Topic 2:Principles for Analyzing Government

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Topic 2Principles for Analyzing Government
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• Adam Smith (17231790)noted that in a market
  economy, individuals pursuing their own
  self-interests are led as if by an invisible hand
  to pursue the best interests of the society.
• Adam Smith. The Wealth of Nations.1776.
• The market system is based on the principle of
  voluntary exchange.

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• Under ideal circumstances the market allocates
  resources in the most efficient manner possible.
• Then, why should we have a government?

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The Market Economy

• Resource allocation in a competitive
  market(figure 2.1)

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The Role of Government

• Firstly, government protects the rights of
  individuals, which enables them to engage in
  voluntary market transactions.
• Secondly, the government can be viewed as an
  instutution that acts in the public interests.

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• The priciple underlying the private sector of the
  economy is voluntary exchange, while in the
  public sector of the economy, the government
  forces people to obey its rules and pay for its
  output.
• This raises a whole set of questions
• How do we know that we all benefit from the
  government's programs?
• Should someone who never uses a park be forced to
  pay for it?
• If these things really benefit us, why do we have
  to be forced to pay for it?

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• The government's activities can be analyzed
  within the framwork of two general categories.
• the first category concerns the scope of
  governmental activities
• the second category concerns how the government
  finances its activities.

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The Market System and Individual Rights

• The market system presupposes that individuals
  have the right to the output they produce and
  have the right to freedom of exchange.
• police
• national defence
• court system

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• The government as protector of rights
• without government protcetion of individual
  rights, people would have to find ways to protect
  their own rights, which would greatly reduce the
  efficiency of an economy.
• people would have no incentive to produce any
  more than they could individually protect.

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• The government as violator of rights
• with too much government, unconstrained in its
  activies, there is the potential for predation
  through government.

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The Public Interest

• The government should act in the public interest.
  But what is the public interest?

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• Jeremy Bentham(17481832)
• the public interest would be served by policies
  that produced the greatest good for the greatest
  number.
• Jeremy Bentham. An Introduction to the Principles
  of Morals and Legislation. 1789

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• Bentham's method of considering the public
  interest is sometimes referred to as
  utilitarianism because it attempts to take
  account of the relative satisfaction, or utility,
  of everyone in a society.

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• utilitarianism
• the amount of satisfaction or utility that an
  individual received from consuming goods or
  services can be measurable.
• one way to measure the public interest is to add
  up the total utility of all the individuals in a
  society.

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• John Stuart Mill(1806-1873)
• Principles of Political Economy, 1848

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• Policy suggestion
• Any policy that increased total utility would
  then be in the public interest because the
  utility gained by the gainers would be more than
  sufficient to offset the utility loss to the
  losers.
• the policy of distribution of income

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• drawbacks
• there is no valid way to compare the utility of
  one person with the utility of another.
• taken to its logical consequences, utilitarianism
  implies social arrangements that most people
  would find objectionable.

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• Michael J.Sandel
• Justice What's the Right Thing to Do?

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The Pareto Criteria

• Vilfredo Pareto(1848-1923), ecnomics and
  sociologist
• He developed two criteria, now known as Pareto
  optimality and Pareto superiority, for judging
  the public interest.

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• Because it is not possible to compare the
  utilities of two individuals, the only way one
  can be sure that a change will increase the
  social welfare is if the change makes at least
  one person better off, but makes no one worse
  off.
• Such a change would be called a Pareto superior
  move, or a Pareto improvement.

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• the Pareto criteria(figure 2.2)

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• Market exchange and the Pareto creteria
• Unless people not involved in the exchange are
  harmed, every market exchange is a Pareto
  superior move.
• With government allacation of resources, there is
  rarely unanimous agreement, and some people gain
  while others lose, making it hard to say for sure
  that the social welfare has been enhanced.

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• Political exchange and the Pareto creteria
• many activities of government produce benefits to
  some but impose costs on others.
• in practical terms it may not be possible to take
  any action in the public sector if the strict
  conditions of the Pareto criteria are adhered to.

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Other Measures of the Public Interest

• potential compensation
• Hicks-Kaldor cirteria
• if a proposed change benefits the gainers by
  enough that they could take some of their gains
  and compensate the losers so that everyone could
  be made better off, then the proposed change is
  in the public interest.

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• the social welfare function(figure 2.3)

PP utility possibility frontier UNsocial
indifference curve
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• It is really a type of utilitarianism. It is
  applied to income distribution problems to
  determine the optimal amount of redistribution
  through the tax system.
• By contrast, the Pareto criteria are not well
  suited to distributional issues.

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• cost-benefit analysis
• In actual pracice, it is frequently used to
  determine whether public sector projects are in
  the public interest.
• The main difficulty is to place an accurate
  dollar value on all the benefits and costs of a
  particular project.

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Positive and Normative Economics

• Positive economics examines the real world to
  discover its characteristics and
  interlationships.
• Normative economics makes value judgement as to
  how the world should be.

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• e.g. the minimum wage law
• How will the two kinds of economics analyze the
  law?

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• normative analysis and the public interest
• when studying the public sector, the normative
  elements necessarily enter into the picture
  because the government's activities are the
  result of choices.

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Equity and Efficiency the Goals of Pubic Policy

• Whether a change allocates resources more
  efficiently is a positive issue.
• The goal of equity is fundamentally a normative
  issue.

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• Discussion
• Is there a trade-off between equity and
  efficiency in public policy, or can the two goals
  be reached simultaneoursly?