of for-profit firms.

3. The first step in the policy-making process is identifying the appropriate institution for implementing the policy.

4. Policy makers can make decisions only if they have complete information.

5. In a nonprofit organization, surplus revenues are retained by the organization.

Check your answers with those on page 133.

Introduction to Public Policy16

ASSIGNMENT 2 Read Assignment 2 in your study guide. Then, read Chapter 2 on pages 32–66 of your textbook, Introduction to Public Policy.

Public Policy Success: Life Is Better Now

Overall, even given reversals in some areas of public welfare in the last few years, it can be said that life is better for many, if not for all. In the developed world, on average, people live longer than they did several decades ago. Per-capita income (adjusted for inflation) is considerably greater now than it was in 1970. In many areas of the economy, people work fewer hours per week than they did in the 1960s and 1970s. But these are overall, general trends. They don’t account for things like the off-shoring of jobs that’s currently undermining the health of the American middle class. Furthermore, calls for austerity sparked by the international financial crisis of 2008 have stirred a hornet’s nest of protest across the European Union. In America, the “Occupy” movement protested the accelerating gap between the superrich and ordinary wage earners.

So Far to Go

A host of problems remain. The staggering cost of health care isn’t declining; it continues to increase. Mounting tuition costs are resulting in burdensome student loan debt, now approach- ing one trillion dollars. American prisons are overflowing even as crime rates have been in decline for the last couple of decades. In the face of such problems, a variety of challenges face public policy makers. In preview, here’s a quick look at 10 challenges elaborated in your textbook.

1. What is “better”? What’s good for some may be bad for others. For workers and wage earners in general, a liv- able minimum wage will make the world a better place. For private sector corporate interests, raising the cost of labor is bad news. CEOs seek maximum return on investment (ROI) for owners and shareholders.

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2. Disagreements over basic values. Regarding the sharp contention over abortion, imagine a balance-beam scale. In one pan is the “weight” of opinion that a zygote (a fertilized egg) is a person with person rights. In the other pan is the “weight” of opinion that women should control their own bodies. The word weight reminds us that values are subjective, not objective “facts.”

3. Trade-offs among basic values. Again, as illustrated by the abortion issue, the Supreme Court decision in Roe v. Wade (1973) made abortion legal. However, despite that decision, based on the Constitution’s concept of the right to privacy, pro-life sentiments continue to be expressed as legislative measures.

4. “Side-effects” and organized interests. After mass mur- ders, such as those at Virginia Tech and a Colorado theater, the National Rifle Association (NRA) continues to lobby for the sale of all kinds of guns based on the Second Amendment. Would restricting gun ownership eliminate or even reduce such incidents? Does the NRA in effect protect the profits of arms manufacturers by protecting the people’s right to bear arms in spite of public sentiment from others favoring restrictions on access to firearms?

5. Balancing the present against the future. An example is balancing demands for energy against rapidly accumu- lating greenhouse gases in Earth’s atmosphere. Should the use of fossil fuels (coal, natural gas, and petroleum) be reduced to protect future generations from the ecological damage, such as habitat destruction, species die-off, and global warming?

6. Collective-action problems, or the “tragedy of the commons.” Collective-action problems occur when accepted individ- ual behavior results in harm to the common good. The tragedy of the commons is a prime example. If you’re not quite sure what the tragedy of the commons is all about, just consider threats to food-fish populations. In many coastal areas of the planet, people are heavily dependent on harvesting ocean resources for food. However, as indi- viduals and firms pursue their aims, fish stocks in many areas are literally vanishing.

Introduction to Public Policy18

7. Nondemocratic safeguards. These happen when policies deliberately create institutions that bypass the will of the majority in the name of social efficiency. According to polls, most Americans favor some kind of universal health care scheme, such as Medicare for all. However, government policies typically favor the special interests of for-profit, private health insurers, pharmaceutical firms, and for- profit hospital chains.

8. The challenge of changing human behavior. Changing human behavior for the better isn’t easy. In any society, once patterns of attitudes, values, and behaviors are deemed “normal” and “virtuous,” they tend to persist.

9. Progress breeds new challenges. As many have noted, based on historical records, once a weapon is invented, it will be used. So far, no nation has employed nuclear weapons, save for the United States at the end of World War II. However, as demonstrated in the work of Ike Jeanes and others, as proliferation accelerates, the odds that nuclear weapons will be used increases. Today, the United States, the Russian Federation, France, the United Kingdom, China, India, Pakistan, North Korea, and Israel possess employable nuclear weapons. Thus, statistically, the global nuclear threat at present is actually greater than it was during the Cold War.

10. Status-quo bias. This tends to keep us stuck with old ideas, even when they no longer serve the best interests of either individuals or firms. In a nutshell, people who benefit from social institutions as they are will be power- fully inclined to maintain their advantages.

Reconciling Our Differences

Values, Facts, and Theories

Values are strongly held beliefs. Indeed, they’re core beliefs that shape a person’s view of self, others, and the world at large. Values are based on assumptions that may or may not be consistent with reality—whatever that may turn out to be. But because they define one’s identity, they tend to be strongly

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defended when questioned or challenged. That understanding can help us realize why some values, such as those associated with a religious faith, can spark violent rivalries.

A theory is a model that more or less adequately explains the relationships of a set of observed facts. Newton’s (or Einstein’s) theory of gravity is based on mathematical relationships among measurable variables, such as velocity, mass, and acceleration. All valid science-based theories can be modified as new observations unveil new facts. Theories are models, not “the truth.”

Sources of Disagreement

The four sources of disagreement given in your textbook are as follows:

1. Differences in basic values. Sound public policy formula- tion must not be based on the policy makers’ values. For example, the issue of capital punishment must be viewed in terms of “facts on the ground,” such as public sentiment, the political atmosphere, and cost-benefit assessments.

2. Disagreements over facts or theory. Good public policy research requires sound data and sound data analysis. Nevertheless, studies may vary when it comes to the question of, say, the deterrence value of capital punish- ment.

3. Different interests. Even soundly conceived public policy won’t please all of the people all of the time, even if the benefits of a policy are apparent in the overall picture. For instance, someone may decline Social Security benefits because he or she sees them as an unwarranted form of charity.

4. Disagreements over things that are at present unknowable. Existential questions (Does God exist?), questions about the future (such as global warming), and “what if” (coun- terfactual) questions (What if the South had won the Civil War?) may have answers—at least regarding exis- tential and future scenarios. But we can’t know what they are. Even so, assumed answers to such questions can indeed influence public policy formulations.

Introduction to Public Policy20

Self-Check 2

Indicate whether each of the following statements is True or False.

1. Only occasionally can we predict the outcomes of a policy with complete certainty.

2. There is no single, quantifiable measure of public policy success.

3. The so called “tragedy of the commons” is a collective-action problem.

4. A fact is to an objective reality as a theory is to a general principle based on available data.

5. Disagreements over basic values are most often evident with respect to social issues, like abortion or gun control.

Check your answers with those on page 133.

Lesson 1 21

ASSIGNMENT 3 Read Assignment 3 in your study guide. Then, read Chapter 3 on pages 69–105 of your textbook, Introduction to Public Policy.

Simplifying the World

The Role of Models

The most basic model for microeconomics—having to do with the ebb and flow of collective consumer behavior—is the law of supply and demand. As the supply of peanut butter increases, the price of peanut butter declines, and people will buy more peanut butter—but not indefinitely. Once the demand for peanut butter reaches its market limit, an equilibrium price is established. Further increases in the production of peanut butter won’t raise the price and will result in wasted inven- tory. Of course, that simple model is, indeed, a simplification. Be sure to study the graphic illustration on page 73.

The Ceteris Paribus Assumption

That term ceteris paribus is Latin for “all other things being equal.” For example, in the supply and demand model, we assume, for purposes of analysis, that nothing changes in the world except the demand for and the supply of peanut butter. Assuming all things being equal isn’t an offense against logic. In any case, good models have these characteristics:

n Good models allow us to study complex phenomena by putting aside extraneous detail. The good model will focus on the most important factors that lead to such things as poverty, poor educational outcomes, or the exorbitant costs of health care.

n Good models produce theories that can be tested by way of analyzing data or facts.

n Good models point the way toward policies that will have the most impact on problems, like low worker productivity, obesity in children, or income inequality related to gender.

Introduction to Public Policy22

Individuals Seek to Maximize Their Own Utility

In the world of economists, utility has to do with people’s perceived usefulness of particular attitudes, values, and behaviors for providing personal well-being. You might put it this way: People will pursue maximum happiness. To state that idea formally, we can say that individuals will seek to maximize their utility. However, the concept of utility is a theoretical term. It can’t be directly observed or measured. That’s the case because what one person sees as enhancing their well-being may be viewed as an obstruction to happiness by another person.

Firms Seek to Maximize Profits

A basic purpose of a corporation, a partnership, or any private enterprise is getting maximum outputs relative to inputs of time, knowledge, machines, and labor. Relative to public policy, that means one can safely assume that firms won’t voluntar- ily do work that will be unprofitable in the long run. Further, policy makers can properly assume that the profit motive is such a strong motivator that, absent some form of regulation, companies will be tempted to perform in ways that are harmful to society at large.

The Power of Incentives

An incentive can be any practice or policy that alters behavior. Joe may be encouraged to work harder on his algebra home- work if Dad promises him a cash reward for getting an A in algebra. That’s a positive incentive. Your textbook recognizes four vital points to consider when thinking about the power of incentives:

1. Incentives motivate and explain an extraordinary range of human behaviors. As demonstrated in the work of Nobel Laureate economist Gary Becker, many human behav- iors are motivated by economic factors. Individuals will make decisions about investment in education and skill- set training in much the same way that a business will make decisions about allocating resources to things like marketing, new product development, or reorganizing job specifications.

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2. One of the most powerful tools for changing behavior is changing incentives. From a policy-making point of view, for example, sin taxes can raise the price of cigarettes, thus providing an incentive that will reduce the demand for cigarettes. As public health is improved by reduced percentages of smokers, public health costs may also be reduced.

3. Rational individuals and firms will seek to avoid any outcome that makes them worse off. Your textbook illustrates this principle by examining some of the ways married couples in China have tried to get around that country’s “one-child” policy. But the main point of this principle can be gener- alized. Given that any policy will yield winners and losers, losers will look for any and every feasible scheme they can use to thwart or evade an “unfriendly” policy.

4. Policies that fail to anticipate how rational individuals and firms will respond can have serious unintended consequences. There’s a general law in the social sciences called the law of unintended consequences. If policies fail to recognize how rational individuals and firms may respond to policies, there may be unintended consequences. Examples are offered in your textbook.

Moral Hazard

The moral hazard concept is illustrated at some length in your textbook. But, basically, it refers to institutional situa- tions wherein protective provisions of insurance, such as car or flood insurance, may invite a reduced sense of responsibility and responsible diligence on the part of a policy holder. For example, if you know your car is insured for near or complete replacement, you may be less inclined to exercise precaution- ary measures, like locking your car when you’re parked in an urban neighborhood. Fundamentally then, a moral hazard is a financial hazard for insurers.

Introduction to Public Policy24

Incomplete Information

A situation wherein one party to a transaction has more information than the other party represents an asymmetry of information. For those who craft public policy, this sort of information imbalance is relevant because it obstructs the proper functioning of a market. “Lemon laws” to protect con- sumers who get stuck with improperly manufactured cars and regulations requiring packaged or canned food to include a list of ingredients are examples of policies meant to address information asymmetry.

Principle–Agent Problem

Imagine that you’re the owner of a small publishing business. You employ a chief editor, two editorial assistants, and an administrative assistant. Being human, you expect your employ- ees to support and further the interests of your business. However, you discover that one of the editorial assistants, Drake, is padding his expense account while bad-mouthing you to friends who work for a rival publishing company. In an employee–employer relationship, you, the owner, are con- sidered the principle and your employees are agents of your firm. This imaginary scenario illustrates two characteristics of a principle–agent problem.

First, the agent—Drake—is clearly motivated to behave in ways inconsistent with your interests. Second, because you have all you can do to sort through submitted manuscripts and queries, you have no way of closely monitoring the behavior of your editorial assistants. And there’s the problem.

Your textbook offers you some interesting insights into prin- ciple agent problems that were inherent in the Wall Street financial crisis of 2008.

Adverse Selection

The concept of adverse selection is most readily understood through an example. Let’s assume that health insurers aren’t able to gather as much information about policy applicants’ health as is known to the persons seeking health care coverage. Here, we immediately see a case of asymmetrical information.

Lesson 1 25

Adverse selection enters the picture as people with the most precarious health profiles most actively seek coverage. When a high percentage of policy holders are at risk for serious medical care, the insurance companies are placed at an actu- arial disadvantage. As a result, premiums may rise across the board for all the company’s policy holders. And, as an added unintended negative consequence, policy holders may be driven out of the market, thus increasing the total number of uninsured persons.

Mechanisms for Overcoming Information Problems

In a market economy, information problems can wreak havoc. If, for example, a home buyer isn’t informed that lead-based paint has been used throughout the house, he or she may be committing to a mortgage that purchases serious health risks for children and pets. In these kinds of contexts, a number of governmental policies have been established to protect con- sumers. Nutrition and ingredient information is required on packaged foods. The Food and Drug Administration (FDA) provides appropriate policies for labeling pharmaceuticals.

But given that the enforcement of well-intentioned policies may not always suffice, there are other ways to overcome information problems. Your textbook discusses four ways to overcome information problems:

1. Branding. You may not be able to tell an alternator from a fan belt, but if you’ve had good experiences with Hondas or Fords, the brand itself will reassure you. Companies spend lots of time, energy, and money building up brand images.

2. Signaling. A “signal” like a college degree or Phi Beta Kappa key may have no intrinsic cash value, but it can convey a message. When employers are in search of competent, capable employees, such signals may make all the difference.

Introduction to Public Policy26

3. Certification. Information provided by expert third parties can do a lot to overcome information deficits on the part of individuals or organizations. Car and Driver magazine, the 75-year old grandfather of consumer information, Consumer Reports, and the Underwriters Laboratory are invaluable resources when it comes to providing accurate, timely information to people who want to know.

4. Screening. Car insurers offer a good example of screening. As drivers establish a sound record based on a pronounced absence of accidents, DUIs, and traffic violations, they may become increasingly eligible for reduced policy premiums.

How Rational Are We?

Here you’ll learn a bit about a budding specialty in the domain of economics—behavioral economics. You’ll discover some odd, fascinating experimental results. You’ll learn a bit about the way human risk assessments may be unrealistic. You’ll get a few clues as to the kinds of mistakes people make in setting money aside for retirement. In short, all things considered, you’ll be challenged to think again about the accuracy of the assumption that people are rational actors striving to maximize their utility.

Lesson 1 27

Self-Check 3

Indicate whether each of the following statements is True or False.

______ 1. For policy analysts, the law of supply and demand is considered a model.

______ 2. The most serious adverse selection problems occur in the food-processing industries.

______ 3. According to research findings, revenge offers satisfaction even if it doesn’t make one

better off.

______ 4. The principle-agent problem illustrates one kind of imperfect information problem.

______ 5. According to Becker, the fact that human labor can be monetized defines the concept of

human capital.

______ 6. Perverse incentives are associated with the law of unintended consequences.

Check your answers with those on page 133.

Introduction to Public Policy28

ASSIGNMENT 4 Read Assignment 4 in your study guide. Then, read Chapter 4 on pages 106–138 of your textbook, Introduction to Public Policy.

Externalities

A stark example of costly negative externalities is the polluting runoff from factory farms. The runoff from factory farms is contaminating a large percentage of aquifers in the Midwest and elsewhere. Aquifers are underground strata of clay, shale and other natural formations that accumulate and store water. That water, drawn up from wells, in turn, supplies the fresh water needs of millions of people.

On the other hand, there can be positive externalities. A group of investors may decide to construct the Meadowbrook shopping mall in Blankenship’s town square. Of course the investors will hope to profit from their venture. But in this case, there can be a flow of positive side effects. New jobs will appear. Property values near the mall will increase. Taxes derived from increased local incomes can be made available for community needs, like playgrounds, public parks, and recreational centers.

With respect to public policy, the key to negative externalities may be regulation. But with respect to positive externalities, public policy may be aimed at providing incentives for investors to create Meadowbrook-like ventures in other towns and localities.

Property Rights

For a market system to perform effectively, the legal concept of private property must be clearly defined and enforced. In short, the concept of private property is fundamental in a free-enterprise system. When we think about private property, we mostly think of land, buildings, and other kinds of “hard” assets. But private property also extends to intellectual property, such as patents, copyrights, trademarks, brands, original lit- erary works, film option rights, and so on. In effect, anything that can be ascribed value may be defined as private property. All of this is relevant to public policy because it’s important to understand how groups go about allocating resources.

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Transaction Costs

Transaction costs are related to public policy in two impor- tant ways: (1) Transaction costs can be a serious obstacle to transactions that could make all the parties better off. For example, in New England, some towns and localities straddle the Canada–United States border. If the owner of a farm that straddles the border wants to build a new barn, that project is likely to be obstructed by the need to reconcile distinct zoning ordinances on either side of the border. (2) Good public policy can aid in lowering transaction costs. Courts can lay out clear stipulations for enforcing contracts. Government water authorities can assist community commissions by providing information that would be hard to gather by private citizens.

The Coase Theorem

Ronald Coase received a Nobel Prize in 1991 for figuring out how private property and transaction costs influence that structure and dynamics of modern economies. There are dif- ferent interpretations of the Coase Theorem. Your textbook focuses on the idea that negative externalities like pollution can be abated or ameliorated if the market is characterized by clearly defined property rights and low or nonexistent transaction costs. Presumably, this would be because a non- polluting company being impinged on by an adjacent polluting company will be advantaged in terms of relative social efficiency. Put another way, when a nonpolluting company contends with a polluting company, the nonpolluting company can buy out and shut down the polluter because it offers more value to the economy at large.

Strategic Interaction

This section introduces you to game theory. In the context of public policy, game theory examines ways in which strategic interactions among economic agents produce outcomes (pref- erences and utilities) that might not have been expected by any of the agents. The complex mathematical formulations that drive game-theory models in many areas, from strategic corporate planning to strategic foreign policy determinations, are beyond the scope of this course. However, the logic of game theory can be represented by the prisoner’s dilemma game.

Introduction to Public Policy30

The Prisoner’s Dilemma

Imagine this scenario: Jake and Calvin have been charged with armed robbery. At police headquarters, the two men are interrogated separately. They have no opportunity to interact with each other. While being interrogated, each of the men has two options: confess or stay quiet. However, each of the culprits understand that the outcome of his choice—confess or don’t confess—will depend on whether the other man con- fesses or doesn’t. Jake and Calvin may be failed bank robbers, but they’re not stupid. As you study Figure 1, you’ll see that if both Jake and Calvin confess, each will do 20 years in the slammer. If Jake confesses and Calvin doesn’t, Jake will get a light 3-year sentence for cooperating, and Calvin will be slugged with a 30-year sentence. If neither Jake nor Calvin confesses, the case against the two will remain largely circumstantial and both will end up with 5-year sentences. Finally, if Calvin confesses and Jake doesn’t, he’ll get the 3-year sentence while Jake gets 30 years.

Remember the primary idea here. In a prisoner’s dilemma game or in similar games, the agents (actors) produce out- comes that are unexpected by the players. In the prisoner’s dilemma, self-interest dictates that each player will adopt a dominant strategy: confess. Come clean, and go for a plea bargain for being so nice and cooperative. Yet, from an out- side perspective, that’s clearly not the best strategy. The heaviest aggregate prison term, 20 + 20 = 40 years is what these guys get when they both choose the confession strategy. Clearly, the best strategy, in terms of aggregate time in prison, occurs when neither man confesses.

CALVIN

Confesses Doesn’t Confess

JAKE

Confesses 20, 20 3, 30

Doesn’t Confess 30, 3 5, 5

FIGURE 1—An Example of the Prisoner’s Dilemma

Lesson 1 31

An Arms Race

Something like a prisoner’s dilemma happens in an arms race. Take two irritable nations—Nation X and Nation Y. They share a common border and both are moderately armed in the name of self-defense. Say Nation X begins to acquire guns, tanks, and bombers, on a large scale. Nation Y becomes uneasy. If Nation Y responds with an arms buildup, the likelihood of war is likely to increase. On the other hand, if Nation Y decides against an arms buildup, the country becomes vulnerable; it could be overrun. The ministers and dignitaries of Nations X and Y could meet somewhere and rationally determine that war is a lousy idea. It’s expensive. The arms race scenario could be cancelled in favor of diplomacy, joint trade ventures, and other agendas of common interest. Nations X and Y could decide on a positive-sum scenario.

Zero-Sum, Positive-Sum, and Negative-Sum Games

In economic contexts, strategic interaction “games” can be sorted into three categories.

In a zero-sum game, the size of the resource pie is fixed. Imagine that players are competing for a larger slice of a fixed budget. Under such a scenario, if the department of high- ways manages to increase their share of the budget, funding for other priorities, like education, will be reduced. One party may grab more of the pie, but overall, the sum of the slices of the resource pie remains the same.

In a positive-sum game, the size of the resource pie can be increased, given certain conditions. For example, in a contest between workers and management, the size of the pie might be increased by finding ways to cut nonlabor costs and increase productivity. If that works out, both parties benefit.

In a negative-sum game, the payoff gets smaller over time. For example, a union strike may aim at better pay and work- ing conditions even as the market share for an industry is contracting. The “game” will be aimed at grabbing the largest possible slice of the contracting resource pie.

Introduction to Public Policy32

Dynamic Behavior

Human behavior is dynamic. Individuals make choices, day by day, hour by hour. As that happens, group behavior is altered. If the Joneses place a plastic deer on their front lawn, others in the neighborhood may buy lawn ornaments. Or the neighborhood association might meet to condemn plastic deer and other sorts of lawn decor. In any case, you’ll want to be able to explain three kinds of dynamic behavior.

A negative feedback loop is also referred to as a vicious cycle. Your textbook offers the example of a bank run, which was fairly common before the Roosevelt Administration introduced the Federal Deposit Insurance Corporation (FDIC). The FDIC insures bank deposits (for up to $250,000 currently) and, thus, keeps most banks solvent as economic tides wax and wane.

A positive feedback loop is the opposite of a negative feed- back loop. Maybe you recall the film Pay It Forward. The film’s protagonist, a young boy, decides to do good deeds to inspire others to act with compassion and kindness. The film ends in tragedy, even though some others decide to “pay it forward.” Socially positive behavior, economically speaking, can inspire others to pursue socially positive behavior.

An equilibrium situation occurs when system changes, such as price changes or changes in the labor market, don’t upset the system’s overall inputs or outputs. To illustrate how the market system can be “self-correcting,” your textbook uses the example of an increase in the cost of tomatoes. The mar- ket will respond as people buy fewer tomatoes in favor of alternative vegetables. The decrease in demand for tomatoes, in turn, will tend to restore the former equilibrium price level for tomatoes. Supply and demand will be “rebalanced.”

Collective-Action Problems

At this point, you’re familiar with the concept of collective- action problems with respect to individuals. Here, the focus shifts to groups. Thus, if we can assume that individuals will rationally pursue behaviors that will make them better off, so will groups. Of course, that assumption fails when people are engaged in a prisoner’s dilemma or similar situation.

Lesson 1 33

On the other hand, experiments and studies have demonstrated the reality of the key collective-action problem—shirking. Individuals who share in the benefits of collective action with- out doing their share of the work are called free riders. Free riders are parasitic. And if more and more people decide to be free riders, the benefits offered by a group will be diminished, even for the shirkers.

A phenomenon called the Ringelmann Effect illustrates collective-action dynamics. In 1913, a French agricultural engineer, Maximilien Ringelmann, conducted experiments based on rope-pulling contests. He found that as people were added to each team, individual effort declined as a precise function of group size. And so, when you learn from your textbook that free rider problems increase as groups get larger, you’ll now know just how this has been empirically demonstrated. You can add that to the other two reasons that encourage free riders—efficiency and monitoring problems. As groups get larger, individuals will perceive their contribution (or non- contribution) to the group’s goals as negligible. Furthermore, as groups get larger, it gets increasingly difficult to monitor indi- vidual behavior. Two heads may be better than one, but 100 or 1,000 heads may simply be a road to productive inefficiency.

Note: In your textbook, you’ll want to pay careful attention to the ways in which the tragedy of the commons, a concept devel- oped by Garrett Hardin, illustrates collective-action problems.

Your textbook offers you six strategies that may serve to alle- viate collective-action problems. For example, regulations, like rules for fisheries and fishermen, can be helpful, at least if the individuals involved can grasp the need for the rules. Government services can provide a public good through services like park maintenance, fire-fighting, and sanitation services, all of which are paid for through taxation. Be sure to think about all six of these strategies to consider when or how they might be right for a particular situation.

Introduction to Public Policy34

Nobel Ideas: Elinor Ostrom and Governing the Commons

Elinor Ostrom, a Nobel Laureate in economics, wrote a book titled Governing the Commons: The Evolution of Institutions for Collective Action. That title should give you a hint as to the concerns she has addressed. Ostrom compels us to understand that users who depend on shared resources have developed effective ways to protect that resource for the common good. She proposes seven principles for effective common-pool resource management. Before you get to the list of seven, here are three that stand out:

1. Clear rules should define who has what entitlement.

2. Adequate mechanisms should be in place for resolving disputes and conflicts.

3. Governance of the resource should be democratic.

It’s nice to know that solutions for some of our most pressing problems are being tried and tested.

Lesson 1 35

Self-Check 4

Match each statement with the correct term. Not all of the terms will be used.

______ 1. Strategic interactions include an arms race or the

prisoner’s dilemma.

______ 2. People who depend on a shared resource often

create rules and other mechanisms that preserve

and protect the resource.

______ 3. This is the legal right to exercise control over

some resource.

______ 4. Externalities can be corrected without government

intervention if property rights are clearly defined

and transaction costs are low.

______ 5. There are effective strategies for alleviating collective-

action problems given particular situations.

______ 6. When an organization has a fixed budget,

funding one program will reduce funding

for some other program.

Check your answers with those on page 133.

a. Zero-sum game

b. Coase Theorem

c. Transaction costs

d. Property rights

e. Game theory

f. Negative-sum game

g. Common-pool resources

h. Regulate, privatize, selective incentives

Introduction to Public Policy36

ASSIGNMENT 5 Read Assignment 5 in your study guide. Then, read Chapter 5 on pages 139–174 of your textbook, Introduction to Public Policy.

What Is Poverty? And Who Is Poor?

Becoming more aware of one of this world’s most pressing problems—poverty—will sharpen your focus on the main text. Study the comparative poverty levels for the mainland United States, Alaska, and Hawaii in the table on page 139. Then note the ambiguity inherent in the term poverty. You’ll see that the “market basket” concept of poverty was based on rough estimates provided by the Department of Agriculture decades ago. The estimates summed up the amount of money needed to provide a person with an adequate, nutritious diet. For a family of three, that estimate was multiplied by three, and so on. However, you’ll see that significant variables weren’t accounted for in this calculation, such as government subsidies, like food stamps or the fact that standards of living, after accounting for inflation, have increased over time. Moreover, you’ll discover that commonsense revisions for estimating poverty thresholds proposed by the National Research Council have never been adopted.

Measuring Social Welfare

From an individual’s perspective, the previously introduced concept of utility can be thought of as a good. People will be guided by the Freudian pleasure principle; they’ll try to maxi- mize the “goods” in their lives while minimizing the “bads.” But, given the way poverty rates are estimated, how can a policy maker aim to maximize social welfare without any objective measure of social welfare?

Indicators

Ideally, indicators of social welfare should be easily measurable and strongly correlated to the underlying variable of interest, such as poverty. In that context, even though the concept of poverty is fuzzy, it can be useful. For example, the measure can help policy makers determine who should be eligible for

Lesson 1 37

government assistance programs. It can also give us a sense of trends. If poverty rates are increasing or decreasing, we can look for reasons why this is the case. Meanwhile, we can use comparative indicators, like life expectancy, to examine relative well-being in different countries.

Indexes

Indexes combine several indicators that would seem, logically, to contribute to social well-being. The human development index (HDI), developed by a Pakistani economist, is a prime example. The HDI looks at

n Life expectancy at birth

n The adult literacy rate

n The population percentage of enrollment in primary, secondary, and tertiary schools

n The per capita gross domestic product (GDP)

Being able to reduce the social well-being measure to a single number is the upside of an instrument like the HDI. The downside is the subjective uncertainty inherent in assigning a weight to any of the HDI indicators. If, for example, the GDP per capita measure is given greater weight, HDI comparisons across countries would be altered to some extent.

Note: In the table on page 147, you’ll note that the United States isn’t included among the top 10 highest HDI ratings. Norway, Australia, Iceland, and Canada are at the top. Reasons for this include wide variations in social well-being across regions and social classes and the exceptionally large wealth gap between the wealthiest people and the middle and lower classes in the United States. On average, the high HDI coun- tries feature fairly homogeneous populations and, typically, strong social safety nets.

You may wonder how a rural farmer in Zaire or Bolivia can live on less than $2.00 a day. The answer is simple: They can’t. In such places, absolute poverty may be alleviated to some extent by immediate access to subsistence resources and informal trade and barter. But these variables exist “outside” the parameters one applies in a money-measured economy.

Introduction to Public Policy38

The Philosophy of Well-Being

The essence of this section boils down to exploring a continuum of economic systems based on distinct philosophies of well- being. A continuum is proposed with two bookends—Marxism and libertarianism. The Marxist ideal was “from each according to his abilities to each according to their needs.” However, following the Bolshevist Revolution of 1917, the actual economic system that emerged in the Soviet Union imposed central economic planning by way of brutal police-state tyranny, particularly under the iron-fisted rule of Josef Stalin. Ideologically, more humane communist governance has emerged here and there. Your textbook outlines the fascinating development of the communist-ruled state of Kerala in India. Interestingly, while that state ranks poorly on the GDP measure of the HDI, it performs admirably in areas like life expectancy and infant mortality. That fact suggests that hard and fast boundaries between communist and capitalist ideals aren’t easily drawn. For example, in Western European countries like France, Germany, Norway, and Finland, socialist policies in respect to education, workers’ rights, and health care, exist side by side with robust market-driven economies.

Be that as it may, it’s appropriate to view libertarianism as the antithesis of communist (or socialist) ideologies. Libertarian economic philosophy, expressed in the ideas of Friedrich Hayek and Milton Friedman, argue strongly against undue government interference with the market. For libertarians, people pursuing private property and individual self-interest in the marketplace generates the highest level of personal freedom and the most effective system for allocating resources.

Note: Economics, like psychology, biology, and physics, is guided by theories. Recall that theories are models based on sets of observations. Theoretical models are valid only if they can be revised or rejected on the basis of new information or alternative conceptions of basic things, like efficient or ineffi- cient market mechanics. However, because humans aren’t omniscient; their observations will be filtered through basic, often unquestioned, assumptions. For example, the concept of “economic man” maintains that people are motivated by self- interest guided by rational calculations that weigh advantage

Lesson 1 39

against disadvantage. Other approaches to the production and allocation of resources may be based on different assumptions about human motivation. To explore that idea, be sure to read about the Bhutan’s concept of gross national happiness on pages 148–150.

Tools for Making Inferences about Social Welfare

Efficiency

The extent to which resources are used to generate produc- tive outcomes is the extent of efficiency. If crop rotation and erosion control generates lush harvests of corn, wheat, or soybeans, these practices are economically efficient. If we use our time efficiently, we’re more likely to be productive.

Note: Be sure to examine the three interesting examples of inefficiency offered to you on page 155.

If there’s one topic in this section that may lead to confusion, it’s the ideas about resource allocation attributed to the Italian economist Vilfredo Pareto. Be prepared to understand that the allocation of resources is Pareto-efficient when it’s not possible to make anyone better off without making someone else worse off. By contrast, where we find Pareto-inefficiency, it’s possible to make one or more person better off without making anyone else worse off. Clearly, Pareto-efficiency doesn’t claim that life is fair and equitable. It does mean that where people pursue economic self-interest, there must be winners and losers. In any case, it’s suggested that you carefully pur- sue your textbook’s elaborations on these ideas to sort out their meaning. Meanwhile, keep in mind that your textbook’s discussion here is meant to help you grasp the idea that, in spite of Pareto’s principle, the most efficient tool we have for allocating resources is the market.

Introduction to Public Policy40

Deadweight Loss

Simply put, deadweight loss refers to the net result of economic inefficiency. The example expanded on here is the issue of the minimum wage. For some, the minimum wage expresses the ideal that workers should earn wages sufficient for a modest but livable lifestyle. For others, a minimum wage cre- ates deadweight loss because employers may not profitably pay the minimum wage to dishwashers and similar workers. As your textbook sums up the matter, a minimum wage, at whatever level, will exclude job seekers willing to accept low wages, thus creating some degree of deadweight loss.

Equity

The measure of a public policies’ fairness is its level of equity. While keeping in mind that most people favor fairness, you’ll want to recognize three different kinds of equity.

Horizontal equity has to do with the extent to which people in similar circumstances are treated the same way. For exam- ple, in the workplace, people who do the same kinds of jobs should receive the same level of pay. In academic venues, people who get the same score on a test should get the same grade.

Vertical equity can point up or down. For example, looking upward, the level of one’s tax burden should reflect the level of one’s income. Looking downward, the poorest people should receive the higher levels of government subsidies.

Intergenerational equity relates to public policies that should remain consistent from generation to generation. A public policy discussed here is Social Security. The Social Security fund comes from direct payment of payroll taxes. So here’s the equity problem: As our society ages and more and more people reach retirement age, the payroll taxes on younger people may have to be raised if they’re to receive equivalent Social Security benefits when they retire. Is that fair? If not, what are the alternatives?

Lesson 1 41

The Efficiency-Equity Trade-Off

Economic efficiency may be perceived as equitable or inequitable. Social mechanisms perceived as equitable (fair) may be seen as efficient or inefficient. Prepare to think about this conundrum as you tackle this section. As you do, be ready to ponder the public policy challenges involved in balancing equity and efficiency. For now, consider these points:

n An efficient market rewards only people who can offer something translatable into monetary value. So, an effi- cient market may well produce paradox when it comes to equity. At one end of the reward spectrum, the efficient market may leave some people with no income at all. At the opposite end of that spectrum, a few may be rewarded at levels which must seem inaccessible to ordinary people struggling with bills and taxes.

n A market economy will distribute resources efficiently based on any person’s initial endowment. Your initial endowment will include your talents, interests, education, and social class. In our society, initial endowments vary enormously as a function of social class, race, ethnicity, and gender.

n Inequity provides powerful incentives. People who want to reduce the gap between what they have and what they want are encouraged to work hard, innovate, create, and compete. On the other hand, equity may be too much of a good thing. For example, generous unemployment com- pensation may discourage a person’s active pursuit of a job, thus harming the economy.

Introduction to Public Policy42

Absolute versus Relative Well-Being

Absolute poverty is measured in terms of basic needs, includ- ing food, shelter, and health care. Relative poverty has to do with how people fare in comparison with other people within their neighborhood, work place, or society at large. For public policy makers, an absolute poverty measure provides means for assessing the extent to which a society is meeting the needs of a polity. By contrast, measures of relative poverty can be fuzzy. Hard-to-measure psychological factors enter the picture. For example, a sense of relative deprivation may be quite dif- ferent for a hedge fund manager, a social service worker, a cop, or a plumber. Furthermore, individuals’ attitudes and values can be radically different. For some, making do with a modest income may be seen as responsible citizenship. For a brain surgeon, being excluded from the “Ferrari-and-yacht” class may be viewed as bitter evidence of relative poverty.

When you’ve reviewed Lesson 1 and you feel confident that you understand the material, complete the Lesson 1 examination.

Lesson 1 43

Self-Check 5

Fill in the blank with the best word to complete the statement.

1. Under _______ governance, the Indian state of Kerala is distinctive for healthy indicators of social welfare in spite of modest wealth.

2. As an illustration of _______ equity, if Family A has the same income as Family B, the two families should have the same tax burden.

3. A combination of indicators is a/an _______.

4. In a market economy, one’s life chances will be related to one’s _______, which may include talent, health, parental income, and old-fashioned luck.

5. An allocation of resources is _______-efficient if it’s impossible to make one individual better off without making another individual worse off.

6. As a measure of inefficiency, _______ loss is observed when the loss of welfare of one party exceeds the gain in welfare of another party.

Check your answers with those on page 134.

Introduction to Public Policy44

NOTES

Markets and Government

ASSIGNMENT 6 Read Assignment 6 in this section of your study guide. Then, read Chapter 6 on pages 177–213 of your textbook, Introduction to Public Policy.

Aggregating Preferences

To aggregate means “to gather together.” In the political process, aggregating preferences means gathering together and organizing the diverse opinions and beliefs of a group to forge some kind of consensus. In this context, the study of comparative politics explores how different kinds of political systems effectively or less effectively aggregate preferences around the world.

Direct and Representative Democracy

Direct democracy requires direct participation and decision making in and for a community. The first experiment in democracy, the citizen assembly of Athens, was a direct democracy which, in Plato’s view, had all the finesse and character of a mob. (On a side note, Socrates was condemned to death by this “mob” for corrupting the youth of Athens.) In America, direct democracy thrived in the immediate postcolonial environment due to the influence of citizen assemblies. Echoes of that era remain in the traditions of New England town meetings.

However, direct democracy becomes unwieldy as populations grow larger. One can hardly expect the citizens of Trenton, New Jersey, to gather in some venue like a sports arena to debate issues, resolve differences, and pass laws. So, simply as a practical matter, methods of representative democracy were established early on.

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Introduction to Public Policy46

Methods of Assigning Representation

In a representative democracy, the rules for allocating repre- sentation in a legislative body will have a profound effect on the relative power of the different groups being represented. The framers of the U.S. Constitution were deeply concerned with this issue. Based solely on proportional representation, the larger states, like Virginia and Pennsylvania, would drown out the voices of small states like Delaware and Rhode Island. The final resolution of this contention proposed proportional representation in the House of Representatives and equal representation in the Senate. Namely, there would be two senators from each state, regardless of its population size. Of course, there are other approaches to assigning representation.

In an at-large legislature, say for a county or city, the mem- bers of a council will be directly elected by the voter-eligible citizens of that polity. In such a system, all of the elected council members will represent all of the citizens. In the case of single-member legislative districts, as illustrated by the U.S. House of Representatives, people can elect only one candidate to represent their congressional district.

On pages 184–187, your textbook offers five hypothetical cases to illustrate likely political outcomes under five types of voting rules. You should pay special attention to the fourth case, in which the electoral districts have been subject to gerrymandering. This term derives from the actions of then Governor of Massachusetts, Elbridge Gerry. In 1812, he redrew the boundaries of the state’s electoral districts to favor the interests of his Democratic–Republican Party prior to a state senate election. Today, efforts of both Republicans and Democrats to redraw congressional districts to “lock in” advantages to their party have effectively biased election out- comes in a number of states.

Deliberately Nondemocratic Institutions

Within democracies, some institutions are deliberately insulated from the slings and arrows of electoral politics. The concept of the separation of powers gets a lot of attention here. The political philosopher Montesquieu invented the concept during

Lesson 2 47

the era of the Enlightenment. It was adopted by those who framed the U.S. Constitution in 1789. Distinguishing a legislative, executive, and judicial branch of government was meant to restrain the power of the central government in relationship to the states. In that context, however, the democratic process was “diluted” to some extent, largely to assure greater free- dom of action on the part of high-level government officials. To that end, Senators (mostly drawn from the upper classes) are elected to six-year terms as opposed to two-year terms, like the members of the more populist House of Representatives. The president, as the head of the executive branch, is freed up to either embrace or ignore populist demands if he or she can manage election to a second term. Federal district and Supreme Court justices, appointed by the president, hold their office for life.

Arrow’s Theorem

One can assume that, in a democracy, public policy options will be related to social welfare concerns. Therefore, all voting systems are meant to aggregate the preferences of many indi- viduals into an option preferred by the whole. But is that actually possible in every instance? According to the work of Nobel laureate economist Kenneth Arrows, it isn’t. If three or more options are on the table, no social welfare function (purpose) can aggregate individual preferences into a collective group preference without violating one or more basic condi- tions that should characterize democratic decision making. The basic conditions are as follows:

n Unrestricted domain. The process should take account of all rational individual preferences and allow them to be ranked in preferential order. If, for example, there are three abortion-procedure options (A, B, and C), they can be ranked in some way, such as B, C, and A.

n Completeness. The voting must deliver a clear answer, such as B as the clear preference.

n Transitivity. If B is preferred over C, it must also be preferred over A. (If a number, N-1, is greater than N-2, and N-2 is greater than N-3, then N-1 must be greater than N-3.)

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n Pareto optimality. If every individual in a group prefers B over C, then the group (collectively) must also prefer B over C.

n Nondictatorship. The social welfare function can’t simply reflect the preferences of one individual while disregarding the preferences of the remaining voters.

n Independence of irrelevant alternatives. If B and C are the dominant options (as in Republicans or Democrats), then votes for alternative A (such as a third party) shouldn’t affect the final showdown in the preference contest between B and C.

Note: Arrow’s theorem is expressed through complex mathe- matical assumptions and algorithms. Simply try to get a general feel for these ideas.

Here’s the key idea derived from Arrow’s theorem: Democratic decision making won’t automatically aggregate individuals into group preferences. Instead, the key factor is the design of institutions. For example, with respect to policies regarding abortion (trimester rule, medical procedure, and so on), the option agreed on will have more to do with legislative rules and procedures than with the aggregation of individual preferences.

The Legislative Process

Parliamentary versus Presidential Systems

Parliamentary systems, like those in the United Kingdom, Canada, and Western Europe, are more common than presi- dential systems. In parliamentary systems, the effective head of the government is the prime minister. There are exceptions. For example, the chief executive in the Russian Federation is an elected president who, in turn, appoints a prime minister with the approval of the Duma (the bicameral Russian legisla- tive body). For Americans who have access to C-Span, the nature of most parliaments is well illustrated in the proceedings of the British House of Commons. In the United Kingdom, the prime minister is elected by the members of the Commons,

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and, in most cases, the prime minister is the head of his or her party. Margaret Thatcher, for example, was the head of the Conservative (Tory) Party. Tony Blair was the head of the New Labour Party. Once elected, in a sort of medieval ritual, the queen charges the new prime minister with the duty of forming a government. The prime minister then appoints assorted ministers to administer the government.

In a fair number of cases, as in Italy, the prime minister’s party may not hold a majority of seats in the parliament. In such cases, the prime minister must form a coalition government, which may quite often be politically unstable. Also, in the United Kingdom and elsewhere, a prime minister may be voted out of office by the Commons MPs through a vote of no confidence.

The British upper house, the House of Lords, is presently composed of “peers of the realm,” whose seats are inherited as a right of noble title, and appointed members. However, under Tony Blair, a movement began to eject entitled and appointed lords in favor of democratically elected members. Traditionally, the lords may propose legislation, but more often, they serve as a critical overseer of legislation originating in the Commons. An appointed body within the House of Lords, informally called the Law Lords, serves as the equiva- lent of a supreme court in the British judicial system.

Perhaps the greatest strength of a parliamentary system is providing a legislative voice for minority parties, and also a capacity to remove an ineffective prime minister who has lost the confidence of the people through a vote of no confidence.

Rules, Committees, and “Gatekeepers”

The American constitutional republic is composed of the three branches of government mentioned earlier. In your textbook’s discussion of the American system, a great deal of emphasis is placed on the nature of the rules and procedures in the House and Senate. The point of that emphasis is to help us understand that these rules and procedures have a major impact on the formulation and enforcement of public policy.

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For example, the House Rules Committee exercises control over the legislative calendar. Decisions by that committee determine the order in which bills are presented to the House for consideration as well as the number of amendments that may be proposed or adopted. The Rules Committee is one among 25 standing committees in the House. The immensely powerful Senate Finance and Senate Armed Services committees are among the 20 standing committees in the Senate.

Most of the work of the U.S. Congress, or in state legislative bodies for that matter, is carried out by deliberations within committees. For example, most bills (proposals for a law) submitted to the House or Senate will be sent on to a com- mittee which, in turn, is enabled to hold hearings and/or revise and “polish” the bill (referred to as marking up a bill) before allowing it to either “die in committee” or be reported out to the floor for general deliberation. In the House, the elected Speaker of the House, representing the majority party, is responsible for sending bills to one of the various House committees. So, in effect, the Speaker of the House and the various committees act as gatekeepers who deter- mine which bills will be considered and in what order.

After the vice president, the Speaker of the House is next in line to ascend to the presidency. Therefore, he or she has an immense influence on legislative actions in the House. There is no equivalent role in the Senate. The Senate’s majority leader certainly serves as a gatekeeper. However, the role of the President Pro Tem of the Senate, held by the vice president, is mainly ceremonial. He or she may cast a deciding vote in the event of a tie, but otherwise is seldom even in attendance for Senate deliberations.

Note: Be sure to study the graphic on page 195. It will help you understand how legislation is passed in the U.S. system of governance.

Perhaps the greatest strength of a presidential system is provided by a strong executive who can stand apart from the legislative body. The greatest weakness of the U.S. system is the risk of legislative “gridlock” when the president and the Congress represent opposing political parties.

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Understanding Political Outcomes

The Median Voter Rule

Most people who pay attention to politics will recognize evidence of the median voter theory. Namely, to gain a majority in an electoral contest, politicians will strive to attract the voters who hold centrist public policy views. If, for example, the issue is funding education initiatives, a politician will try to attract voters who are in favor of moderate education-budget increases. That is, they stand between the extreme views that would reject all such spending on one hand or opt for major education-budget increases on the other hand.

However, in the view of public policy analysts, the median voter rule can apply only given a set of unequivocal and specific assumptions. They include the following:

n There are only two candidates. If third-party interests are influencing public opinion, the rule won’t apply.

n Voters have single-peaked preferences. That is, the median voter position is expressed by a significant majority of voters.

n Voters care about just one issue. For example, in some electoral districts, the education-funding issue may be competing with voter concerns about crime rates or the need to invest in roads and bridges.

n All voters are equally informed and engaged. Poll-based research suggests that many voters are either uninformed, indifferent, or both.

The Power of Organized Interests

In the real world of politics, the median voter rule is often contradicted by actual electoral outcomes. In fact, in many cases, voter preferences, pro or con, seem to have less to do with electoral outcomes than what’s referred to as the intensity of preference. “Intensity” in this context refers to how much winners or losers desire some preferred outcome. You can think of this idea in terms of an old adage, “It’s the squeaky wheel that gets the oil.” Or, put another way, the loudest voices attract the most attention.

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With respect to how organized interests impact public policy decisions, you’ll want to become familiar with these assumptions:

n Organized interests manipulate the political process to compete for benefits, such as tax breaks, subsidies, and tariff protection, or to avoid costs, such as taxes and expenses related to regulations.

n The intensity of preference with respect to specific issues rises as a function of how much is at stake, monetarily speaking.

n The cost of organizing a group aimed at influencing a policy position increases with the size of the group to be organized. In particular, as group sizes increase, free rider and collective-action problems also increase.

Based on these observations, we can deduce that small organized interests have an advantage for two reasons. (1) Given any level of capital benefit, the costs of organizing are spread out across a much larger segment of the popula- tion. For example, if domestic sugar interest demands a price subsidy, the cost of that subsidy will be spread out across millions of taxpayers with minimal influence on indi- vidual tax burden. (2) Smaller groups are both easier to organize and more likely to use resources efficiently.

Coalitions and “Logrolling”

It’s often said that “Politics is the art of the possible.” Basically, that means ideal legislative outcomes are nice when they happen, but half a loaf is better than no loaf at all. That often makes sense because governing very large groups inevitably involves compromises. And so, legislators make deals. “I’ll support your appropriations bill if you sup- port the dam project I want for my congressional district.” In other words, “I’ll scratch your back if you scratch mine.” This is an example of logrolling.

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Rent Seeking

The process by which political interests use the powers of government to gain advantages is called rent seeking. That rather odd term comes from the concept of economic rent, which basically has to do with securing an advantage in the market system. Your textbook’s discussion of this topic uses the example of licensure. Most states require people to attain licenses to practice law or medicine. However, licensure is also required for all kinds of other occupations, ranging from public school teachers and accountants to plumbers and manicurists. Licensure policies benefit the state in at least two ways. First, licensing boards gain immediate revenue for the state from fees required to sit for the licensing exams. Second, by restricting entry into a profession, the smaller number of qualified practitioners will lead to increased market values for services rendered. Furthermore, the public should benefit from higher levels of proficiency on the part of licensed professionals.

Strategic Points of Entry

Individuals, groups, and corporate organizations will seek the best ways to initiate and establish advantageous policies. The obvious direct route is encouraging legislatures to pass desired laws that will be endorsed by an executive authority, such as a president, a governor, a mayor, or a county board of supervisors. However, there are alternative strategic entry points for pursuing policy initiatives. They include the following:

n Referendum. California law permits the electorate at large to propose and vote directly on policy initiatives. Thus, laws can be passed by way of direct democracy.

n Executive order. Illustrating the direct opposite of a public referendum, presidents and governors, informed by staff and advisors, may issue executive orders. During World War II, Franklin Roosevelt’s infamous Executive Order 9066 permitted authorities to round up and deport Japanese American citizens to detention camps.

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n Agency rules. Agencies of the executive branch, such as the FDIC, are empowered to create and enforce what are called quasi-judicial policies. Your textbook mentions the authority of the Environmental Protection Agency (EPA) to identify and regulate toxic and harmful industrial wastes and set clean-water standards.

n The courts. In some instances policy initiatives can be introduced through legal challenges, mainly in the context of reversing standing policies. A famous example is the Supreme Court’s 1950 decision in Brown v. Board of Education of Topeka. The decision reversed earlier court rulings that supported discriminatory segregation in public schools and public facilities.

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Self-Check 6

Fill in the blank with the best word to complete the statement.

1. A/An _______ figures out ways to influence government policies to alter tax codes and regulations to his or her advantage.

2. When conditions seem favorable, politicians will cater to the political center to maximize their votes in a senatorial election. This idea illustrates the _______ rule.

3. _______ are the pork that members of Congress insert into bills.

4. According to _______ theorem, when a group is making a decision among three different alternatives, no voting system will meet generally accepted criteria for a fair election.

5. As a student of _______ politics, one would study the ways political systems vary in different countries.

6. In the domain of political coalitions, the concept of _______ is illustrated by the adage “I’ll scratch your back if you scratch mine.”

7. The _______ rule stipulates that only legislation germane to unemployment insurance can be introduced in a bill dealing with unemployment insurance.

Check your answers with those on page 134.

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ASSIGNMENT 7 Read Assignment 7 in your study guide. Then, read Chapter 7 on pages 214–249 of your textbook, Introduction to Public Policy.

Allocating Scarce Resources

Allocating resources is a basic challenge in any society. And, as it turns out, a propensity to trade and barter is a basic type of interaction in any society. Even simple tribal societies have characteristically engaged in trade, often using some kind of an exchange medium like salt or cowrie shells. Money (based on precious metals) was first used in lieu of live animals or vegetable produce in Babylonia around 1500 BCE. Paper money was first used in China during the Song dynasty (960–1127 CE). So there’s nothing new about either markets or money.

Features of Markets

Modern societies use fiat currency. It has value only because international accords, like those that gave birth to the World Bank in 1944, have accepted national currencies as legal tender. (The U.S. dollar is, for now, the international reserve currency.) Be that as it may, markets provide immensely effi- cient mechanisms for allocating most goods and services. That doesn’t mean that markets serve all of a society’s needs. In every modern society, there are contentious policy disputes over areas of human life that should be excluded from mar- ket considerations in favor of universal equity. Many feel that health care, basic education, and adequate shelter should be considered basic human rights. There’s also a sort of “black hole” in societies where values are all but universally mone- tized. For example, most would agree that healthy children are vital to a society’s viability. Yet child raising isn’t consid- ered to have intrinsic (monetary) value. That’s why, in some Western European countries like France, government subsi- dies afford benefits and extended maternity leave to new

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mothers, and even new fathers. In any case, all markets share a number of key features that can help us understand both the strengths and potential weaknesses of this immensely efficient system for allocating resources:

n All markets bring together utility-maximizing consumers with profit-maximizing firms. The essential quality of this mutual attraction is voluntary exchange. Day by day, people make opportunity cost calculations as they decide whether or not to spend money on X, Y, or Z, which amounts to maximizing utility. This can be thought of as getting the most for your money according to how you derive utility. A principle of this feature is that as prices decrease (for desired goods or services), demand will increase, ceteris paribus. This is called the aggregate demand curve. Study the graphic on page 220.

n Price is the mechanism that brings supply of a good or service into equilibrium with demand. You’re now familiar with the supply and demand curve. So that feature of markets should be no mystery to you. But keep in mind that price considerations dictate investments on the sup- ply side. As prices increase, supply is increased ceteris paribus. If the market value for soybeans is stronger than the market value for corn, you’ll plant more acreage in soybeans and less acreage in corn. That sort of phenom- enon illustrates the aggregate supply curve. Your textbook supplies you with elaborate examples of the ways supply and demand meet as an equilibrium price is established. Study the graphic on page 221.

n Markets are a powerful force for innovation and progress. People have been inspired to “invent the better mouse- trap” mostly by visions of wealth and, maybe, 15 minutes of fame. Furthermore, to the extent that economic competition is healthy, innovations aimed at improving product quality and consumer services tend to contribute to the overall quality of daily life.

n Regulating markets, or otherwise limiting the degree to which prices are allowed to bring supply and demand into equilibrium, will also dull the mechanism by which markets “heal” themselves. Basically, interfering with the mechanisms that produce the supply and demand curve restricts the

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flow of voluntary transactions that make markets efficient allocators of goods and services. Yet, taking the “big picture” perspective, it has sometimes been necessary to estab- lish caps on prices and regulate supply. During World War II, the war effort required restricting consumer demand by rationing war-vital resources like rubber, gasoline, and various kinds of food stuffs, like butter and beef. On the other hand, the war years produced innovations like Spam, the first computers, advanced radar technology, and commercially viable jet aircraft. Study the graphic on page 227 to visualize the way price caps produce shortages.

n Market outcomes are amoral. Markets are driven by self-interest, and self-interest may or may not be in the public interest. The same market mechanisms that deliver cornflakes, automobiles, and fresh spinach to consumers also provide prostitution and illegal drugs in response to the principles of supply and demand. Meanwhile, one’s socioeconomic place in a capitalist society, as well as one’s chances of succeeding within that system, depends on the initial endowments you read about earlier. Regardless of the efficiencies of markets, market outcomes are related to the impulses of human behavior. These unknowns are summed up in the final characteristic of markets.

n The same features of markets that make our lives steadily better also make it difficult to stop socially pernicious behavior for which there are markets, whether it is selling guns, drugs, sex, or even human organs. This fact is illustrated by the less than successful “war on drugs.” Consider this paradox: To the extent that a desired com- modity is deemed illegal, it will inevitably produce an illegal market. The market for cocaine has killed thousands and corrupted any number of governments. America’s experi- ment with prohibition had the unintended consequence of financing organized crime families. The mafia families acquired enough financial clout to seriously impact polit- ical power equations in cities like Chicago and New York, not to mention Las Vegas.

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Elasticity

For economists, elasticity refers to the degree to which supply and demand relationships will respond to changes in price. The higher the price elasticity is, the higher the sensitivity of demand in response to a price change. As prices increase, consumers will buy significantly less of a given product or service. Similarly, the higher the price elasticity is, the higher the sensitivity of supply in response to a price change. Producers will significantly reduce output quantities of a given product or service. The general formulas for price elasticity are found on page 231 of your textbook. Percentage values are plugged into the formulas to calculate demand or supply price elasticity. So, arithmetically, price elasticity is a percentage ratio. You’ll want to understand that when supply or demand are all but impervious to changes in price, we are observing an inelastic market relationship.

So, what’s the point? If economists or public policy analysts can calculate price elasticity, they can evaluate or even pre- dict market stability. Home buyers, investors, economists, and public policy analysts like to know these things.

Creative Destruction

The Austrian economist, Joseph Schumpeter, invented the concept of creative destruction. He was referring to the manner in which innovations in the means of production have the effect of outdating older skills and technologies. As personal computers delivered their digital blessings to writers, reporters, data analysts, and people searching for information, type- writers became junk and IT became a familiar acronym. Cassettes were replaced by CDs, which in turn were replaced by MP3s. As breakthroughs in cybernetics made industrial plants robot-friendly, assembly line skills of yore became dated, along with rather large numbers of automobile factory workers. That is the nature of creative destruction. Market economies are dynamic. And, as has always been the case in a market economy, there have been, and will be, winners and losers.

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The voices of the losers tend to be louder than the voices of the winners, even if there are more winners than losers. The political process tends to be more responsive to small, organized interest groups seeking protection from creative destruction. As a result, public policy makers are often charged with pro- viding safety nets for the dispossessed. Often these days, people on the downside of international free trade agreements, such as the North American Free Trade Agreement (NAFTA), are the people calling for compensation.

Productivity

Economists agree that productivity is the single most impor- tant determiner of our material standard of living. Thus, since standard of living is a major concern of public policy analysts, you’ll want to have a good understanding of all the things that promote or inhibit productivity.

In a market economy, goods and services are derived from processing raw materials and information. Here’s a simple example: Back in George Washington’s day, hemp was a mar- ketable agricultural product, not unlike cotton or tobacco. Especially in New England, hemp fibers were woven into all kinds of rope vital to shipbuilding and maritime trade. So we can trace a rough “chain of trade”: Raw hemp à Hemp market à Rope fabricators à Maritime market. Money flowed along this chain as long as there was a demand for hemp and hemp products. For rope fabricators, productivity (and prof- its) were dependent on how efficiently various fabricating techniques could turn inputs (hemp fiber) into finished rope (outputs) for standing rigging, running rigging, and ratlines. At every stage of this “chain,” information was the creator of value. Farmers had to know how to grow hemp. Factors (raw product wholesalers) required knowledge of the market. Rope fabricators had to have skills based on knowledge passed down from generation to generation, as well as a fine understanding of maritime markets and ship outfitting requirements.

Modern society is based on a highly complex division of labor wherein trends in almost any industry will impact many other industries. But our simple example still applies. Production, whatever its level of efficiency, is based on supply, demand, and information. And in that context, we identify a basic

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principle: A society that can, overall, produce more goods and services from a stock of available inputs will have a higher level of consumption and, thereby, a higher standard of living.

As you study this chapter, be sure you come away with an understanding of the following concepts:

n Diminishing marginal returns. Imagine you own a catering business. Your market is confined to a travel radius that takes in the town of Clyburn, Indiana. But, at least you own the only catering business in town. You run your small business with the help of three employees, all of whom, like you, can purchase and prepare food, prepare a venue, drive the company van, act as servers, and faithfully pro- mote your services to the local public. Presently, your firm is moderately profitable, but you would like to increase your profits. To do that, you decide to lease a second van to increase the number of customers you can serve, expand your menu selections, and spend more money on advertising. But here’s your dilemma. As you add to the span and scope of your business, your costs also increase. In fact, you’ll reach a point where increasing your menu selections will require hiring an additional employee even as your food-purchasing costs (and hours on the job) increase significantly. Here’s the lesson you learn: At a certain point, adding more menu selections and more customers actually diminishes your return on investment. Moreover, each unit of added input will eventually lead to diminishing returns on each unit of added output. The moral of the story might be this: Tailor your business to produce an optimal output rela- tive to inputs. What applies to small business, may also apply to the crafting of public policy.

n Human capital. As you become more and more savvy about how to prepare for a catered affair, attract new customers, and get the best deal on food, each hour of your labor becomes more productive. This smarter, wiser approach has what acquired knowledge economists call human capital.

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n Marginal product of labor. This is the incremental output produced by each added unit of labor, holding all other inputs constant. Roughly, that translates as workers will be paid what they’re worth to the firm. More specifically, where there is a competitive labor market, employees will earn wages and salaries that reflect their marginal prod- uct of labor. To see how that works, study the examples offered in your textbook. As you do that, note that it can be difficult to ascribe a specific marginal product of labor to a particular individual when strong levels of produc- tivity are the product of group efforts. Also, be sure to follow the discussion of just how a society may become more productive.

Specialization and Gains from Trade

This section of your assigned chapter is focused on how job specialization and trade encourage and facilitate wealth creation. At the outset, one should understand that, in a modern society, a complex division of labor is crucial to high levels of productivity. But, in turn, that complex division of labor can exist only because people can become skilled and efficient in performing specialized tasks. (The U.S. Department of Labor’s Dictionary of Occupational Titles includes over 12,000 job descriptions—and that list is likely to be changing month by month.) Meanwhile, trade, based on specialization within nations, expands the arena of wealth creation literally across the planet. However, not all trade is equal. In some cases, a nation may have an absolute advantage. In other ways, a nation may benefit from comparative advantage.

Absolute Advantage

Here’s the general idea: If a nation specializes in what it does best, it will have a trade advantage that invites wealth cre- ation. For example, to cite the example elaborated on in your textbook, Saudi Arabia has an absolute advantage in produc- ing oil. Iowa, on the other hand has an absolute advantage in the production of corn. Therefore, Iowa has no advantage in producing oil and Saudi Arabia isn’t likely to see corn grow on the arid expanses of the Arabian Peninsula. All things

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being equal and accounting for transport costs, Saudi Arabia will derive an absolute benefit from trading oil for corn and Iowa will have an absolute trade advantage in getting oil in exchange for corn. But that’s only part of the story. Given this trade relationship, total production of both goods will be higher because demand for both goods has been increased.

Comparative Advantage

Trade advantage is said to be relative for a person, firm, or country when it has the lowest opportunity cost for produc- ing some good or service. Recall that opportunity cost can be defined as the value of doing X over the next best option, Y. The profitability of doing X minus the profitability of doing Y equals the opportunity cost of doing X. For example, Can-Do, Inc. produces home security systems. As a second choice, the company could produce garage door openers with the same raw materials. So, in this case, the opportunity cost of pro- ducing home security systems is equivalent to what the firm might reap from producing garage door openers.

Note: Your textbook illustrates the concept of comparative advantage by examining comparative opportunity costs in China and the United States when it comes to focusing on the production of either televisions or jet engines. It will take you a while to sort out the numbers, but the bottom line will be the same: Both China and the United States will benefit from doing what they do best.

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Self-Check 7

Match each statement with the correct term. Not all of the terms will be used.

______ 1. Prices aren’t allowed to bring supply and

demand into equilibrium and allow the

market to “heal” itself.

______ 2. Innovations in technology make old skills

less valuable.

______ 3. You’ll want to determine the ratio of outputs

to inputs.

______ 4. At Motel Zee, for most of the year, the supply

of motel rooms exactly matches the demand

for rooms.

______ 5. Holding all other factors constant, you calculate the

incremental output produced by one additional unit

of labor.

______ 6. As an example, percentage change in quantity is

divided by the percentage change in price.

Check your answers with those on page 134.

a. Creative destruction

b. Market equilibrium

c. Comparative advantage

d. Regulated market

e. Marginal product of labor

f. Elasticity

g. Maximized utility

h. Productivity

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ASSIGNMENT 8 Read Assignment 8 in your study guide. Then, read Chapter 8 on pages 250–287 of your textbook, Introduction to Public Policy.

Market Failure

Human behavior, as is the case with all complex systems, is inherently unpredictable, like the weather. Human-behavior- driven markets emerge from immensely complex systems composed of countless transactions. Therefore, market behavior may be described in general terms at either the macro or the micro level, as we might predict either local or global weather patterns in response to an El Niño event. However, the assump- tion that humans are rational actors when it comes to weighing self-interest is just that—an assumption. Like all science-based assumptions, it must contend with uncertainty. Actual human behavior may be reflexive (simply reactive) semi-conscious, driven by emotions, and/or flatly irrational. Therefore, markets may fail to be efficient allocators of resources for reasons that can’t be entirely predictable.

On the other hand, economists can identify ways in which government policies may, at least potentially, play a con- structive role in preventing market failures or dealing with the effects of market failures.

Creating and Enforcing Property Rights

The concept of ownership is basic to a market economy. For a market to be an efficient allocator of resources, private property rights must be clearly defined and effectively enforced. For example, people won’t enter into voluntary transactions if there’s uncertainty about who owns the goods to be exchanged. At the whimsical level, think about naïve visitors to New York City being offered a great deal on the Brooklyn Bridge. At a more serious level, consider potential investors in a real estate development project, like a shopping mall. No rational investor will be willing to put up capital if there’s a shred of uncertainty about who owns the land where the mall is to be constructed. In a similar way, no one is likely to invest in a newly invented product if the inventor doesn’t hold a patent

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right to his or her invention. In that context, think about the importance of intellectual property. Ideas expressed in patents, novels, screenplays, trademarks, textbooks, brand logos, and works of art are examples of intellectual property.

Here’s the bottom line: For markets to perform effectively, the government must identify and enforce private (or corporate) property rights.

Lowering Transaction Costs

Government policies can offer vital assistance in lowering transaction costs. Consider the following:

n Currency valuation. Governments in tandem with inde- pendent agencies, like the Federal Reserve or national banks, establish and maintain a sustainable value for currencies like the U.S. dollar, the British pound sterling, or the euro. Imagine how hard it would be to conduct business transactions without an assurance that a dollar is worth a dollar.

n Infrastructure. Public investments in roads, bridges, port facilities, railways, canals, dams, and so on are absolute necessities for lowering the cost of doing business.

n Information. Government agencies can establish and coordinate market standards. Government mandated labeling of food products (lists of ingredients, expiration dates, and so on) provides useful information to consumers, which spares them the effort of gathering information on their own. If people can trust that a 16-ounce can of tomatoes actually contains 16 ounces of tomatoes, they’ll shop with confidence and profit margins will reflect that confidence. In a similar way, mandated safety and hygienic standards for restaurants facilitate consumer confidence and the profit interests of restaurant owners.

n Regulation. In a healthy economy, some voluntary transactions must be protected by laws. For example, immense sums are put at risk through the sale or pur- chase of equities (stocks, bonds, and so on). If these kinds of transactions weren’t regulated by the Securities and Exchange Commission (SEC), Bernie Madoff-type

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predators might wreak more havoc in financial markets than the system could bear. Furthermore, consider these questions: Would you put your money in a bank if you didn’t know that banks operate under strict regulations, such as limits on fractional reserves? Would you trust your bank to protect a $100,000 deposit if that deposit wasn’t insured by the FDIC? Probably not. That’s why during the Great Depression, the favored personal “vault” was under your mattress.

As has been mentioned, most of a bank’s assets are evaluations of “accounts payable” represented by loans to customers. However, under regulations managed by central banks, the ratio of loans put out at interest to money stacked in vaults or deposited in central banks can’t exceed a set fraction of the bank’s actual cash reserves. As of 2006, the required ratio in the United States was 10 percent on transaction deposits (checking accounts and savings accounts), but zero on time deposits like CDs. Roughly speaking, that means that more than 90 percent of a bank’s assets can be in the form of money lent out at interest. In any case, fractional reserve policies are meant to assure depositors that they can withdraw or deposit money without risking the loss of their funds.

Promoting Competition

In an ideal free market economy, all the players are equally informed and all have access to capital. As Adam Smith argued in his famous book, An Inquiry into the Nature and Causes of the Wealth of Nations (1776), concentrations of wealth constrain the “invisible hand” that otherwise converts individual’s pursuits of self-interest into a common good shared by all.

Needless to say, this isn’t an ideal world. And, in fact, oligopolies, like the “big three” automakers (Ford, Chrysler, and General Motors) effectively and collectively were able to set prices and effectively implement economies of scale that produced a sort of “consumer heaven” from about the end of World War II (1945) to the early 1970s. The rise of the global economy put an end to all that as a cascade of corporate mergers, many of them transnational, created de-facto oligopolies in media, energy, publishing, and so on.

Introduction to Public Policy68

Oligopolies occur when a handful of corporations dominate an industry. For example, today, among nine top-tier media companies, five giant corporations maintain dominant control over media—Time Warner, Disney, Bertelsmann, Viacom, and Rupert Murdoch’s News Corporation. However, it’s assumed among public policy analysts that these sorts of oligopolies still provide consumer benefits through competition for customers.

In any case, public policies aimed at breaking up monopolies (also called trusts) are crucial to maintaining a vital and viable free market. A major principle of free markets is competition. Ideally, competition spurs innovation and market efficiencies that increase overall benefits afforded to consumers. A com- pany that controls an entire market, as did Standard Oil under John D. Rockefeller in the 1920s, has market power because it can decide unilaterally on production goals aimed at maximum profit. Monopolies have pricing power because they can set prices above marginal return precisely because they have no competitors. This draining of consumer resources amounts to deadweight loss to the economy as a whole. Keep in mind that when companies collude to act like a monopolist, they’re called cartels. A cartel, such as a drug cartel, is a de facto monopoly. Illegal cartels can generate a lot of dead- weight loss, simply in terms of funds directed to law enforcement and international border surveillance.

Note: Be sure to study the graphics on pages 257 and 258 to understand how an open market (for lemonade) is distorted by a firm that has a monopoly (on lemonade).

Ameliorating Externalities

At this point, you’re familiar with the concepts of negative and positive externalities. Presently, the most prominent, and global, negative externalities have to do with the environmen- tal destruction produced by industrial effluents on the one hand and aggregate private behaviors on the other hand. For example, steel production is directly related to coal produc- tion. Both of these industries produce negative externalities resultant from greenhouse gas emissions. Developed nations are heavily dependent on mostly privately owned motor vehi- cles. Cars, trucks, and buses produce many metric tons of carbon dioxide pollution year by year.

Lesson 2 69

Here, you’ll encounter a lengthy exploration of just how, in economic terms, the marginal cost of production of steel is related to the social marginal cost of production. After you’ve studied the textbook’s treatment of this topic, you’ll want to make this distinction. The private marginal cost of manufac- turing steel is the cost borne directly by the steel company. The social marginal cost of steel production is the private marginal cost, plus the cost borne by the whole society

Note: Studying the graphics on pages 262–266 will help you visualize the extent of deadweight loss as you compare dis- tinctive relationships of each kind of cost in terms of supply and demand curves.

Recall the Coase Theorem. It predicts that parties dealing with a negative externality can reach a private agreement to produce an efficient outcome if (1) the relevant property rights are clearly defined and (2) the transaction costs are low. If it turns out that these conditions can’t be met, public policy tools are available for dealing with either a positive or a negative externality. Respecting negative externalities, governments can regulate behavior through legal sanctions imposed on people or firms that violate clean air standards. Respecting positive externalities, governmental bodies can stipulate standards that encourage pro-social behavior. For example, homeowners associations can require homeowners to meet landscaping standards.

A Pigovian tax (or subsidy) can be used to induce market par- ticipants to embrace pro-social behavior. Such a tax will be based on the difference between the private marginal cost of a behavior and its social marginal cost. For example, taxes on cigarettes and alcohol (“sin taxes”) can reduce behavior that generates social costs. Under so-called cap and trade schemes, a regulatory body can set a cap on the total of, say, carbon dioxide emissions allowed within an industry or group of industries. With the cap in place, individual industries can buy or sell carbon emission permits such that the average of net carbon emissions stays within the aggregate cap allowance. In sum, governments can exercise coercive power to encourage or require outcomes that markets aren’t likely to deliver.

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Providing Public Goods

Some goods and services that may enhance social welfare may not be offered by the market. The reason for that fact also characterizes two properties of public goods:

n Nonrivalry. Nonrival goods or services may be offered to any number of additional consumers without further cost. That is, the cost of the service doesn’t increase over time. A lighthouse once built can be used over and over again based on the initial cost of building the lighthouse.

n Nonexclusivity. A lighthouse once built can’t exclude ships’ navigators from using it, regardless of the fact that they didn’t contribute to its cost. The same principle goes for most public parks. While some citizens may contribute to park maintenance through taxation, many others, such as tourists or visiting relatives can’t reasonably be kept from enjoying the park.

Note: Study the 2 � 2 matrix on page 272. It will help you understand how concepts of exclusivity/nonexclusivity–rivalry/ nonrivalry explain the way goods and services are provided in a modern economy. Note the distinctions between private goods, club goods, common-pool resources, and public goods.

Providing a Social Safety Net

While you study this and the final section of this chapter, keep in mind that there’s no objective measure of what economists call utility. What’s considered a “good” by one individual may be considered a “bad” by another individual. For example, the utility of smoking (pleasure and anxiety reduction) may be seen as outweighing the potential health costs (lung cancer and circulatory disorders). For landless peasants, the utility of land reform may seem obvious. Starvation has very low utility. Yet, for landowners, the utility of land reform, which might mean breaking up large land holdings in favor of many smaller land holdings, may be seen as a great evil. In any case, there are two basic approaches to providing a social safety net.

Lesson 2 71

Redistribution

Within a given society, policies of redistribution aim at trad- ing some degree of economic efficiency for increased human welfare based on equity. In America, the primary mechanism for redistributing wealth is taxation. Taxes are used to support public education, Social Security, and social-aid programs like rent subsidies and the food-stamps program.

Wealth redistribution schemes are typically controversial. That’s largely because ideas about social equity tend to be divided along entrenched ideological lines. At one extreme is the libertarian, “survival of the fittest,” position associated with laissez-faire (unregulated) capitalism. Rights of private property are paramount and there should be no restrictions on how people use their property, save infringement on any- one else’s property rights. At the other extreme is the radical socialist ideal that rejects capitalism in favor of the Marxist aphorism, “From each according to their abilities to each according to their needs.” Somewhere in the middle are ideo- logical positions that would base social equity on some kind of human rights platform. For example, all members of a society should have access to the basics of life, including food, shelter, and basic health care.

Paternalism

Basic to the concept of paternalism is the assumption that people will abuse freedom. They must therefore be protected from themselves. People will smoke cigarettes, drink too much, drive recklessly, drop out of high school, experiment with drugs, eat too much, and so on. So in effect, paternalistic policies are meant to improve overall social welfare by preventing people from engaging in behavior that will harm society as a whole. Seat belt laws, motorcycle helmet laws, required warnings on cigarette packages, and regulations meant to reign in predatory “pay-day” loans are examples of paternalistic policies.

Introduction to Public Policy72

The Limitations of Government

A modern market economy can’t exist without government agencies. Courts are needed to settle contract and property disputes. Government funded infrastructures, such as roads, bridges, and railways, are needed to keep transaction costs under control. Law enforcement agencies are required to protect property rights.

On the other hand, policies exercised by government agencies have their downside. In general, when it comes to efficient use of resources, government agencies tend to be less efficient than private firms. More importantly, there are no self-correcting mechanisms that can cure bad government. For example, the administrators of government bureaucracies are frequently tempted to overstress agency needs at budget time, thus leading to sometimes extraordinary cost inflations. In other instances, private contractors hired by government agencies, such as the military, may negotiate “sweetheart” contracts that would never be accepted between private firms, such as auto parts suppliers and auto manufacturers.

Ultimately, the public policy challenge is finding the balance between public welfare and economic efficiency. All govern- ment isn’t good government, but too little government can sometimes be a recipe for great harm to the common good.

When you’ve reviewed Lesson 2 and you feel confident that you understand the material, complete the Lesson 2 examination.

Lesson 2 73

Self-Check 8

Fill in the blank with the best word to complete the statement.

1. To deal with a negative externality, such as second-hand smoke, you can recommend a/an _______ tax, which will be equal to both the private and social marginal costs of smoking.

2. Governments can provide infrastructure, information, and judicious regulatory measures to reduce _______ costs.

3. Aiming to improve overall social welfare, _______ policies attempt to prevent individuals from participating in behaviors that will harm them sooner or later.

4. Because it controls the whole market, a/an _______ can exercise market and _______ power, thus effectively regulating supply and demand.

5. Both nonrivalry and _______ are illustrated by a lighthouse.

6. Inventions, ideas, and works of art are examples of _______ property.

Check your answers with those on page 135.

Introduction to Public Policy74

NOTES

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s s

o n

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3

Tools for Analysis

ASSIGNMENT 9 Read Assignment 9 in your study guide. Then, read Chapter 9 on pages 291–327 of your textbook, Introduction to Public Policy.

The introductory discussion for this chapter is a guided tour of analytical approaches to two public policy related issues. Is global income inequality growing or decreasing? And, how large is America’s national debt? Give this discussion some undivided attention before you turn to the rest of the chapter.

To introduce this chapter, our focus will be on basic measuring, sampling, and statistical concepts. You may already be fully familiar with research methods and the principle concepts of statistical analysis, or you may not be familiar with these concepts. In either case, if you can increase or refresh your understanding of concepts like the normal curve, correlation, measures of dispersion, and probability sampling, you’ll find it easier to follow explorations into the ways in which they may be applied to public policy analysis.

Descriptive Statistics

The Mean

Imagine that 20 students have taken a math exam. Under a standard scoring system, the students’ scores range from 2 to 10. The array of scores from low to high looks like this:

2 3 3 4 4 4 5 5 6 6 6 6 6 7 7 8 9 9 10 10

The mean, or average, score will equal the sum of all the scores divided by the number of observed scores. In this case that will be 120 divided by 20 � 6. The mean score is 6. Here the students as a whole are the unit of observation. The data points, or observations, are individual scores. Here it is more formally:

∑X/N = μ

Introduction to Public Policy76

The sum (∑) of X (all units of observations) divided by N [the number of units (scores, people)] equals the mean. If the set of scores for the 20 students is all you’re interested in, the set of 20 scores is your study population. In that case, N � the number of scores and μ (mu) stands for a population parameter (measure), which in this case is the mean.

If the scores for these 20 students is a sample drawn at ran- dom from 200 students, then you would write: (“x-bar”)

Here, n � the sample population size and x-bar � the sample mean. The distinction is important because statistical calcu- lations based on population parameters are a bit different from calculations based on sample parameters.

The Median

The median is the midpoint of an array of observations when the observations are arranged in either ascending or descending order. If the total number of scores is an odd number, the median is simply the score at the midpoint of the array. If the total number of observations is an even number, the average of the two midpoint scores is the median. In this case, the two scores in the middle are 6 and 6 and 6 + 6/2 � 6. But if the two scores in the middle were 6 and 7, the median would be 6 + 7/2 � 6.5.

Note: Another measure of central tendency is the mode. In our sample data array, the most common score is 6. Therefore, 6 is the mode for thus array.

Statisticians divide arrays into percentiles, deciles, and quartiles to think about where scores or observations fall in a data array. For our hypothetical data array:

MEDIAN

2 3 3 4 4 4 5 5 6 6 ↓ 6 6 6 7 7 8 9 9 10 10

1st quartile 2nd quartile 3rd quartile 4th quartile

Mean or Median?

Sometimes, the value of a population or sample mean will be skewed by outliers. Outliers are relatively small numbers of observations that are distant from the rest of the distribution.

Σ X n x/ =

Lesson 3 77

For example, let’s say that the typical range of incomes for a population of 100,000 is $4,000 to $6,000. However, 500 people have incomes ranging from $50,000 to $200,000. In such a case, the mean will be skewed to the right. Therefore, the mean income will be a poor indicator of the actual income distribution in the total population. In such cases, breaking down populations by quintiles, quartiles, and percentiles ordered around a median will give us a better picture of income distribution.

Measures of Dispersion

Variance and standard deviation are the key measures of dispersion. Dispersion is the degree to which observations (data points) are spread out in a data array. A basic clue to how statisticians view dispersion is thinking about the nature of a bell curve, also called a normal curve (Figure 2). As it turns out, normal curves are very common in nature. If you measure the precise diameter of, say, all the acorns you can find around a grove of oak trees, those diameters will be spread out from smaller to larger following a normal curve. IQ scores follow the normal curve. The height of male adults within a population will follow the normal curve. So will the height of female adults, but the mean values will be different.

–4 –3 –2 –1 0 1 2 3 4

FIGURE 2—A Bell Curve

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For any set of N observations X1, X2, X3 . . . Xn, with mean μ,

variance � [(x1 � μ) 2 + (x2 � μ)

2 + (x3 � μ) 2 � . . . (xn � μ)

2]/N

For any set of N observations X1, X2, X3 . . . Xn, with mean μ,

standard deviation � σ (sigma) � the square root of [(x1 � μ) 2

� (x2 � μ) 2 � (x3 � μ)

2 � . . . (xn � μ) 2]/N

Put simply, to find the variance, you subtract the mean from the value of each observation—expressed as an absolute value— add all these up, and divide by N. To find the standard deviation, you simply find the square root of the variance. Finding the square root of the variance allows you to visual- ize areas under the curve.

Specifically, about 68 percent of observations for some population (N) will be found between one standard deviation above the mean and one standard deviation below the mean. About 95 percent of observations will be found between two standard deviations above the mean and two standard devia- tions below the mean. About 99.7 percent of observations will be found between three standard deviations above the mean and three standard deviations below the mean (Figure 3).

–4 –3 –2 –1 0 1 2 3 4 68% 95% 99.7%

FIGURE 3—The Spread of Standard Deviations Above and Below the Mean

Lesson 3 79

Correlation

As opposed to constants like π, variables are any kind of phenomena with a range of values that can be measured. Height, weight, IQ, and income are variables that can be measured fairly precisely. Subjective attitudes can be meas- ured on some kind of a quantified scale. For example, a questionnaire item might be posed as follows.

If “Strongly Agree” is coded as 5, where “Agree” = 4, “Undecided” = 3, “Disagree” = 2, and “Strongly Disagree” = 1, we can correlate an attitude variable with quantitative values like income or, for that matter, other kinds of attitudinal values like approval ratings of Congress or attitudes about abortion. For example, if we measure height and age variables for a small population of middle school students, we’ll find that height and age are positively correlated. That is, in general, kids get taller as they get older.

Often, when we explore the correlations between variables, we can assume that one variable precedes the other. For example, increasing height is dependent on getting older. Thus, we may want to think of height as a dependent variable (Y) and age as an independent variable (X). We’ll then postulate that X precedes Y and make a note that “X à Y.” However, this notation doesn’t mean that we’ve determined that X causes Y.

In other cases, we may detect negative correlations. For example, as protein deficiency increases, cognitive abilities decline. In other cases, we find that there’s no correlation at all or one so weak as to be negligible.

You should keep in mind two key ideas as you contemplate the nature of correlation. Mathematically, a perfect correlation is +1 and a perfect negative correlation is –1. However, in actual research, most correlations are suggestive rather than definitive.

Item 3: Government is the problem, not the solution. (Please respond by checking only one of the following.)

Strongly Agree ____ Agree ____ Undecided ____

Disagree ____Strongly Disagree____

Introduction to Public Policy80

That is, even relatively strong correlations leave much to be desired. For example, a positive correlation like 0.8 may seem convincing. But, in fact, 0.80 squared (which returns us to variance) accounts for only about 64 percent of the variance in the relationship between X and Y. That leaves 36 percent of the variance unexplained. Above all, remember that corre- lation doesn’t establish causality. The only research method that can reasonably identify a causal relationship, such that X causes Y, is a carefully designed experiment.

Absolute versus Relative Figures

Data such as dollars spent, petroleum consumed, or bushels of corn produced can be analyzed as absolute figures on their own. Analyses based on comparisons look at ratios. For example, using absolute figures, we can examine the ratio of health care spending per capita to measures like longevity and infant mortality.

Much of your textbook exploration here focuses on public expenditures for education. For example, we can use absolute figures (money spent) to compare relative investment in educa- tion in different countries. As it turns out, average expenditures per student in the United States, in absolute terms, ranks near the top internationally according to the Organisation for Economic Co-operation and Development (OECD). On the other hand, when we look at spending on education relative to GDP, the United States ranks thirty-seventh among OECD nations.

In short, what we find depends on where and how we look. To take another angle on the education issue, given how much is spent on education in the United States, why is it that students in less wealthy countries often outperform American students in areas like mathematics and science?

Percentage Change

Percentage change is a relative statistic because it has meaning only to something else. For examples, a 25 percent decrease in price will have meaning only if it applies to some product or service, like fishing rods or a carpet cleaning service. A Dow Jones average increase of 6 percent has meaning only

Lesson 3 81

with respect to the end of one trading period and the Dow average at the opening of the immediately succeeding trading day. What you will find in this subsection are some tips on how to appraise percentage changes with respect to things like stock prices, profit reports, and equity trends.

Expected Value

An expected value (EV) can help us make decisions during times of uncertainty. The basic idea is conveyed by an exam- ple involving a single die. What are the odds that a toss of the die will yield a 1, 2, 3, 4, 5, or 6?

Where the probability in each throw is 1 chance in 6,

EV � 1/6 [1] � 1/6 [2] �

1/6 [3] � 1/6 [4] �

1/6 [5] � 1/6 [6]

The sum of probabilities is then 1/6 � 2/6 �

3/6 � 4/6 �

5/6 � 6/6 � 21. So, EV �

21/6 � 3.5.

That figure, 3.5, is the average outcome if you throw the die repeatedly. That may not strike you as terribly exciting infor- mation. Nevertheless, precisely this sort of probability sorting is used by insurance companies to calculate expected loss. Using this sort of calculating can help the insurance company establish actuarially fair premium rates.

Sources of Data

Many things public policy makers might like to know can be derived only from rigorously controlled experiments on actual human beings. But that’s simply not an option. Imagine, for example, researchers trying to identify the effects of child abuse. In a controlled experiment, the researchers would have to purposely abuse children in an experimental group to com- pare them to the children in the control group. Clearly, this sort of scenario is out of the question. Therefore, public policy analysts have to depend on other sources of data. These include data sets and representative samples.

Introduction to Public Policy82

Data Sets

Cross-sectional data can be compared to a snapshot. Researchers will examine a set of observations of individuals, countries, or some other unit of observation at a specific time. For example, we might be able to compare academic achievement scores for children with a history of child abuse and similar children who have no such history based on a sample taken in the fall of 2011.

Longitudinal data (also called time-series data) can track observations over a period of time. For example, we might study trends in poverty rates in rural Kentucky from 1930 to 2011.

Panel data combines cross-sectional and longitudinal data. For example, in a study of juvenile crime, we might combine observations and interviews with 100 at-risk working class teenagers every six months for a period of five years. Panel studies are excellent for tracking changes in attitudes and behaviors over time. However, they’re also expensive.

Natural experiments can be conducted unobtrusively. For example, researchers can observe and report on differences in behavior and academic achievement among students in a private school and a public school. Or economists might be able to observe and compare indexes of productivity in a worker- owned company and a similar privately owned company.

Representative Samples

It’s not normally feasible to study every person in a town, every firm in an industry, or every instance of product malfunction. Instead, researchers can draw probability samples designed to be representative of the study population. The topic of sta- tistical sampling will be elaborated in Chapter 10. For now, the simplest example of a representative sample is a random sample in which every unit (person, firm, or product) has an equal chance of being selected. Random number tables, found in any text on research methods, can be used to draw a random sample such that the sample n is representative of the study population N.

Lesson 3 83

Cautions regarding statistical sampling include the following:

n Selection bias. A data selection bias occurs when the sampling process can generate only a nonrepresentative sample process. Your textbook gives a good example. If a polling firm uses a telephone survey to determine typical attitudes of homeless people, this won’t work—most homeless people don’t have phones.

n Self-selection bias. A marketing firm selects a random sample for conducting a marketing survey. All those con- tacted are offered a discount on stainless steel cookware. The result is that only people with an interest in cookware are likely to answer the survey questions.

n Survivorship bias. When survey forms are lost or damaged before a study is concluded, the study findings will be, to some extent, distorted or inaccurate.

n Positive-finding bias. Especially in the pharmaceutical industry, there’s a tendency to publish research findings that endorse the efficacy of a new drug as opposed to studies that question the efficacy of the new drug. Sadly, there’s a lot of pressure on researchers to highlight the good news and suppress the bad news.

Introduction to Public Policy84

The Time Value of Money

The simplest way to prepare for this section is by getting familiar with a couple of simple formulas.

Future Value

You’ll want to know the value of a $1,000 deposit five years from now, assuming the interest rate will be 6 percent. Here’s the general formula:

FV � PV(1� r )n

Here, FV is future value, PV is the present value of $1,000, r is the rate of return, and the superscript exponent, n, is the number of periods, which in this case is five years. The number 1 in the parenthesis is added to the rate of interest, 0.06 percent, to make the calculation easier. (Otherwise, 0.065 would equal 0.06 � 0.06 � 0.06 � 0.06 � 0.06 � 0.00000007.) Here,

PV � $1,000 (1.06)5

Therefore, 1.065 � (1.06) (1.06) (1.06) (1.06) (1.06) � 1.3382255, or ~1.34.

So, FV � $1.000 � 1.34 � $1,340

In five years, at 6 percent interest, $1,000 will be equal to $1,340.

Present Value

Public policy analysts sometimes have to go backwards to convert future value to present value. For example, what would be the cost of a bond that will pay out $10,000 ten years from now if the interest rate is 7 percent? We can apply a bit of algebraic manipulation to FV = PV(1 + r )n, to yield

PV � FV/(1 � r )n

PV, FV, and r mean the same as before, except that now, n � 10 years in the future.

PV � $10,000/(1.07)10

Thus, as you’ll see in the textbook example, PV � $10,000/1.97 � $5,100

Lesson 3 85

Self-Check 9

Fill in the blanks with the best word to complete the statement.

1. Using _______ figures, as opposed to absolute figures, to make comparisons among U.S. states, we calculate the proportion of money spent on education relative to the gross domestic product for each state.

2. In the data array 2, 2, 3, 4, 5, 6, 6, 7, 7, 8, the median is _______.

3. A/An _______ bias occurs when the process used for collecting data produces a nonrepresentative sample.

4. Statistically speaking, the main purpose of figuring out the variance of a data set is being able to calculate the _______ of that data set.

5. In the domain of pharmaceutical research, there’s a tendency for researchers to avoid publish- ing findings that question the effectiveness of a new drug in favor of findings that affirm the effectiveness of that drug. This sort of phenomenon is referred to as _______ bias.

6. _______ data is also referred to as time-series data.

Check your answers with those on page 135.

Introduction to Public Policy86

ASSIGNMENT 10 Read Assignment 10 in your study guide. Then, read Chapter 10 on pages 328–363 of your textbook, Introduction to Public Policy.

Sample Populations

As you’ll discover in your textbook discussion, remarkably accurate assumptions about behaviors or attitudes within a specific population can be determined by relatively small samples. Indeed, in some cases, a small sample, properly selected, may be superior to a large sample that may be more vulnerable to survivor bias.

Simple Random Sampling

Imagine 1,000 differently colored marbles in a big jar. There are 250 red marbles, 250 white marbles, and 500 yellow marbles. We decide to draw a sample of 20 marbles. The sample-selecting person is blindfolded. He or she reaches into the jar, takes out one marble, and hands it to a recording person, who records the color of the marble and replaces it in the jar. The jar is then tumbled, to assure that the marbles of different colors remain well randomized. This procedure is repeated 20 times. Based on the laws of probability, the chances are quite good that the sample distribution of red, white, and yellow marbles will be fairly close to that of the jar. That is, the odds are good that the sample will be composed of 10 yellow marbles, 5 red marbles, and 5 white marbles.

However, in actual research, drawing a sample in which each unit of a study population will have an equal chance of being selected can be quite difficult. For example, in a study of college students’ attitudes toward hazing, we use a random number table to select a 10 percent sample. However, if we use a phone survey approach, we may not be able to reach all the people selected for various reasons. Some potential respon- dents will be put off by the caller ID and ignore the message. A few of the selected students may have left the campus for some reason. Any of these reasons may produce some degree of sampling bias. Sampling bias occurs when errors or mis- judgments on the part of researchers, or simple bad luck, distort the survey findings.

Lesson 3 87

Stratified Sampling

Imagine we want to study comparative attitudes about unions in a small town, recognizing that social class may be related to views on unions. Our study population is the male adult population of the town. Through available data on income, level of education, and occupation, we determine that 60 percent of the male population is working class, 30 percent is middle class, and 10 percent is upper middle class—lawyers, dentists, business owners, and so forth. To make sure our sample is representative of the town’s adult population, we’ll survey 60 working class men, 30 middle class men, and 10 upper middle class men. That’s an example of stratified sampling.

Cluster Sampling

Let’s say we want to study national attitudes about organic foods in upper-crust America. Job one will be locating up-scale zip codes in general. Job 2 will be defining a specific cluster of up-scale gated neighborhoods. Job 3 will be drawing a random sample from, say, 400 gated neighborhoods which comprise our defined cluster. If our budget is meager, we may randomly pick only one community from our cluster. That community will be the target for our sur- vey. If our budget is substantial, we may, by random selection, choose 5 percent (20) of these communities as survey targets.

Oversampling

If we want to make comparisons among two or three samples, statistical analysis will require adequate sample sizes. For example, there will have to be at least 30 study units (n � not less than 30) in a pair of samples. Otherwise, we can’t apply statistical techniques like analysis of variance (ANOVA) tests. For this reason, we may draw a proportionally larger sample from a smaller subgroup to permit such tests. However, when we oversample a group, some kind of weighting will be applied when statistical tests are performed to avoid biased findings. For example, if we’re comparing attitudes about Hollywood for a large group of “below-the-time” people, such as carpenters, electricians, and caterers who work on movie productions, versus highly paid talent (a much smaller group), analysts might multiply the aggregate talent attitude measures by a coefficient (like 0.5) to reduce their impact on the overall findings.

Introduction to Public Policy88

Drawing Statistical Inferences

Not surprisingly, public policy analysts must often draw inferences from sample data. In statistical terms, that means using the tools of statistical inference. Here, we’ll provide some basic ideas about these tools.

The Sample Mean and the Central Limit Theorem

Mathematically, you calculate the sample mean in the same way you do a population mean, except that you use a formula that reads

A sample mean (x-bar) is the sum of the sample observations (x) divided by the number of observations (n). To calculate the sample standard deviation(s), you’ll first find the sample variance by subtracting the sample mean from the value of each sample observation—expressed as an absolute value— add all these up, and divide by n – 1. To find the sample standard deviation, you simply find the square root of the sample variance.

Note: You’ll use n – 1 rather than n for mathematical reasons having to do with the properties of a sample mean relative to a population mean.

The central limit theorem states that the sample means will be distributed around the population mean as a normal curve. Of course, you won’t know the value of a population mean or a population standard deviation from looking at a sample. Let’s say you draw 15 samples of n = 30 from a statistical population, N = 1000. It’s unlikely that any of your sample means will be the same. But the array of sample means will be distributed as a normal curve, regardless of the shape of the actual underlying population. That means that as the number of sample means is increased, their central tendency will gather around the actual population mean.

Note: Consult the graphic on page 339 of your textbook.

Σ x n x( ) =/

Lesson 3 89

The Standard Error

The standard error measures the dispersion of all the sample means you’ve gathered. Specifically, for any population with a mean, μ, and a standard deviation, σ, the standard error is expressed as σ divided by the square root of n, which is the size of the sample population.

Given that we still don’t know the actual standard deviation of the study population, what do we do? We improvise. That is, we calculate the standard error of the distribution of sample means by substituting s for σ. Thus, we calculate the stan- dard error of our distribution of sample means by dividing s by the square root of n, which, of course, is the sample size.

We can now make inferences based on the properties of the normal curve. Namely, about 68 percent of our sample means will be found between one standard error above the population mean and one standard error below the population mean. About 95 percent of our sample means will be found between two standard errors above the population mean and two standard errors below the population mean. About 99.7 percent of our sample means will be found between three standard errors above the population mean and three stan- dard errors below the population mean. See the graphic on page 342 of your textbook.

Confidence Intervals

A confidence interval is simply the likelihood that the actual population mean will be found within a defined span under the normal curve. Let’s say, for example, that we’re sampling a study population to determine the average income of flight attendants for Southwest Airlines. It turns out that our calcu- lated standard error is $100, given an estimated population mean of $10,000. Choosing the 95 percent confidence level, we can state (with 95 percent confidence) that under the cen- tral limit theorem, the typical annual salary for Southwest Airlines flight attendants will be 1.96 standard errors above and below the mean. Therefore, the typical salary for the flight attendants will be between $9,796 and $10,196. When you think about confidence levels, be aware that the likelihood that we’ll be off the mark increases as we increase our confi- dence level.

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Polling

Polling analyzes representative samples to calculate confi- dence intervals regarding the proportions of people who will, for example, vote for Candidate D versus Candidate R among likely voters. The emphasis would be on sampling likely voters because, otherwise, the poll won’t be accurate. In studying your elaborated textbook treatment of this topic, note two things.

The formula for calculating the standard error for a sample proportion is different from the one we use for figuring out the standard error for quantitative samples. In the formula, the letter p with a symbol over it, called “p-hat,” stands for “proportion.”

standard error of a sample proportion �

Most pollsters aim for a 95 percent confidence level, which in the context of polling is called the margin of error. The topic of error margins is actually quite complex. For example, when you hear a newscaster report a poll as accurate within plus or minus 3 percentage points, that assertion may be derived and interpreted in different ways. Be that as it may, you can get a feel for the polling concept of margin of error with examples laid out in your textbook. The math is simple, but patience is called for. Take some time to follow the logic. Meanwhile, here’s a simplified example to consider.

Imagine that you’ve gathered 100 representative samples of likely voters in a Nebraska Senate race. If you apply the 95 percent confidence level, you can expect five of these samples to fall outside two standard errors to either side of the mean of your 100 means. Thus, the margin of error can be viewed as accurate within plus or minus 5 percentage points. Meanwhile, one other idea to keep in mind is that error margins are likely to be reduced as sample sizes get larger.

Decision Trees

Decision trees are logic maps or algorithms used for making decisions in the presence of uncertainty, if you can estimate the probabilities of contingencies or “payoffs” resulting from possible courses of action. If, for example, you’re considering installing a solar panel on your home, you would want to

p(1 – p)/n^ ^

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consider all relevant variables, such as initial cost, unit efficiency (savings on power bills), maintenance costs, averages of sunny versus cloudy days where you live, aesthetic factors, and so on. In any kind of decision tree, your objective is weighing the probabilities of positive returns versus costly contingencies.

Note: The best way to get a handle on this concept is through studying your textbook’s discussion and paying special atten- tion to the illustration of a decision tree on page 350.

Hypothesis Testing

Most statistical inference is based on hypothesis testing. A hypothesis may be thought of as an educated guess that can be confirmed or rejected based on statistical analysis. Here’s a simplified example: You reasonably suspect, based on available data, that juvenile delinquency (JD) rates within neighborhoods are correlated to average differences in neighborhood income levels. Let’s call juvenile delinquency rates your dependent (Y) variable since you postulate that average income level (X) encourages juvenile delinquency and, therefore, precedes delinquent behavior. You’ll pose two hypotheses.

H0: JD rates are unrelated to income levels. (X and Y aren’t correlated.) That’s your null hypothesis.

Your alternative hypothesis, which you hope to prove by rejecting the null hypothesis, would be

Ha: JD rates and income levels are negatively correlated. (As income increases, JD rates decline.)

You gather representative samples from 20 neighborhoods that roughly represent a spectrum from wealthy neighbor- hoods to lower income neighborhoods. You pair income levels and JD rates for each neighborhood to create a scatter plot with 20 X-Y junction points. After deciding that the correla- tion coefficient should be statistically significant at the 0.05 level (five chances in 100 that the finding is due to random fluctuation) to reject the null hypothesis, you calculate the correlation coefficient.

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Note: Significance levels for correlation coefficients are usu- ally found in an appendix at the back of any basic statistics textbook.

Regarding our example, you might be surprised to learn that several classic studies found that delinquency rates for lower class and middle class teenagers were roughly the same. However, lower class kids are far more likely to be prosecuted and incarcerated. Now there’s an interesting challenge for people who formulate public policy.

Type I and Type II Errors

When testing a hypothesis, two basic kinds of errors can occur. Put simply, a type I error occurs when we reject a hypothesis that is, in fact, true. For example, in our study of delinquency rates and income levels, if we reject the alternative hypothe- sis and embrace the null hypothesis, we have made a type I error if, in fact, delinquency rates and average neighborhood income are inversely related. By contrast, a type II error occurs when we accept a hypothesis as true when, in fact, it is false. For example, if we reject the hypothesis that delinquency rates and average neighborhood income are inversely related, such that delinquency rates decline as neighborhood income increases, we’ve fallen prey to a type II error.

Let’s consider another example. A jury will embrace a type I error if it wrongly rejects the null hypothesis that John is not guilty. As a result, the innocent John will be treated as a criminal. If the jury rejects the not-guilty null hypothesis when John is actually guilty, the jury has accepted a false negative and John will skip town, a free man, due to a type II error.

An important insight to look for under this topic is that public policy makers must tread a fine line between the risk of making either a type I or a type II error. Strive to understand how and why this is the case.

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Self-Check 10

Fill in the blanks with the best word to complete the statement.

1. If your selected confidence level is 95 percent and n = 100, you know that _______ of your sample means will fall outside the range of two standard deviations to either side of the mean of our sample means.

2. In trying to decide on the risks versus the advantages of making an investment in a new milling machine, you can estimate the probable outcome of alternative courses of action using a/an _______.

3. If you’ve gathered a/an _______ sample, each person in your study population has an equal chance of being selected.

4. A/An _______ error occurs when a null hypothesis is rejected even though it’s true.

5. Following the _______ limit theorem, the standard error is a measure of the dispersion of any number of _______ means.

6. If, in the process of hypothesis testing, you reject the _______ hypothesis, you’ve accepted the null hypothesis.

Check your answers with those on page 135.

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ASSIGNMENT 11 Read Assignment 11 in your study guide. Then, read Chapter 11 on pages 364–404 of your textbook, Introduction to Public Policy.

A discussion of the Framingham Heart Study leads this chapter. That study has persisted for the last 50 years and has contributed immensely to understandings of health issues, like the relationship of coronary disease to exercise and diet. You’ll want to study it because it illustrates the considerable potency of regression analysis.

Linear Regression

In general, regression analysis aims at explaining how one or more independent variables (X1, X2, X3) helps explain some dependent variable (Y), like heart disease, attention deficit disorder, unemployment, or poverty. For example, if poverty is our dependent variable, we might explore the relationship of poverty to factors like, age, gender, and socioeconomic status (SES).

Establishing a Linear Relationship

From your earlier exploration of correlation, you’ll have some insight into the concept of bivariate regression analysis. Consider any scatter plot, such as the one on page 369.

Now visualize a straight sloping line that best describes the obvious positive correlation of height and weight as children mature over time. Of course, your visualization would be subjective. Someone else might come up with a different line. The solution is offered by applying an ordinary least squares (OLS) equation to the data you’ve gathered. You won’t have to figure that out by hand. Statistical procedures, like those available through SPSS (Statistical Package for the Social Sciences) will calculate a line that best fits your height-weight scatter plot points. It will do that by minimizing the distance between each observation point and the fitted line. The verti- cal distance between a given observation and the best-fitted regression line is called an error term.

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The slope of the line will be represented by a number, like 3.5 or 2.2. The bigger that number—called the regression coefficient— the steeper the pitch of the regression line. Regression coefficients show us the best relationship between a dependent and an independent variable. They also allow us to predict the height- weight relationship of added observations, such as those for any child not included in the original sample.

Note: Although your study guide doesn’t cover many of the mathematical equations in this chapter, you should still study the quantitative examples offered in your textbook. You should try to grasp an overall feel for how these analytical tools are used.

Multiple Regression Analysis

Multiple regression analysis allows us to quantify the rela- tionships between a dependent variable and more than one independent variable. The general multiple regression equation looks like this:

Y � a + b1x1+ b2x2 + b3x3 . . . + bixi + e

Here, Y is the dependent variable; a is an intercept; x1, x2, x3 . . . xi are independent variables and e is the error term. The term b stands for the regression coefficient. For each inde- pendent variable, b (times a value x) allows us to quantify the relationship between the independent and dependent variable, ceteris paribus.

At this point take note of two ideas. First, we can easily graph a bivariate regression relationship because it can be represented two-dimensionally. However, multivariate regres- sion relationships are extremely difficult to visualize because they are multidimensional. Second, for reasons that will be considered in your textbook, in multivariate analyses we dis- tinguish between variables with a range of values and binary variables, referred to as dummy variables. Sex is binary (if we exclude cross-gender people). Smoking may be classified as a dummy variable if we give it a binary definition, such as “smoker” or “nonsmoker.”

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Interpreting Regression Results

Sign, Size, and Significance

The sign of a variable value—plus or minus—is important. If income has a positive (+) relationship (positive correlation) with our dependent variable, longevity, we need to know that. A negative value means that a variable (like income) is nega- tively correlated to the dependent variable such that as income increases, longevity decreases. (That would seem an unlikely outcome. But, in fact actual global longevity studies have identified the longest-lived people in remote, relatively impoverished places like Bolivia and Kazakhstan.)

The size of the relationship matters. You would probably agree that a higher correlation is better than a modest correlation if we’re looking for likely causal factors. In multiple regression analysis, the quantitative product of b times x is more impor- tant if b (the coefficient of the independent variable) is larger rather than smaller. (By analogy, a steeper regression line is more relevant to the relationship between a dependent variable and a given independent variable than is a shallow regression line.)

For public policy purposes, the statistical significance of a relationship is important. In that context, a researcher will draw on the procedures required in hypothesis testing. An alpha (significance level) where p = 0.05 (5 chances in 100) is better than p = 0.5 (5 chances in 10). If public policy is to be effective, resources should be directed toward the factors with the most weight.

Goodness of Fit

Beyond sign, size, and significance, there is a measure of the overall degree to which a regression analysis helps explain an outcome. Specifically, the R2 measure of goodness of fit tells us how much variation in the dependent variable is explained by the regression equation relative to the total variation in the dependent variable. For example, R2 could tell how much of the variation in worker productivity at Company Z is accounted

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for by our multiple regression analysis. Meanwhile, the statistical significance of R2 can be calculated by way of the F-test, as explained on page 385 of your textbook. Notice that the F-test is based on the principles of hypothesis testing.

Note: The textbook discussion of linear transformations, cover- ing pages 385–389, is recommended but optional. Questions about this material won’t appear on your lesson exams or in the self-check for this chapter.

Common Regression Errors

n Confusing correlation with causation. Regression analysis is based on correlations. As previously noted, only properly designed experiments can demonstrate or prove causation.

n Endogeneity (reverse causality). In the real world, most variables don’t stand all alone in their own cell-like space; they interact. For example education can lead to certain occupations or working in an occupation may lead to expanded education. So, sometimes a postulated inde- pendent variable will turn out to be best considered as a dependent variable.

n Omitted variable bias. Sometimes an independent vari- able stands as a sort of proxy for a variable that’s been omitted from a multiple regression analysis. For example, reported frequent headaches and above-normal blood pressure may be “stand-ins” for a variable omitted from consideration—job stress.

n Multilinearity. The ideal in multiple regression analysis is isolating the effect of different independent variables. However that objective may be compromised if, say, two of the independent variables are so closely correlated that it’s all but impossible to identify their specific impact on the dependent variable.

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n Data mining. One can load up a multiple regression equation with all kinds of variables that may have little or nothing to do with likely factors producing variation in the dependent variable. Further, as more and more “junk” variables are loaded into the equation, the chances of spurious relationships increase. A spurious relationship amounts to a false correlation. For example, ice cream consumption can be positively correlated with levels of street crime. But, in fact the causal factor related to both crime rates and ice cream consumption is temperature. Both crime rates and ice-cream eating increase during hot weather.

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Self-Check 11

Fill in the blank with the best word to complete the statement.

1. Among errors that can occur in regression analysis, endogeneity refers to reverse _______, such that Y causes X where Y is the dependent variable.

2. In interpreting regression analysis findings, we’ll consider the _______ ascribed to a given independent variable to determine if it is either negatively or positively correlated to the dependent variable.

3. In the general equation, y = a + bx, the term _______ is the point where a regression line intercepts the y axis.

4. It’s true that the _______ error of a regression coefficient will decrease as the sample size increases, all things being equal.

5. _______ squares is the most common method for fitting a regression line to the set of observations in a bivariate regression analysis.

6. In a bivariate regression analysis, the vertical line between a data point representing any height-weight junction (data point) and the regression line is called the _______ because it is a measure of the portion of the dependent variable that remains unexplained by the regression equation.

Check your answers with those on page 136.

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ASSIGNMENT 12 Read Assignment 12 in your study guide. Then, read Chapter 12 on pages 405–443 of your textbook, Introduction to Public Policy.

Basic Tools of Cost-Benefit Analysis

In purely economic terms, comparing the utility of two or more public projects, such as building roads versus laying railways versus building a dam, it makes sense that the cost- to-benefits ratio should be positive. But if that’s the case, how will we go about determining those ratios? There are no easy answers to that question. But one can begin by becoming familiar with the tools of cost-benefit analysis.

Establishing Common Units (Monetizing)

A fundamental tool is called monetizing. It’s fundamental because a basic challenge of cost-benefit analysis is assigning a common value denominator, usually dollars, to all kinds of conceivable costs and benefits. In that way we can establish and assign costs and benefits to such diverse things as human safety, reduced transaction costs, environmental externalities, and improved quality of life. That can seem to propose an insurmountable menu of difficulties. Given inevitable con- tentions over basic economic and human values, how, for example, does one assign dollar values to quality of life, or for that matter, human safety? Well, at least we can begin with a basic premise: The goal of public policy is making the best use of society’s finite resources.

Present Discounted Value (Net Present Value)

To monetize is to assign a common denominator of value. But even before we attempt that task, we have another problem we can call the time value of money. In fact, we explored that issue in Chapter 9. But we can recall the upshot of that issue quite simply: The value of money in hand is greater than the value of money to be received at some future time. Reasons for this include the cost of delayed satisfaction, investment opportunities that might vanish while we wait for “our ship to come in,” and, of course, inflation.

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Note: You can benefit from reconsidering the formula for net present value, N/(1 + r)t where N is the nominal or future value of costs or benefits, r is the discount rate, and t is the exponent given in numbers of periods (years usually) that will pass before the cost or payment will come due.

Evaluating Uncertainty

All projected costs and benefits may be subject to uncertainty. The value of a public investment in roads may falter if light rail investment increases. The cost of maintaining public water treatment plants may increase as result of fertilizer runoff adjacent to factory farms. Changes in technology may reduce the value of parking meters if more people begin to telecommute. In light of these kinds of contingencies, public policy planners must calculate the probabilities of possible things that can go wrong, or right.

Note: Study your textbook illustration of how cost uncertainty may be addressed. If two cost estimates differ significantly, they can be reconciled by mathematically evaluating the weighted average of two possible cost outcomes.

Opportunity Cost versus Cash-Flow Accounting

For accountants, the cost of your time on the golf course amounts to cart costs and greens fees. The cost of getting your license renewed is the license renewal fee. In short what matters is cash flow. Cost-benefit analysts take a different point of view. Whatever you have to give up to spend time on the golf course will be the opportunity cost of that choice. The time you lose waiting in line at the Department of Motor Vehicles is the opportunity cost of getting your license renewed. In cost-benefit analysis, cash flow isn’t irrelevant, but the opportunity costs of inputs and outputs are always taken into consideration. For accountants, money is money. For a cost-benefit analyst, time is money.

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Economic and Noneconomic Values (Use and Nonuse Values)

In the context of public policy formulation, cost-benefit analysts have to be skillful jugglers. Imagine four balls they have to keep in the air. The Economic Cost-or-Benefit ball is emblazoned with a dollar sign. It’s all about dollars and good sense. The Noneconomic Cost-or-Benefit ball is like a translucent sphere. Now you see it, now you don’t. It’s all about intangible gains or losses related to things like self-esteem, motivation, and one’s views as to what’s important in life. The ball stamped Use Value has to do with how a resource can be used directly for recreational or commercial purposes. The ball stamped Nonuse Value is similar in appearance to the Noneconomic Cost-or-Benefit ball—intangible. Here we find values that may attach to a resource one may not actually use. The preserva- tion of historical antiquities may be more a value than a used resource. The value of preserving National Parks for future generations is one of the finest “nonuse” ideas Americans ever came up with.

Even though the distinctions among these four concepts may be hard to determine, public policy formulators must strive to weigh and balance each ball, always remembering that the goal of public policy is making the best use of a society’s finite resources.

Note: The concluding “For Discussion” feature at the end of this chapter will help you better understand the cost benefit juggling act.

Making a Decision Using Cost-Benefit Analysis

Consider these principles:

n If, for any proposed project, the total expected social bene- fits outweigh the total expected social costs, it should be adopted because it will expand that society’s net resources.

n When weighing project options, policy makers should, as a rule, choose the one with the largest net present value (NPV).

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n Policy makers must decide which parties, such as the people in Watts or the residents of Cornwall County, will have standing. The parties who have standing are the parties we’ll consider in our analysis of a proposed project.

n In some cases the project with the greatest NPV won’t be favored by those who have standing. For example, risk- averse policy makers may adopt an alternative option with a lower NPV if outcome probabilities are more certain.

n In some cases policy makers will turn thumbs down on a project with a large NPV because of distributional effects. For example, a sales tax that will provide needed revenues in a locality may be rejected because the poor and needy will be cruelly burdened by such a tax. (In such cases we say the tax policy is regressive.)

Valuing Inputs and Outputs

Economists and cost-benefit analysts share a common idea about the value of anything at all. It’s summed up in the willingness to pay (WTP) principle. That principle asserts that the most accurate measure of the value of anything from a taco to a toaster to a luxury car is how much any person is willing to give up to get it. That certainly makes sense in the marketplace. But the WTP principle can also be applied to things that aren’t goods or services with price tags. In this section, keep an eye out for the following ideas.

Tradable Goods

When a project will rely on resources that can be bought and sold in the marketplace, the best measure of social cost is the cost of those inputs. However, market prices aren’t a good guide to social cost when there are distorting factors. These may include negative externalities, monopolies, tax rates, or the impacts of regulation.

In some cases, opportunity costs will be greater than account- ing costs. The example used in your textbook is conscription for military service. An extreme historical case in that context is offered by the impacts of World War I. The generals on all sides used Napoleonic tactics against barbed wire, machine

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guns, and massive artillery barrages. Casualties on all sides were appalling. Among the belligerents, particularly in Europe, entire generations of young men were bled dry. The “opportunity costs” reckoned in terms of the extermination of future scientists, skilled artisans, actors, artists, and entrepreneurs were incalculable.

Shadow Pricing

The process by which an opportunity cost is assigned to resources with no obvious market value is called shadow pricing. As a visual metaphor, imagine the unknown costs of a present-day controversial practice—“teaching to the test.” Imagine a shadow cast by that educational philosophy. What might be the opportunity costs associated with graduates’ diminished capacities for critical thinking or creatively “thinking out of the box” to come up with socially beneficial innovations?

Where market feedback is absent, a process called contingent valuation can help policy analysts estimate price values asso- ciated with a proposed program or project. Specifically, carefully crafted surveys, guided by probability sampling, can gather vital information from publics or parties that would be impacted by a policy. However, surveys of this sort must provide the following:

n An adequately detailed scenario or description of a pro- posed program, such as measures to protect endangered species or revitalize a town’s commercial center

n Items that require survey respondents to indicate willingness to pay

n Relevant demographic data, such as age, gender, race, income, and political philosophy

The latter information will permit analysts to use, for exam- ple, regression analysis to isolate and correlate demographic variables to attitude variables regarding a proposed project.

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Value of a Statistical Life

In the context of conducting a cost-benefit analysis, when human lives are assessed as a cost or benefit, policy makers must assign a monetary value to each life. That sum is called the value of a statistical life (VSL). Contingent valuation is one approach to identifying a VSL. But there are alternatives.

n Revealed preferences. Assume we can identify people’s willingness to pay for goods or services that reduce the probability of infirmity or death. We can use that data to make inferences based on willingness to pay for things like health insurance, home security systems, or even pricey organic food over processed foods. In that way we can infer people’s monetary valuations of measures that will protect a statistical life.

n Hedonic market analysis. Assume that workers who work at risky jobs will expect a premium (a bit like combat pay) added to their base wages. If this is the case, we can use regression analysis to estimate the risk premium, or compensating differential that must be offered to induce people to work in risky occupations, like high steel construction. As noted in your textbook, these kinds of analyses may wobble a bit, given that some risky occupations, like coal mining, rely on low SES workers who have limited bargaining power.

Choosing a Social Discount Rate

Native American wisdom proposed that an appropriate use of resources will consider the people’s future needs unto the seventh generation. Considering present-day global challenges like climate change, species die-off, and soil depletion, that formula seems like an unrealistic ideal. Nevertheless, how to go about allocating resources for the immediate future, much less future generations, presents thorny problems for cost-bene- fit analysts. The essence of that thorny issue is how to go about establishing a social discount rate. The social discount rate is used to discount costs and benefits to the present time, just as we would determine an NPV where we’re con- cerned only with a strictly monetary cost-benefit analysis.

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However, a social discount rate must also take public senti- ment into account. Indeed, as you study this topic, pay attention to how different social philosophies may influence ideas about how best to establish a socially acceptable and monetarily viable discount rate.

Note: Study the table on page 430 to think about the value of $100 at different points in the future using different discount rates. Also, to think about the utter lack of consensus as to appropriate social discount rates in regard to climate change, study the discussion and the graphic analysis on page 433.

Sensitivity Analysis

As you round out your study of this chapter, make sure you understand two concepts.

n Sensitivity analysis. Cost benefit analysts will look at the results of applying a range of discount rates to a given problem—like maintaining clean water standards. A program design in which the social benefits outweigh the social costs regardless of which discount option is applied would be ideal. The default option is choosing a social discount rate that appears to be better than the alternatives. The term sensitivity used in the context sensitivity analysis refers to the extent to which a program appears viable or not, given some range of discount rate alternatives.

n Cost-effectiveness analysis. Imagine that the goal of reducing CO2 emissions is taken as paramount. There’s no real alternative. Either CO2 emissions are curbed or the biosphere becomes terminally hostile to human life as we know it. No dollar amount can weigh the cost of nonaction. In such a case, a range of policy solutions is evaluated. But now the goal is identifying a program that will most immediately and effectively reduce CO2 emission, regardless of the cost.

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Self-Check 12

Fill in the blank with the best word to complete the statement.

1. A cost-benefit analysis always values inputs and outputs in terms of their associated _______ costs.

2. We can employ a/an _______ market analysis to determine the compensating differential in pay required to induce workers to take jobs that involve an increased likelihood of injury or death.

3. _______ to pay offers the simplest measure of what anything is worth.

4. To conduct a/an _______ analysis, we’ll look at several different estimates of future energy costs to complete our cost-benefit analysis of a proposal to install solar panels on the roof of our office building.

5. In respect to the concept of _______ goods, the price of anything that can be bought or sold in a competitive market is the best measure of the social costs of those inputs.

6. In the process called _______ pricing, we assign an opportunity cost to resources, like clean air, that have no obvious market price.

Check your answers with those on page 136.

Introduction to Public Policy108

ASSIGNMENT 13 Read Assignment 13 in your study guide. Then, read Chapter 13 on pages 444–475 of your textbook, Introduction to Public Policy.

You should come away from this chapter with a good overall sense of how one goes about evaluating the outcome of a policy- driven program, intervention, or project. In that context, you’ll find that a lot of the chapter material elaborates concepts that have already been introduced. Consider that a plus. Learning is enhanced when we can explore ideas of any sort from a different angle.

The Treatment Effect

The impact of a policy or program is called the treatment effect. If, for example, a fitness program is mandated for public schools, we would assess the program by assessing the extent to which indicators of fitness have improved in the wake of the program. If, overall, kids can do more sit-ups, run faster, and show improved body-fat to weight ratios, we could justly claim that the program is doing what it was intended to do.

In this example, we have a clear comparison group if we have data on kids’ physical fitness indicators prior to the initiation of the new fitness program. On the other hand, if we have lit- tle or no data on kids’ fitness prior to the implementation of our program, we’ll have a lot more trouble assessing the value of our fitness program.

Confounding Factors

This section elaborates on the nature of factors that can dis- tort or totally invalidate a research design. Consider the following:

n Selection effect (selection bias)

n Distinguishing causation from correlation (or just coincidence): Be sure you can differentiate the possibilities: A causes B. A and B are correlated, but A doesn’t neces- sarily cause B. B may cause A (reverse causality). Some

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omitted variable, C, may be responsible for both A and B. A and B are related as a result of coincidence; B just happens to show up when you observe A.

n Dropout effect (survivorship bias)

n Evaluator or participant bias

Evaluation Strategies

Randomized Experiment

As your textbook points out, the properly conducted experi- ment is the “gold standard” in all kinds of research, including research to evaluate the outcome of public policy programs, projects, or interventions. If you have a good understanding of an ideal experimental design, you’ll have a handy tool for understanding the shortcomings of alternative research designs. Imagine this ideal research scenario.

An experiment is conducted to assess the treatment effect of a drug, “Nova 22,” on hospitalized patients suffering from emphysema. At a large general hospital it proves feasible to use probability sampling to select two matched samples of n = 20. All subjects are male. All subjects are between the ages of 45 and 55. All subjects developed their symptoms while engaged in manufacturing activities that exposed work- ers to asbestos particulate.

Sample 1 is designated the control group. Sample 2 is designated as the experimental group. Once a day, nurses administer a plain white tablet to each person in both the control and experimental group. All subjects are informed that the drug is intended to improve respiratory functioning (make for easier breathing). However, while the subjects in the control group are actually taking a placebo (a sugar pill), only the subjects in the experimental group are ingesting doses of Nova 22. The medication regimen lasts precisely 20 days. Respiratory function (RF) for each patient is measured immediately following day 20 and at the same time of day.

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Your hypotheses are as follows:

HO: The difference in RF between the Control and the Experimental group � 0

HA: The difference in RF between the Control and the Experimental group = 0

To eliminate possible bias, the study is double blind. That is, neither the nurses administering the medication nor the patients themselves know which patients are in the control or experimental groups.

Assume that RF can be precisely measured on a scale from 1 to 10, such that any reading greater than 5 is considered meaningful (significant) improvement in ease of breathing.

Finding: The average RF reading for the control group � 3.8 with a range of 2.5 to 6*. The average RF reading for the experimental group turns out to be 8.5 with a range of 7.8 to 9. The null hypothesis is rejected.

* The modest improvements in RF among patients in the control group might be said to result from what’s called a placebo effect. All the patients understood what the drug was intended to do. Expectations and assumptions can and often do produce physiological effects.

Conclusion: Nova 22 produces a significant and precisely measurable increase in respiratory functioning.

Now let’s return to the real world. Let’s say that the problem you want to address is domestic abuse. Your public policy concern is reducing rates of domestic abuse. To address that issue you’ll review all the available literature and data on domestic abuse in search of hypotheses that can be tested. You know that previous studies have shown that socioeco- nomic status (SES), a history of child abuse, and financial insecurity are related in the incidence (frequency) of domestic abuse. But can you imagine carrying out any kind of controlled, double blind experiment to establish precisely measurable causes of an increased rate in domestic abuse? Maybe you can (without spending a very large sum of money on the research). If so, you may become a legend in the field of public policy analysis.

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Natural Experiments

An example of a natural experiment was offered to you earlier and another is provided in your textbook. The basic idea is that occasions may arise when a study population can be naturally divided into a control and experimental group. It might turn out, for example, that there are two middle schools in Claxon County, one at either end of the county, such that kids from School A seldom if ever interact with stu- dents from School B. Both schools serve populations with similar demographics. But for no particular reason, one class of seventh graders at School A viewed a documentary film on the Civil Rights Movement. The film wasn’t used at School B. If you were interested in the attitudinal impact of this film on student views on racism, you could select a seventh-grade class at School B that’s fairly well matched to the class that viewed the film. At both schools, you administer a reliable and valid survey designed to assess attitudes toward racism to each class. If you find that the seventh graders who viewed the film at School A are significantly more likely to embrace ideals of racial equality, you would reject your null hypothe- sis in favor of alternate hypothesis. Namely, exposure to the documentary film increases sensitivity to racial issues.

Nonequivalent Control Group (Nonrandomized)

A nonequivalent control group design (NEGD) is the most common research design in the social sciences. Imagine that at Grace Middle School, to assure a satisfactory teacher–student ratio, there are two eighth grade classes. Based on observation, the characteristics of the students in Class 8A and Class 8B are at least roughly equivalent. A standard pre-test–post-test design is adopted to assess learning outcomes based on a new approach to teaching math. A “map” of the research design looks like this:

Class 8A: Treatment group of size N à Pre-test à Treatment à Post-test

Class 8B: Control group of size N à Pre-test à Post-test

Introduction to Public Policy112

All the students in both classes take a standardized math- achievement test. However only the students in Class 8A (the experimental group) are exposed to the new approach for teaching math—the treatment. At the end of the experi- ment, students in both classes take the math-achievement test again. If the post-test scores are significantly higher for the students in Class 8A, the superiority of the new approach to teaching math is supported.

So, what’s wrong with this design? Nothing, not if Class 8B is truly equivalent to Class 8A. But there’s the rub. The students in the two classes weren’t assigned to the experimental or control groups by random selection. That’s why an NEGD is called a nonequivalent control group design. The researchers can’t be absolutely sure that the two groups are equivalent. Therefore, to the extent that the two groups aren’t equivalent the findings may be distorted or flat-out wrong. The antidote for this dilemma is replicating the experiment in different places over time.

Time-Series Analysis

A researcher can use longitudinal data to conduct a time- series analysis. The objective will be to assess outcomes of an intervention before and after its implementation. Suppose the issue is gang violence. The intervention we’ve implemented involves coordinated efforts of police officers and psychiatric social workers. Now if it turns out that gang violence is noticeably reduced after the intervention, we can reasonably assume that our program has been effective. On the other hand, it can be difficult or impossible to show that the inter- vention has, in itself, reduced gang violence. For example, neighborhood parents may have decided to take an active role in the matter or another project, the creation of a neigh- borhood recreation center, may be causal factors.

Also, it’s possible that response to the intervention may take awhile. For example, social psychologists are aware of what are called sleeper effects. A person who has been exposed to arguments against racism may not begin to revise his or her attitudes for some period—which, oddly enough, turns out to be about 21 days.

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Note: You should read the feature on pages 462–463, “Twin Studies: Are Psychopaths Born or Made?” These days, the issue of psychopathic or sociopathic behavior in high places is getting a fair amount of attention. The social costs of psy- chopathic behavior, illustrated by the scandals surrounding powerful corporations like Enron and WorldCom, are far from negligible. Pensions are lost. Jobs vanish, and public confidence in institutions is seriously compromised.

Multiple Time Series (Difference in Difference)

Suppose Tarrytown and Whitesburg are Midwestern towns. Both towns are located in the “corn belt” and the demograph- ics of the two towns are similar. An intervention program is launched to reduce teen delinquency rates in Tarrytown but not in Whitesburg. Two years later the teenage delinquency rate has risen by 12 percent in Whitesburg but only 2 percent in Tarrytown. Note here that every three months we analyze longitudinal data in both towns. In this context, we can think of the teen population of Whitesburg as our control group and the teen population of Tarrytown as our experimental group. At the end of our two-year study we can assess the so-called difference in difference for the teen delinquency rates in the two towns. In sum, we’ve established that there is a 10 percent difference between the delinquency rates in the two towns that can, reasonably, be attributed to our intervention.

Discontinuity Studies

Imagine a flock of bright high school graduates applying to Calumet University. All hope to qualify for the university’s Advanced Placement (AP) program. Data has shown that graduates who get into the AP program earn significantly higher salaries than students who don’t make the cut. The qualifying score on the AP academic proficiency test is 90. Researchers want to compare the impact of the AP program on future earnings for those who make the cut and those who don’t. So how can we do that?

Introduction to Public Policy114

Here’s how: Over a period of years, we examine the income records for those who barely made the cut and those who came close, but not quite close enough. We do so under the assumption that psychometric and academic achievement measures for applicants who score 87, 88, or 89 on the exam will be very similar for those who score 90, 91, or 92. We can then compare long-term income levels of graduates who just made the cut or who just missed it. If the average income difference is statistically significant, we have a measure of the relative utility of the AP program among graduates of Calumet University.

Multivariate Analysis

At this point, you’ll understand that the purpose and the power of multivariate analysis is isolating a factor (independent variable) that may be associated with the outcome (dependent variable) while controlling for other factors that may effect that outcome. Your textbook illustration designates Y in the multiple regression equation as an assessment of changes in sexual behavior resulting from a sex-education regimen of some sort. For example, intervention in the form of a sex-education program may be associated with a longer delay before onset of sexual behavior. In the context of that discussion, it’s noted that in this sort of analysis a particular kind of dummy (bivariate, “yes or no”) variable will indicate whether or not the individual participated in the sex-education program. That variable will be called the treatment dummy. If the (regression- line slope) coefficient on the treatment dummy, bnxn, is correct, it will measure the relationship between participation in the sex-education program and the onset of sexual activity, holding other factors constant.

Two problems with multivariate analysis are identified. First, recalling that numbers must always be interpreted, causality may run in the opposite direction, such that the dependent variable is causally influencing one or more dependent vari- ables. Or, because variables may interact, it may be the case that causality is running in both directions; that is, parental role models may influence the student’s decision to enroll in the sex-education program while peer attitudes are influenced by individuals in that group who elect enrollment in that program.

Lesson 3 115

Second, where we are focused on the observed relationship between, say, onset of sexual activity, and sex education, it may turn out that variation on both variables is caused by an omitted variable. For example, strong religious commitment may be the chief causal influence with respect to both of these variables. Or, put another way, both A and B are caused by C.

When you’ve reviewed Lesson 3 and you feel confident that you understand the material, complete the Lesson 3 examination.

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Self-Check 13

Fill in the blank with the best word to complete the statement.

1. An antipoverty program has been implemented. Your effort to evaluate that program includes a multiple-regression analysis. If your equation was properly conceived and includes a binary independent variable called the _______ dummy, the coefficient on that variable will measure the relationship between those who were participants in the program and those who were not.

2. The “gold standard” of program evaluation is the randomized _______.

3. As a public policy analyst you want to find out if the outcome of a program was actually caused by the implementation of the program. In other words, you are tackling the _______ problem.

4. Trying to distinguish causation from correlation, you might determine that some _______ variable has thrown the study off-track, such that the apparent relationship between variables X and Y is spurious, given that both are causal effects of a variable Z.

5. Using longitudinal data to assess the “before and after” effects of a public policy intervention is referred to as a/an _______ analysis.

6. The problem with using the approach from question 6 is that before and after findings won’t allow you to prove _______.

Check your answers with those on page 136.

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Making Policy

ASSIGNMENT 14 Read Assignment 14 in your study guide. Then, read Chapter 14 on pages 479–510 of your textbook, Introduction to Public Policy.

What we call institutions are, ultimately, shared ideas that guide the ways in which we think and behave. Ritual head- hunting and head-shrinking technologies are institutionalized among the Jivaro of the Orinoco Basin. The institutionalized concept of family among the Hopi of the American Southwest normalizes a matrilineal kinship system in which you get your name from your mother who, with her sisters, will own the house you live in. Based on Enlightenment ideals, the concept of freedom of expression is institutionalized in the U.S. Constitution’s First Amendment.

In general, in any society, four generalized concepts are first to appear as a society evolves—family, economy, some mode of governance, and religion. The enormous array of institutions in a modern society are “spin-offs” from these basic shared concepts. In terms of how we see the world and how we interact, the dominant institutions in a modern Western or western- ized society include some kind of representative governance interacting with an economy informed by mass production and mass society, generally organized around the concept of sovereign nation states.* Within this dominant pattern, family and kinship norms organize interpersonal relationships, as will some form of what we may call a “cosmic” philosophy. These idea-entities include long-established organized religions, sec- ular philosophies like Marxism or Neo-liberalism, cults of all kinds, and narrowly defined sects like the Old Order Amish.

*The modern concept of sovereign nation states originated with the Treaty of Westphalia (1648) which ended the Hundred Years’ War in Europe. The idea of ethnically and culturally homogeneous nations identified with delineated geographic borders was refined in France following the French Revolution of 1789.

Introduction to Public Policy118

Public policy in a modern state is primarily focused on recon- ciling the interests of the many faces of mass society—often viewed as either publics or markets—with the inherent interests of a for-profit market system as moderated by the institutions of governance. In general, the most potent and influential institutionalized form in the market system is the corporation. The most potent institutions of American governance are federal, state, or local legislatures, courts, or executive bodies that include regulatory agencies. This trio represents the American constitutional ideology of checks and balances provided by the executive, legislative, and judicial branches of government.

In the United States, the notion that a corporation is a legal person with person rights originated from interpretations of an 1886 federal court decision. Most recently, the idea that corporations have person rights has been greatly expanded by Supreme Court decisions declaring that money is a form free speech and the 2010 ruling in Citizens United v. Federal Election Commission declaring the right of corporations to make essentially unlimited political campaign contributions under the First Amendment.

The Role of Institutions

Ideally, institutions must enact three roles:

1. Gather together (aggregate) the preferences of people that constitute a group. A group in this sense can be called a public. Working mothers, residents of a neighborhood, extractive industry workers (miners), and likely voters can be thought of as publics.

2. Implement and enforce communal decisions. The thorny issue here is that, by definition, public policy involves changing behaviors, often through coercion. Think about the Civil Rights Movement and civil rights legislation of the 1960s to get the point.

3. Protect minorities and dissenting views. Nothing resem- bling a representative democracy can exist if dissent is forbidden or suppressed. By the same token, a system of governance that ignores the rights and concerns of minorities creates oppressive majorities and, thereby, defeats the ideal of government of, for, and by the people.

Lesson 4 119

Why Can’t Government Operate Like a Business?

Your textbook offers five reasons why business practices may be antithetical to the welfare of a society as whole. But basically, the matter boils down to a simple observation. Private sector enterprises are driven by the profit motive. That’s fine for allocating a wide range of goods and services that can be understood in terms of supply and demand measured in dollars and cents. However, some kinds of goods and services required for the general welfare, like low-cost public housing or unemployment insurance, have to be administered on a nonprofit basis, simply to keep costs under control. At the same time, appropriate regulatory measures, like mandated food safety standards, must be provided by public agencies that are accountable to the public, not the commercial enterprises that must meet those standards.

Institutions and Outcomes

The prime directive for people who craft public policy is improving people’s lives. And so it follows that the main pur- pose of institutional analysis must be aimed at enhancing and protecting people’s lives. In turn, that means figuring out how and why institutions produce outcomes that either aid or detract from the public welfare. For example, if roads, bridges, and other aspects of a country’s infrastructure are deficient, what policies might be initiated to cost-effectively upgrade the country’s infrastructure?

Note: As you study the main points under this topic, be sure to give some special attention to the Policy in the Real World feature, “Institutions and Development: The Institutional Legacy of Colonialism,” on pages 492–493.

Introduction to Public Policy120

The Attributes of Effective Institutions

In general terms, effective institutions are laws, organizations, and accepted modes of behavior that allow a society to make the best use of its resources. Specifically, effective institutions have certain attributes:

n Authority. Let’s assume you have access to safe clean water. If you do, it will because some institution will have the authority to assure that access. That institution may be a state water authority that sets standards for local water treatment plants. That’s a simple example, but it illustrates the main idea here. A policy can exist only if some institution has the authority to administer the policy. In that context, there’s a downside to the geopolitical organization of our planet-based nation state sovereignty. Assume that global climate change must be addressed in the interest of humanity-at-large. How can that happen absent an internationally recognized authority enabled to administer ecology-friendly polices worldwide?

n Legitimacy. An institution can be thought of as legitimate if its policies and practices are in accord with the preferences of people whose lives are affected by that institution. In some cases, legitimacy is based in custom and tradition. Norms and practices surrounding the institution of marriage offer one example. At the level of the state, monarchy may be granted legitimacy even though actual governance is implemented by a parliament composed of democratically elected representatives. On the other hand, people gener- ally feel that autocratic governance backed by force and fear is illegitimate.

n Mission. An institution must have a clearly defined purpose if it is to effectively improve people’s lives. For example, the Rural Electrification Administration (REA) is a federal agency under the Department of Agriculture. It was established under the presidency of Franklin Roosevelt in the 1930s, during the Great Depression. Its goal was extending electric power to rural areas to improve both the lives and productivity of farmers and ranchers located far from urban centers. The program was justified because private sector energy providers refused to extend the

Lesson 4 121

range of substations and transmission lines beyond a profitable distance from power plants. The REA program worked. All of America was “electrified, and REA co-ops continue to be part of people’s lives across the prairie and mountain states to this day.

n Money, people, and expertise. A budget, personnel, and expertise are absolute requisites if programs like the REA are to be initiated, implemented, and sustained. One of the pressing problems in less developed countries is the absence of these fundamental resources. In your text- book discussion of this topic, comparisons are made between the effectiveness of private and public sector approaches to utilizing these resources. In either case, attracting funding is a major concern.

n Internal incentives. The key idea here is that institutions are more likely to be effective if the incentives offered to the people carrying out a policy are likely to align their self-interest with the goals of the program or policy. An infamous example of misaligned incentives has, historically, been illustrated by the New Orleans Police Department. Officers of the NOPD are notoriously underpaid and all but universally tempted to accept bribes from vested interests that don’t serve the public interest. Another example has to do with tenure policies for college teachers. If the route to tenure is basically measured in journal articles published, academics have weak incentives for devoting time and energy to teaching.

n Enforcement. The basic idea here is simple: A law that can’t be enforced is not really a law at all. Similarly, if a law can be only weakly enforced, it’s a lousy law. America’s experiment with prohibition simply created a massive illegal market for alcoholic beverages.

n Rules. Rules have profound effects on how power and resources are allocated within an institution. Recall, if you will, the insights you may have gained from consid- ering how bills may or may not become laws depending on the organization and procedures of the House of Representatives and the Senate. Rules are necessary, but some rules are better than others when it comes to initiating and implementing public policy.

Introduction to Public Policy122

As you wrap up your study of this chapter, think about these three observations:

n The same set of preferences filtered through different institutions will produce different outcomes.

n Often, the quality of an institution will dictate the quality of policy outcomes.

n Because power structures are strongly inclined to sustain the status quo, institutions are inherently difficult to change.

You’ll also want to spend some serious time pondering the For Discussion feature, “Global Governance: Reform at the United Nations,” on pages 506–509. Pay special attention the five criteria for the legitimate use of force on page 508.

Lesson 4 123

Self-Check 14

Fill in the blanks with the best word to complete the statement.

1. The fact that public institutions will take on socially desirable tasks that the private sector won’t or can’t accomplish is one reason why government institutions can’t operate like a/an _______.

2. Among other things, institutional _______ can help us reform defective institutions and make sense of observed public policy outcomes.

3. An institution is most likely to be effective if the _______ incentives for employees, like adequate pay and a good job fit, are aligned with and complement the institution’s mission.

4. Thinking about the attributes of effective institutions, like authority and enforcement, legislative procedures, like the committee system and the filibuster, exemplify the importance of _______ that may either facilitate or obstruct the formulation of effective public policies.

5. In developed countries, _______ is the most common mechanism for attributing legitimacy to an institution.

6. Two important roles of institutions include aggregating people’s _______ and protecting minorities and people’s right to _______.

Check your answers with those on page 137.

Introduction to Public Policy124

ASSIGNMENT 15 Read Assignment 15 in your study guide. Then, read Chapter 15 on pages 511–547 of your textbook, Introduction to Public Policy.

How can public policy change people’s behavior in ways that lead to better social outcomes? That central question has been addressed throughout this course. You’ve explored basic concepts in economics and been introduced to the analytical tools used by public policy analysts. In that context you’ve pondered game theory, particularly as illustrated by the pris- oner’s dilemma. You’ve explored a host of principles that should inform effective public policies and, with an overview of the all these things, pondered a wide variety of illustrative “snap shots” of public policy issues in the real world.

A famous poem written by T. S. Eliot includes this passage: “We will return to where we began to know the place for the first time.” That idea characterizes this final chapter of your textbook. Beginning with a case study focused on poverty in Brazil, you’ll be afforded the opportunity to pull together all you’ve learned to this point. You’ll notice, for example, that you’ve come full circle in considering the steps in the policy-making process. The content of this chapter is both a summary and a review of your textbook and of this course.

Note: Use this chapter to reflect on both what you’ve learned and what you may have missed. To do that, go back to sections of your textbook that will help refresh your understanding of key terms and basic concepts.

When you’ve reviewed Lesson 4 and you feel confident that you understand the material, complete the Lesson 4 examination.

Lesson 4 125

Self-Check 15

Fill in the blank with the best word to complete the statement.

1. In the context of evaluating policy options, the downside of cost-benefit analysis is that it fails to take _______ effects into consideration.

2. _______ is using language in such a way as to broaden the appeal of a policy proposal.

3. Who will be affected? How will people respond? Both of these questions are important focuses of _______ analysis.

4. Step 1 in the policy process is identifying the potential _______.

5. A/An _______ tax, like a tax on alcoholic beverages, is meant to offset the social cost of inadvisable or addictive behaviors related to the use of alcohol.

6. Step 2 in the policy process is figuring out why the _______ isn’t delivering a desirable outcome.

Check your answers with those on page 137.

Introduction to Public Policy126

NOTES

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BACKGROUND AND PREPARATION

For this research project, you’ll write a two-part essay identi- fying an ineffective public policy and suggesting how it can be improved. In the first part, you’ll choose a topic and discuss a related the current policy that you feel is ineffective. In the second part, you’ll research your point of view and write about changes you would make to the policy to make it more effective. You must use at least two outside sources in addition to the textbook and you must document the sources using a standard format, such as MLA or APA.

OBJECTIVE

This research project will help you apply what you’ve learned about public policy. More precisely, you’ll have a chance to make some public policy suggestions of your own on a topic of your choice.

PROCEDURE

Write an essay of at least 500 words, typed and double spaced in a standard, 12-point font, such as Times New Roman. You may use both Internet and print sources for your research. The format of your essay must include an introductory paragraph that summarizes what the paper is about and a concluding paragraph that summarizes your observations and conclusions.

Part 1

Select a topic related to one of the following issues:

n Immigration

n Education

n Entitlement programs

n Foreign policy

n Economy

Introduction to Public Policy128

Once you’ve selected your topic, identify a current policy within the topic that you feel isn’t effective. Read related journal arti- cles or books and use the most relevant material to explore the issue. Discuss relevant ethical, ideological, practical, and any other relevant problems you find with respect to the policy issue you’ve selected. Analyze every aspect of the policy; determine which goals are being met, which aren’t being met, and the reasons for the success or failure of the policy.

Part 2

Once you’ve completed assessment of the policy, introduce the changes you would make to remedy the problems you identified in Part 1. Refer to your research sources as needed, using proper citation for any quotes or paraphrased ideas that aren’t your own. Discuss how your changes would address the problems you’ve identified:

n Compare the merits of your proposed policy to the existing policy

n Analyze both policies with respect to the empirical and normative dimensions, the cost-benefit analysis, short- and long-term goals, and indirect benefits as discussed in your textbook

n Discuss how your policy would be implemented in light of groups (stakeholders) that would favor or oppose your policy proposals

n Explain and discuss just how your policy would be administered

Lesson 1 129

WRITING GUIDELINES

1. Type your submission, double-spaced, in a standard 12- point font. Use a standard document format with one-inch margins. (Don’t use any fancy or cursive fonts.)

2. Include the following information at the top of your paper:

a. Name and complete mailing address

b. Student number

c. Course title and number (Introduction to Public Policy, SSC265)

d. Research project number (50178700)

3. Read the assignment carefully and complete both parts, using proper citations according to either an APA or an MLA style guide.

4. Be specific. Limit your submission to the assigned issues.

5. Include a reference page in either APA or MLA style. On this page, list websites, journals, and all other references used in preparing your submission.

6. Proofread your work carefully. Check for correct spelling, grammar, punctuation, and capitalization.

GRADING CRITERIA

Your project will be evaluated according to the following criteria.

Content 60 percent

Written communication 15 percent

Format 25 percent

Introduction to Public Policy130

Here’s a brief explanation of each of these points.

Content

The student

n Provides clear answers to the assigned issues

n Addresses the issues in complete sentences

n Supports his or her opinion by citing specific information from references using correct APA or MLA guidelines for citations and references

n Stays focused on the assigned issues

n Writes in his or her own words and uses quotation marks to indicate direct quotations

Written Communication

The student

n Addresses the issue in complete paragraphs that include an introductory sentence, at least four sentences of explanation, and a concluding sentence

n Uses correct grammar, spelling, punctuation, and sen- tence structure

n Provides clear organization (for example, uses transi- tional words like first, however, on the other hand, and so on, consequently, since, next, and when)

n Makes sure the paper contains no typographical errors

Format

The paper is double-spaced and typed in font size 12. It includes the student’s

n Name and complete mailing address

n Student number

n Course title and number (Introduction to Public Policy, SSC265)

n Research project number (50178700)

Lesson 1 131

SUBMITTING YOUR ASSIGNMENT

Follow this procedure to submit your assignment online:

1. On your computer, save a revised and corrected version of your essay.

2. Go to http://www.pennfoster.edu and log in.

3. Go to My Courses.

4. Click on Take Exam next to the lesson you’re working on.

5. Enter your e-mail address in the box provided. (Note: This information is required for online submission.)

6. Attach your file as follows:

a. Click on the Browse box.

b. Locate the file you wish to attach.

c. Double-click on the file.

d. Click on Upload File.

7. Click on Submit Files.

After you submit the assignment, you should receive a confir- mation e-mail with a tracking number. If you don’t receive this number within 24 hours, you must resubmit your assignment.

Introduction to Public Policy132

NOTES

Self-Check 1 1. True

2. True

3. False

4. False

5. True

Self-Check 2 1. False

2. True

3. True

4. True

5. True

Self-Check 3 1. True

2. False

3. True

4. True

5. False

6. True

Self-Check 4 1. e

2. g

3. d

4. b

5. h

6. a

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Self-Check 5 1. communist

2. horizontal

3. index

4. initial endowment

5. Pareto

6. deadweight

Self-Check 6 1. rent seeker

2. median voter

3. Earmarks

4. Arrow’s

5. comparative

6. logrolling

7. Byrd

Self-Check 7 1. d

2. a

3. h

4. b

5. e

6. f

Lesson 1 135

Self-Check 8 1. Pigovian

2. transaction

3. paternalistic

4. monopoly, pricing

5. nonexclusivity

6. intellectual

Self-Check 9 1. relative

2. 5 + 6/2 = 5.5

3. selection

4. standard deviation

5. positive-findings

6. Longitudinal

Self-Check 10 1. five

2. decision tree

3. simple random

4. type I

5. central, sample

6. alternative

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Self-Check 11 1. causality

2. sign

3. a

4. standard

5. Ordinary least

6. residual

Self-Check 12 1. opportunity

2. hedonic

3. Willingness

4. sensitivity

5. tradable

6. shadow

Self-Check 13 1. treatment

2. experiment

3. identification

4. omitted

5. time-series

6. causality

Lesson 1 137

Self-Check 14 1. business

2. analysis

3. internal

4. rules

5. democracy

6. preferences, dissent

Self-Check 15 1. distributional

2. Framing

3. stakeholder

4. benefit

5. Pigovian

6. market