For tutor faith..

Part 2  

Invisible Hand Revisited

 

4) long run equilibrium requires _______ _________

 

 

Normal profit- just enough profit to make staying in business worthwhile.

Low (high) equilibrium price- profits are below (above) normal, firms will exit (enter) the industry

If there is a saturated market with one product and a very under produced market with another (class example- shirts and trousers), some profit seeking people will stop making the item we have too much of (shirts) and begin making what we have less of (trousers).

A massive over/under supply RARELY happens because the market is good at correcting itself before it’s too late.

 

5) The Myth of “Price gouging” 

 

· CATASTROPHIES- EXAMPLE OF HURRICANE HUGO IN CHARLESTON

· Ice was as high as $20 for several days.

· Why was that an optimal price for consumers?

 

· It motivates unusually fast, heroic efforts to __________ ___________ _____________

· Motivates the necessary extreme ____________________

· Generally, only people who REALLY _________ ice will pay for it.

· Makes sure ice is ______________for purchase by Salvation Army,etc to be distributed

to the very poor who have urgent need

·  

Government mandated “fair” price- a price knocked out of equilibrium, we get much _______ ice

used far less ______________

 

Rationing device- deciding who gets what, usually use price to determine (very efficient.)

But, if price is regulated, forced too low and quantity is limited, then it’s first come first serve.

With the government price imposed, the first come first serve method is only slightly better than random distribution. It leads to a lot of time spent waiting in line.

 

 

· Dead weight loss- (ex: waiting in line) cost imposed on someone with no direct offsetting benefit to someone else. This is a non-socially productive method. (Time is money). 

 

Fights would break out from people trying to cut line and the National Guard was forced to come in

 

 

· When we consider the dead weight loss, the real cost of ice rises higher than $20 for most consumers.

 

· HOW??

· Ice was originally $20, but the government put a mandated price on it to be $2. According to the graph, if the mandated price were to be removed, the price would rise above $20 Let’s say ice would rise to $32. But, since the mandated price has not been lifted and ice still costs $2, the average time people are willing to sacrifice to purchase the ice would be $30 worth. ($32 - $2).

 

 

*Quality always declines with price held artificially low.

 price $2, the ice would be dirty and melted because it was just thrown from trucks onto the ground.  Can still sell it for $2 since it’s real value is 10 times higher

 

 

 

 

6) Public choice- economic analysis of government

 

· Government is not wisdom or compassion. Government is _______________. Like fire, government is a dangerous servant and a deadly master.

 

 

· Most people are ignorant of economics, that’s why price controls are generally thought to be good by the public.

 

 Benefits for the individual voter to be well-informed (study up on politics and issues) would be:

 

NOT  likely to get __________________government since 1 vote is not likely to ___________ election

outcomes, especially at national level  (influence on other voters is usually not enough to matter either)

 

· Real benefit: A sense of fulfilling a civic duty

 

· Unfortunately, given human nature, these benefits are not enough for the large time cost that would be necessary to learn the issues

 

· Huge costs + small benefits = rational political ignorance (rational not being good in this case, just logically consistent with preferences)

 

 

7) Problems in Public Choice

 

· ****a) Rational political ignorance

 

· b) Undue special interest influence (politicians can sometimes buy votes from certain groups by handing them government funds or helpful regulations that hurt the economy in general.)

 

·  Example: government bought 9 million pigs and destroyed them during the great depression to keep pork prices high and buy farmers votes.

 

· Note:  campaign contributions are not central to this problem; could ban them and have no important impact

 

 

· c) Bureaucratic inefficiency- government tents to be far less efficient than private organizations.

· **Rule of thumb: it costs the government twice as much to do things not as well. Effective does NOT equal efficiency; govt is often at least somewhat effective

.

· Incentives are weaker in government. (Government runs companies are usually more inefficient because they can waste money and still know they will receive more money from the government. If a government run company does really well, is under budget and everything, it will get budget cuts-no real incentive to do well.)

 

· Government employees are much more heavily regulated

When you hand someone tax money and give them substantial power over others, they no longer have to please customers, there has to be more regulations.

Govt Reform

1) Reform through Privatization- private/public partnership, taking some government duties and delegating them to the private sector; Gov’t becomes more of an overseer, less involved in operations

· Complete privatization (virtually never happens). E.g. Simply Sell gov’t airline to private sector

· “With Strings” – special regulations apply to new private firm e.g. British Airways -“string”- no layoffs for first 5 years politically, some “strings” for

job security is a must.

· Tax Credit Systems- government helps by reducing net after tax costs. Ex: Tax credit to support private education.

· Voucher system

· Socialized funding but provision of good or service is through private companies that compete for the voucher

· Subcontracting

· Socialized funding and gov’t ownership maintained, but competing companies compete to handle at least some operations

· Prone to corruption more than other forms of priv, because gov’t is more ______________________

But still much better on average than govt _________

Consider defense subcontacting

· has much wider application, virtually anything

2) Privatizing Education

· Private Education out performs Public education, on average, by any measure: graduation rates, test scores, college performance, etc.

· Also, frequently costs far less

· Not because private schools have “better students” Bottom US 20% income group sends their kids to private schools at about same rate as top 20% income

· Adjusting for income and other demographic data, private schools still do better

· Public schools routinely send their worst problem students to private schools

· Gov’t monopolies (Public school system)

· Have weak incentives

· Major regulation inhibiting teachers, ex: private schools have freedom and incentive to discipline effectively

3) Voucher Program – Privatize Education by allocating all funds to parents, in a voucher, with no direct funding to any school

Schools that attract students can thrive and grow (in part by taking over failing schools), schools that don’t satisfy students/parents will go out of business

Invisible hand will replace govt as school regulator—parents and teachers drive decisions rather than politicians and bureaucrats

In competing for students schools will also compete for teachers to attract those students; teachers will no longer face a monopoly employer

Economists of all philosophies have long favored this reform and voucher programs are becoming more common, but still very controversial politically

4) Possible Issues

· A. What about schools raising prices because vouchers make the prices affordable?

· Might happen somewhat but schools are still competing. Parents will be drawn to best quality value

· B. What about transportation?

· Voucher can easily cover transportation costs.

· More mobile families, in practice, help the immobile families because they force schools to compete

· Even a monopoly school is likely to improve because their monopoly is no longer guaranteed

· C. If politicians control education, can’t they then impose a common body of knowledge; won’t we lose that if parents are now free to manage their own kid’s education?

· Right now, public schoolers have weaker grasp of this common body of knowledge than private schoolers

· Parents want this for their kids; it doesn’t have to be dictated

· Private control of curriculum is free speech, Gov’t control isn’t

· D. If we have vouchers won’t that violate the idea that gov’t should stay neutral regarding religion?

· No, true neutrality requires vouchers! current public education is strongly biased against religion

E. Would this lead to segregation?

· Worst public school are already segregated, virtually 100% minority students

· Inner city private schools are more integrated than public schools

· Legal provisions against racial discrimination exists and can be continued

· Whole history of desegregation was focused on getting better quality education, which parents can do if they have voucher

F. What about problem kids, won’t they just spread out and ruin more schools ?

· Problem kids routinely moved from public school to private now

· Private schools have freedom to impose creative measures; there’s incentive to find a place for a given student as long as he doesn’t disrupt other students

· G. Politicians can use some students to help others- be good role models, where as won’t parents too narrowly focus on well being of their own kids?

· However, private schools can attract good role models or others by offering special benefits – special classes, facilities, and scholarships.

· H. What about KKK, Nazi, Commie Pinko schools?

· 1 answer, tolerate this possibility on free speech grounds (this line of thought is based on idea that govt censorship is worse, more dangerous than whatever private abuses of free speech may occur)

· Alternatively, allow schools to be disqualified from voucher system by something like unanimous vote of legislature

5) Could vouchers lead to government control over all schools by setting eligibility rules for vouchers?

· Maybe, but existing private schools are currently not heavily regulated, in part because private schoolers are strong political group—this group will become bigger and more powerful.

· Still, historically it is common—not a certainty, but common, for gov’t funding to lead to gov’t control.

6) Universal tax credit less likely to result in gov’t control. Any taxpayer supporting private education for anyone’s children can take $ for $ tax credit so that there is no net cost to donors

7) Other Reform: If you can’t privatize then use

· Decentralization- where possible, taking federal government programs and giving them to local (if possible) or state governments.

Why is that helpful? More citizen/individual control: you can ___________if you don’t like your local government. Vote with your ________

· Local governments tend to be less inefficient than state or federal governments; state governments tend to be more efficient than federal.—can think of it in terms of monopoly power, the greater the geographic area the greater the monopoly power

Some miscellaneous economic principles

2) Excess burden- a type of dead weight loss, the cost of taxation beyond the actual paying of the tax.

· EXAMPLE: suppose it’s cheaper by, say, $50 for you to fly instead of drive to Miami. A huge tax is imposed on airfare and you now decide to drive instead. The tax is harming you, costing you $50 per trip even though you don’t pay the actual tax—that $50 cost to you that is not tax revenue for govt is your share of the excess burden

· Thus, the cost of government is higher than it actually appears, maybe about 75% of tax revenues collected**, meaning the real cost of a program that uses $100 million in taxes is $175 million when excess burden is added in

**Feldstein, Martin. 1999. Tax avoidance and the deadweight loss of the income tax. Review of Economics and Statistics 81, 674-680. and

· Feldstein, Martin. 2006. The effects of taxes on efficiency and growth. NBER Working Paper No. 12201.

.

3) Roles for government-economists generally agree government should:

· Provide police protection (criminal courts)

· National defense

· Establish and protect property rights regulate external costs (spillover costs)

4) External costs- cost imposed on someone without their permission (example: someone stealing your stereo.)

· Pollution is often an external cost (stealing clean air or water) and something that most would say should be regulated by government.

5) Observations on pollution:

· Pollution creates _______ as well as costs

· Products are cheaper and the material living standard is higher if we allow some pollution)

· Best to have the government set up framework for invisible hand to work rather than detailed command and control regulations.

6) Ex: Pollution tax- it’s better and cheaper to allow for different methods of pollution control than imposing a certain type of method

· Those that can reduce pollution readily will. If they will pay less out of pocket to reduce pollution than a government mandated tax would cost, they opt to reduce pollution, perhaps to 0 rather than just some accepted standard. Those who can’t viably reduce pollution (would drive them out of business) can pay tax instead

· Can get same level of pollution control but done by a command and control method but far cheaper.