Transcription
Hi class. So now we're going to be covering chapter five, public spending and public choice. But before we get into chapter five too much, let's review some of the ideas from chapter four, as well as chapter three.
Chapter three introduced supply and demand, essentially looking at the main components of a market system or a price-based system. And from chapter four, recall some of the ideas of the benefits of the market price system. And one of the first ones is this idea of consumer sovereignty. This idea of consumer sovereignty is that the consumer can decide what they want to purchase. They have the ability to decide what they want, what they don't want, and what they need to purchase. Of course, there are some ideas that might muddy the water a little bit. For example, if you purchase an automobile, you're also required by law to purchase things like automobile insurance. But that doesn't go against this idea of consumer sovereignty because, as an individual who is a licensed driver, you do or should know that if you purchase an automobile, along with that comes the requirement, the responsibility of also obtaining automobile insurance. So, there you are still sovereign over your over your choices. You just need to be aware. You're responsible to have that awareness.
Now, the market system or the price-based system indicates what is also relatively scarce and what is relatively abundant. If a high price generally indicates what is relatively scarce, a low price indicates what is relatively abundant.
Now, the market system also provides information to individuals and businesses through their interactions. Information is exchanged. This market or this price-based system makes both parties subjectively better off because nobody's forcing the other to engage in it. The person who purchased it, whether purchased is a good or service, whether you think that person who purchased it got ripped off, whether you believe it or not, at least they are subjectively better off in their mind. So, it makes both parties subjectively better off. Just like the firm wasn't necessarily forced to sell something, they did it because it was in their best interest to do so.
Now, the market system also sets the prices we pay and receive. In other words, we do not have government officials sitting there up on high deciding that a gallon of milk should cost this much and a pallet of toilet paper should cost this much. It's a market-based system. Supply and demand determines this, and that is one of the efficiencies of the market or price-based system.
Now, the system also reduces transaction costs and it rations or allocates goods in a way that we consider efficient, or does it efficiently. Now, I want you to remember that in economics, efficiency means that the individual or individuals who are willing and able to pay the most for an item and actually receive the item. If that's the outcome, then a marketplace is efficient. Now, if someone is not as willing to pay as high an amount and still gets the item over the person who's willing to pay a higher amount, then we're looking at an inefficient system. Well, which one is fair or fairer? That's a normative topic, and that's another discussion. We're really talking about just efficiency. And with that definition of insufficiency, at least we have some clarity, and there's not much point for argument in that case.
Unfortunately, the market-based system doesn't always cover all the bases. So, situations arise where the price system does not generate optimum results, and these are due to what we call market failures. And a market failure is the situation in which the market economy leads to too few or too many resources going to a specific economic activity. An economic activity might contribute to things like pollution of our air, pollution of our waterways, deforestation, destruction of our coral reefs, destructions of our shorelines, and things like that.
Now, when that involves people who are not engaged in the activity of production or even consumption of the product, that's a situation where the market is not appropriately accounting for the cost, the opportunity cost to everyone affected. And so that is what we call a market failure. And property rights, which is the rights of an owner to use and exchange property, property rights are very important to determining to allow or to mitigate issues such as market failures. So, in terms of market failures, the problem comes oftentimes from a lack of clearly defined property rights.
An externality. This is a very important concept, and it's oftentimes discussed in newspapers or articles. But in my opinion, oftentimes it's overlooked in the discussion when it comes down to government and politicians getting together to determine policy. Sometimes they overlook externalities, or we have one group minimizing the effect of an externality, and the other group magnifying the effect of an externality. Essentially, an externality is a consequence of an economic activity that spills over to affect third parties. For example, pollution.
Now, third parties are parties who are not directly involved in a given activity or transactions. Again, it's parties who are not directly involved in a given activity or transaction. So, in this picture, you see air pollution. Now, all these people in the picture there, you see they're either driving an automobile or they're riding some sort of internal combustion engine that does produce carbon monoxide and emits it into the atmosphere. But who are not shown here are the pedestrians at the side on the side who are walking, not engaging or utilizing a product that creates this pollution into the public atmosphere. And they're the ones suffering as well from the pollution being generated by those who are driving these internal combustion engines. So, these third parties are affected by the externality of pollution.
So, here's a question for discussion, which we won't do on the video, but you can think about it. Should the university provide free flu shots for everyone on campus? What are the campus-wide benefits? Obviously, if everyone gets inoculated with flu shots, then when you show up to class, the campus-wide benefits might be that the person next to you will not be showing up sneezing or coughing and thereby causing you to become affected with the flu and possibly losing five days of class attendance, job attendance, thereby income, and so forth and so on. So, that's one of the benefits of the university providing something like free flu shots for everyone on campus.
How about this next question? Do you favor a ban on cell phone use while driving? What are the societal benefits? I think we've all seen in the news that a lot of needless death, pain, and suffering to families occurs because oftentimes individuals get into accidents because they are distracted due to their phone, whether they are texting, whether they are looking for directions while they're driving and not paying attention, or whatever activity that distracts them. And that could create externalities, spillover effects to people not at all engaged in the activity of the person who is causing the accident.
Okay, so we're going to go to the idea of public goods versus private goods. Private goods are really pretty easy for us to conceptualize because going from chapter three and chapter four, we're essentially talking about private goods, supply and demand for things that you want to purchase and own. A private good is a good that can be consumed by only one individual at a time. Private goods have two characteristics. The first one is that they are rival in consumption, and one person's consumption reduces the amount available for others to consume, like a piece of pizza or a sip of a beer, for example. And it's also private goods are excludable. The ownership and consumption by the owner excludes others from being able to consume the good, like pizza, light beer, or real estate or an automobile.
On the other hand, there's public goods. Public goods are goods that are non-rival in consumption, so one person's consumption does not reduce the amount available for others to consume. So, sunset, me looking at a sunset does not reduce the amount of sunset available for you to look at. Same thing for me breathing in the clean air or national security, something that our taxes go to paying. It's also non-excludable. The benefit of the good cannot be denied to those who do not pay for the good. So, sunsets, clean air, national security are music from that outdoor amphitheater, the Waikiki Shell, where we have live concerts and people can sit outside the amphitheater grounds and not pay the cost to enter and still listen to the music.
So, this brings us to the idea of the free rider problem. The problem of public goods is the free rider problem, and it's when individuals decline paying for their portion because they know others will pay and they can still consume the goods. So, for example, there's that show Sesame Street for children. It's funded by some but enjoyed by many more. They don't make you or your child pay for it before watching it. They can't stop you from watching it if it's on an accessible channel to everybody. And on top of that, it's too costly. It would be too costly for private firms to separate non-payers and to exact payment from the users. So, an example is, for example, traffic lights. You know, they could try to make it a private good, but how are you going to get, how are you going to determine who paid and who didn't pay and who can use it and who doesn't? The closest thing we have to that would be private toll roads or freeways. That would they have the toll booths or some other mechanism of paying to use the freeway, then that's something that it's a private good, no longer a public good for people to use and not pay.
Now, not all externalities are negative. They're not all like pollution and so forth, but there's things with positive externalities. So, all externalities are not negative spillovers.
Now, the government correction of negative externalities. One would be special taxes, also known as effluent fees. It's a charge to a polluter that gives the right to discharge into the air or water a certain amount of pollution. This fee is used to offset the negative effect that the pollution imposed upon society. So, if there's a firm producing a microchip or something that has a lot of toxic waste being pumped out into the waterways or into the air, that company may be charged an effluent fee, and the government is supposed to take this money, and they're supposed to utilize it to offset the negative effect that this company is imposing upon society through their effluence. And then, of course, aside from special taxes or effluent fees, there's also just straight-up regulation, and it's requiring, for example, pollution abatement equipment or regulating the allowable amount of pollution that a company can emit into the atmosphere.
Now, because not all externalities are negative, there are positive externalities. And the government can correct, you can put "correct" in quotes for positive externalities. A positive externality can be subsidized. Subsidy generates more of the activity, generating greater benefits to society, and the government can provide or outright finance the activity. And then there's regulation. And a positive externality based on regulation could be requiring students an inoculation or restaurant workers, for example. They have regular, you know, if you want to work in a restaurant here, then you're forced to go to a health clinic and get your TB test and things like that to show that you're not going to go and spread some sort of illness amongst the community by working there. So, there's a way for correcting positive externality, a positive spillover.
Here's another question to put this idea of pollution in perspective, and in a way, we it's not looking at pollution solely as just a negative aspect. So, here's a question: What are the benefits of pollution? Does the existence of pollution have benefits? Well, if you're watching this video, you are taking advantage of the benefits of pollution. You're watching it on a technology device such as a tablet or your phone or your computer. Those are created with some highly toxic chemicals and create very negative pollution activities. So, keeping in mind that pollution abatement, stopping pollution, is very costly, polluting actually allows firms to save the costs of purchasing pollution-reducing equipment. So, the resulting relative lower cost to the firms avoids the passing on of the cost of this equipment to consumers, thereby avoiding higher prices of goods and services. So, do you enjoy paying $1,000 for your fancy phone, or would you rather pay $2,000 for your fancy phone? You probably enjoy the $1,000. And instead of making the firm internalize all the costs that would come with abating or minimizing or eliminating the pollution, you might say, you know what, I'm willing to accept a little bit of pollution into our environment and pay $1,000 instead of $2,000 for my phone.
So, what we're looking at here is the supply and demand graph. Let's focus first on S1 here, the supply curve. And with the demand curve, it's leading us to this equilibrium point of point E, where we have a quantity of 110 and an equilibrium price of 500. So, this is, I guess, based on a steel industry. So, S1 is a situation where a firm is not being forced to internalize the cost of their pollution, pollution-creating activity. However, if the firm was forced to internalize the cost, in other words, they're forced to bear the cost that they're otherwise imposing upon society and getting a free pass, if they're not getting a free pass and they're forced to take account for it, then now we'd be at S2. It would be a left upward shift of the supply curve, a leftward shifted supply curve, a reduction in supply, leading us to a new equilibrium point at E1, reducing quantity and increasing price. Now, that would, that's an example of what happens when polluting firms are forced to quote, internalize the cost, forced to bear the cost to society that they are creating.
So, one of the key points we should be aware of is that negative externalities occur oftentimes due to imperfect property rights. When property rights are imperfect, we tend to overutilize. Here are some examples: harvesting marine life from the intertidal zone, or dumping trash into a neighboring stream. Who owns the tide pools? Who owns the reef outside where we snorkel and fish, or just bathe in the ocean, so to speak? Recently, in local news, there were people who were caught harvesting sea cucumbers from the reef in Waimanalo. And our fish and game wardens, they caught them, or at least I think maybe it might have been private individuals caught them on film and took pictures of their zodiac filled with sea cucumbers. Now, sea cucumbers are really important for the health of our reefs, and the reefs are important for maintaining our shorelines. When the reefs die and wither away and erode away, then the protect, then the protection of our sandy shorelines starts to go away, and then the wave action starts to erode away, taking away our recreation space, starts encroaching upon our private homes, and so forth and so on. And again, the property right is unclear to many people because it's pretty much a public good, and oftentimes marine life is subject to the rule of capture. So, if you can reel it in, short of any rules prohibiting it, whatever you bring in, you can get and keep. Now, because of these imperfect property rights, you got some people going there and abusing it. If one individual, suppose you were the individual who owned the intertidal zone and all the marine life in it, you would certainly have an incentive to protect it and maintain it and keep people from abusing it and taking actions which might unduly destroy it. Also, dumping trash into a neighboring stream. Again, neighboring streams tend to be owned by not private individuals, by the government. It's not maintained well oftentimes, and there's nobody usually keeping an eye on it because they don't own it, and thereby it encourages people to abuse it in that sense. However, when property rights are well-established, owners of property do have an incentive to use that property efficiently and maintain it properly for value.
So, government and the economy. There's some economic functions of government, and this first one is really important. It provides the legal system, and this legal system is for defining and protecting property rights, essentially the rules of economic gain, and it supports it. It allows us to engage in activity fairly and protects us from abuse of others. The economic function of government also goes to promoting competition. There's what we call anti-trust legislation, which is essentially limiting monopolies. Now, what we're going to find out in later chapters is that the essential effect on monopolies on the economy is that they lead to inefficient outcomes, in a sense that lower quantity than supply and demand would dictate and higher prices also than what supply and demand would dictate.
Government also provides public goods, things that a lot of us aren't willing to cough up our own money for. Things like, are you willing to pay $1,000 to put up a traffic light, or to contribute to the freeway? Are you willing to put up your own money to make sure the air is cleaner, clean oceans, parks? Some people would say yes. How much, though? That's a question. Is it, or when push comes to shove, there's a lot of activities out there that could use your money, and so often times people at some point are going to have to decide where they want to devote it. So, government steps in where private individuals will not.
The government also promotes economic stability through their monetary policy and fiscal policy. They try to smooth the fluctuations of the economy where we have expansions and contractions, booms and depressions, and so forth. Also, government controls merit goods, which are socially desirable goods, as well as demerit goods, which are socially undesirable goods, typically things like alcohol, tobacco, and things like that. And then also, the government does engage in income redistribution. They take money from us in terms of taxes and they provide transfer payments, things like Social Security payments, unemployment, welfare, and etcetera.
So, looking at the political functions of government and the government-sponsored goods. Goods deemed socially desirable through the political process. So, for example, museums. If you can imagine trying to acquire the millions and millions of dollars to view maybe just one of the famous, like a Picasso or something from a Rembrandt or something, and it can be very expensive. But the museums, which are subsidized oftentimes through government money, allows us, the general population, to go and get a look at those and experience some of these culturally thick, culturally enhancing things at lower cost. There's also government-inhibited goods, goods deemed socially undesirable. For example, like we mentioned, certain psychoactive drugs, things like alcohol, tobacco, heroin, other types of narcotics, and so forth.
And in terms of a policy example, government sponsorship keeps light rail systems in operation. And here in Hawaii, we are struggling with a rail system, which is hugely burdened by cost overruns and flawed construction, mismanagement of funds, and just some generally poor decision-making from the get-go, from its very start. But looking at the first point here, it says very few light rail systems in the United States could function without substantial government sponsorship. Washington D.C.'s Metro light rail and bus service incurs about $3.1 billion per year in expenses, and it only collects $0.8 billion in passenger fees and station parking fees annually. So, that difference, the remaining expenses are covered by local, state, and federal governments because this is a product that governments oftentimes deem very important for the economic functioning of a society. We need to move our human resources around within our economy to get them to their jobs, to help them make their appointments, whether it be for health purposes, whether it be for child care, and so forth. These are all things that help us to be more productive as a society. So, looking at simply this dollar value in bold here, that doesn't tell the whole story. So, the government says, okay, we'll step up to put together a system that, in terms of profit-making, is generally a losing proposition, and we'll cover the shortfalls just so people can have a relatively reasonably priced transportation system.
Now, the income redistribution situation includes a progressive income tax system and transfers. We're talking about progressive income tax, meaning we're working in a marginal progressive tax system. So, the more you make, the higher percentage the government takes from you in terms of taxes. If you make enough, you'll fall into a higher tax bracket than somebody else and thereby pay a higher percentage. And so, there's two different types of transfers: transfer payments and transfers in kind.
Now, transfer payments are money payments made by the governments to individuals for which no services or goods are rendered in return. So, some examples: Social Security, old age and disability benefits, and unemployment insurance benefits. So, people get these. Some people call them handouts in the most negative sense, but you know, oftentimes as a society, people, different segments fall into hard times, and as a society, we kind of look at it as our responsibility to kind of help other components of the society, this society that helps us flourish and helps us live with our laws and our infrastructure to enjoy things that oftentimes developing or war-torn countries don't get to enjoy. So, you know, some people look at it as a small cost of living in society, helping to provide things like transfer payments.
Next one: transfers in kind. Transfers in kind are payments that are in the form of goods and services. So, examples, for example, food stamps, subsidized public housing, and medical care.
Now, the concept of government outlays. They're essentially all federal, state, and local spending. So, examples of government outlays would be defense spending, income security, and Social Security at the federal level. Other examples: education. So, we have public, a lot of us went to public schools. Highways are publicly funded. Public welfare at the state level also.
And taking a look at here, we have two pie charts. On the left side, we have federal spending or federal outlays. And on the right side, we have state and local outlays or local spending. And so, you can see the breakdown on the left side. On the federal side, one of the largest ones is Social Security. Another large one would be things like national defense, Medicare, and so forth. And on the right side, we have state and local spending. So, here in Hawaii, where the state of Hawaii, but we also have city and county. Not a lot of, not, I'm sorry, not all states are broken down to smaller city and counties in terms of the government and how they act, I think. But anyway, we have education being about 33%, others 39.3%, public welfare 21.7%, and so forth.
So, this publicly subsidized healthcare is one of the government, one of the government products, I guess, or services that we're going to discuss here. Publicly subsidized healthcare. And the first one is Medicare. Medicare began in 1965, and it pays hospital and physician bills for US residents over 65 using public monies. Keeping in mind that private versus public. Private is essentially the households, you and I. And then public, sorry, is going to be the government side. So, that's where sometimes people get mixed up in use of private versus public. They think, oh, aren't we the general public? Yes, but when we talk about public money, public spending, that's government. We are private individuals, therefore, we are the private side, private spending, private money, and so forth. Anyway, it's the second biggest domestic program in existence. And then added to Medicare is the concept of Medicaid, and it subsidizes people with lower incomes. So, Medicare's for the elderly, Medicaid is for the lower income.
So, taking a look at the supply and demand and therefore the economic effects of Medicare subsidies. Understanding that if we were just to let the market system decide, we'd have an equilibrium over there, and the equilibrium price and quantity over here. Now, what's really going on, though, is that government decides that they're going to lower, lower the price of healthcare. And in this case, what that does is that when the price is lower than the quantity demanded will be at that point over there based on the demand curve. Now, what's happening is that the government is going to be subsidizing this vertical distance between this point and this point. So, the providers of healthcare are receiving this price P sub S up there. What's being paid by the consumers of Medicare, of these healthcare, is going to be P sub D. So, this distance here is the subsidy. The overall amount subsidized by government is this distance here. You would take the dollar value between here and the quantity between here. And the actual amount being paid by private individuals is only this area right here. Okay. So, this is the economic effect of Medicare subsidies. You'll see a price lower than equilibrium paid by the consumer, a price higher than equilibrium received by the healthcare provider, and then quantity is going to be far exceeding the equilibrium quantity as well. So, to increase the quantity of medical care, the government pays a subsidy. The price per unit paid to medical service providers increases. The price per unit paid by consumer falls, and overall more medical services are consumed. Health care subsidies do continue to grow. The cost of Medicare is now $550 billion per year, and unfunded guarantees of future spending exceed $25 trillion. In addition, the federal government pays the expenses of Medicaid, a program that provides healthcare for low-income citizens, and the current cost of Medicaid is more than $400 billion per year.
So, we talked about one area where government outlays goes, and that is going to be the healthcare industry. But also this other one that we're going to discuss briefly is public education.
Now, the economic issues of public education. State and local governments provide primary, secondary, and college education. Prices are well below those that would otherwise prevail in the marketplace. If you're attending the University of Hawaii, then you are attending a state-subsidized, so assuming you're an in-state resident paying in-state tuition, you are paying a price much lower than would be if it was in a private college situation where we're all forced to pay the actual price based on supply and demand of this service. Publicly subsidized, so it's similar to government-subsidized healthcare, and therefore education is priced below the marketplace.
Now, there are some incentive problems of public education. Various measures of performance actually show no increase or decline in performance, and some of these problems are explained by the incentive effects. A per-student subsidy might, what it does is the school might take the per-student subsidy and provide services that actually don't go to improving the quality of education. And some of those things might be, for example, after-school student care or some other activities that are similar that that don't go to improving the actual education that one receives. And it's all based on the incentive system and how administrators decide to make a decision because they are not properly, necessarily properly incentivized to do so.
So, going to this concept of collective decision making. It's how voters, politicians, and other interested parties act, and how these actions influence non-market decisions. So, this takes us to the theory of public choice. The theory of public choice is the study of collective decision making, and it assumes that individuals, politicians, and etcetera will act within the political process to maximize their individual, not collective, well-being. As much as you would like your politician to act, so they're maximizing the collective well-being, they're incentivized oftentimes to maximize their individual well-being. And this can bring in the issues of lobbyists, as well as other types of favors that come from taking one action versus another, supporting one group versus another, pushing one rail system versus all their alternative means of public transportation or traffic mitigation, and so forth. People make less than honorable decisions sometimes.
There are similarities in the market and public sector decision making. In both, self-interest incentives exist. In both, opportunity costs are borne by each action, whether or not you're the market or the public sector. And there's also the idea of competition that exists. Now, in the public arena, the public competes for scarce funding. For example, there's scarce pools of government money, the tax money that was taken from you to help operate our government programs such as the FDA, TSA, and other types of federally funded products and projects. And there's competition for those monies. So, that's a similarity in that, in terms of the market and public sector.
Now, the incentive structure. They exist in both the public and private. However, private versus public incentives or punishments are different, thus different results. Private, you could have an incentive of losing profits, going out of business. Public incentives could be losing reelection or other types of disciplinary action, even leading to jail time, and that can also exist in private as well.
Now, there's government or political goods. Goods and services provided by the public sector. Keeping in mind the concept of majority rule, which is a collective decision-making system in which the group decisions are based on more than 50% of the vote. And then there's proportional rule, a collective decision-making system in which actions are based on the proportion of the votes cast and are in proportion to them. So, I put there, if you notice here at the bottom, I put "votes" in quotes because votes, for example, in a private market system is represented by the amount of dollars being voted. So, the more intense the emotion or the feeling or desire in a private market-based system, the more dollars are being devoted to it. However, in a public system, you get one vote. For example, and it doesn't necessarily indicate your intensity. You might be a relatively indifferent voter that voted for one candidate, or you might be an intensely hot, rabid type of voter, but each of your votes only counts as one. The difference between market and collective decision making. Government goods are provided at zero price, not zero cost, but zero price. There's this idea of use of force. Oftentimes in government situations, they can force payment. So, for example, if you don't pay your state property taxes for your home, even if you outright own it, you don't have a mortgage, you paid it off, you outright owned it, you do have to pay annual state taxes. Now, if you fall behind on those taxes, they can force payment. They can insist that you pay, and if you don't, they can take action to foreclose on your property, seizing your assets, and then selling it to force that money to go to your tax payments, back tax payments. Hopefully, you don't find yourself in that situation, but that is a useful situation in the government. And of course, and of course, the idea that I kind of mentioned before, voting versus spending. For voting, it's one person, one vote. When it comes to spending, more dollars equates to more votes. So, dollars can indicate the intensity of want, whereas votes cannot indicate intensity.
Again, looking at differences between market and collective decision making, and the voting versus spending. The political system versus the market system. The political system, to be clear, is run by the majority rule idea, whereas the market system is run by the proportional rule idea. Okay, just to clarify that concept, I guess, if necessary.
And finally, let's just kind of talk about in terms of issues and applications. Services provided by state parks are not public goods. Although state parks are publicly owned land, the services they provide visitors are not public goods. So, here in Hawaii, we have a state-operated, run facility called Hanauma Bay here in Hawaii, near Koko Head Crater, and it's in that nature preserve, and it's run by a group, a state group, and I think the University of Hawaii also has an engagement portion of it as well. And the principle of rival consumption exists in this situation. For example, it's a limited amount of space on the beach, and you know, they can only allow so many people in there. If you go at a certain time, the parking lot is full, they're not letting other people in, or if there's too many people already, they're not going to allow any more people in. And again, the principle of rival consumption exists. So, if one family camps at a campsite, another family cannot camp at that campsite. So, again, services provided by state parks are not public goods. So, just kind of keeping that specific idea in mind to kind of clarify some of these ideas. Anyway, I hope this was okay for everybody. If you have any questions, you can contact us, of course. Otherwise, take care. Aloha, and I hope everyone's doing well.