Chapter 2 - Goverment Decision Making: Public Choice

Question 1

Incentives

Answer 1

Markets encourage consumers to spend wisely, so that they get the most enjoyment from their incomes.
So if we leave prices free to adjust and leave consumers and producers free to transact, they end up
maximizing the gains to society from production. If a third person were to pay and a fourth to receive
the reward, then the efficiencies of the market would be destroyed. No outside bureaucrat or dictator can
improve on this situation.

Question 2

Milton Freidman - Four Ways to Spend Money

Answer 2

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Question 3

Free Market Prices Function To:

Answer 3

Ration goods to consumers who most want them. You could buy more gasoline by giving up other things. If you valued gasoline more than the other things, you would give up those things and buy more gasoline. For instance, if you got a well-paying job that was further away, you would value gasoline more. If government decreed that gas stations give gasoline away without charging a price, then commuters might not find gas to drive to school or to work, while people who have do not have anything better to do than camp out at gas stations and joyride afterward, would top off their tanks.

• Give incentives to producers to satisfy consumers. If oil prices are high, oil companies will spend more on exploration. If oil prices are low, they will not spend nearly as much. If drug prices are high, pharmaceutical manufacturers will spend more on research.

• Give incentives to conserve scarce resources. Helium is now getting relatively scarce, so the price of helium balloons is rising. This gives consumers and producers incentives to conserve. It also gives producers incentives to find substitutes for helium, and to recycle helium, which further conserves the scarce gas.
• Transmit information throughout the economy

Question 4

“The Calculation Problem”

Answer 4

Calculated moves

Question 5

Spontaneous Order

Answer 5

that people organize themselves and interact efficiently, if given freedom to do so, was, perhaps

Individuals who interact in markets have advantages over state planning:
• Freedom is agreeable to most people.
• Markets utilize the ingenuity of millions of minds.
• There are millions of small market experiments, each with low risk.
• In markets, there is competition to serve others.
• In markets, there are incentives to use resources efficiently.

Question 6

Natural Experiment

Answer 6

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Question 7

Bastiat - Chapter 3: Taxes

Answer 7

Taxes

Question 8

“Public School Choice”

Answer 8

Explores how self-interested government employees make decisions

Question 9

Rational Ignorance

Answer 9

Refusing to expend resources to gather information

that will almost certainly not lead to a change in the quality of life

Question 10

Fallacy of Division

Answer 10

Thinking that what is true for one group must be true for all individuals of the group

Question 11

Free Markets Allow:

Answer 11

individual choice, where individuals decide for themselves

Question 12

Authoritarian Choice

Answer 12

involves a single individual or governing body making decisions for the populace.
The decision maker(s) may be elected or not. If the decision maker is elected, rational ignorance insulates
the decision maker from paying the price of making policy that harms the public

Question 13

Democratic Choice

Answer 13

is an authoritarian choice made by individuals voting on decisions for the entire populace

Question 14

Special Interest Groups

Answer 14

Here are three examples of special interest groups and how much they cost consumers:

• Since there are so few sugar farmers, the $2 billion that consumers pay in higher prices due to
US laws restricting sugar imports and restricting domestic production, only costs each person $2 billion/312 million = $6.41/year. For a family of four, that’s a little over $25/year. That’s not enough for any individual to campaign against.

• Restrictions on ethanol raise the price of corn by 30 percent. One study revealed that ethanol increased food and fuel prices by about $100/household per year.

• The Cheverolet Volt costs taxpayers $80,000 per car—in addition to the purchase price of $40,000
for the purchaser.

Question 15

Cost of Regulations

Answer 15

The costs of regulation can be broken down into these components:

• Direct costs of regulation
• Government administrative costs—sacrificed in order to pay government employees to monitor the regulatory program and enforce the statutes.
• Compliance cost—how much must be sacrificed by the regulated entity to follow the law, which includes reporting costs, planning and administrative costs, and consulting costs.
• Indirect Costs of Regulation—results from changes in behavior of firms and individuals due to the regulation, including:
• value of output that is not produced due to the regulation, and
• wasteful activities that the regulation encourages, such as spending resources to hire lobbyists, to avoid the regulation, or to take advantage of loopholes that are inefficient, except for the regulation—like expensive tax shelters

Question 16

CAFE Standards and Regulations

Answer 16

CAFE standards (Corporate Average Fuel Economy) force auto manufacturers to maintain high average fuel efficiency. Without CAFE standards,some consumers would choose more fuel efficient cars and others would choose cars that had characteristics that were more important to them—cheaper, roomier, safer, more powerful, etc

CAFE regulations distort the market by forcing companies to produce cars they are not efficient at producing—using resources wastefully. CAFE regulations also reduce the supply of large vehicles that consumers would buy if there were a higher supply, which lowers prices.

Question 17

National Defense

Answer 17

Cannot be individually consumed or collectively consumed. It’s either there or not. Government provided.

Question 18

Regulatory Capture

Answer 18

Regulators working for firms rather than people. Done by large firms at the expense of the smaller firms. Can cause instability to the economy

Occurs when regulators find it more advantageous to work to benefit some firms in their industries rather than to perform their oversight duties

When regulatory agencies are captured, it is typically done by large firms resulting in regulations that favor
large firms at the expense of small firms. This diminishes the market’s advantages listed in the above section
on knowledge in society, repeated here:

• Markets utilize the ingenuity of millions of minds.
• There are millions of small market experiments, each with low risk.
• In markets, there is competition to serve others.
• In markets, there are incentives to use resources efficiently

Question 19

Rent Seeking

Answer 19

involves individuals expending resources to prosper, not by creating value, but by using the legal and regulatory systems. For instance, a firm can hire lobbyists to attempt to get the US Justice Department to sue a competitor. Or a firm can pay off legislators in return for tax dollars being spent on them or in return for passing laws restricting competitors’ freedom

Question 20

Bootleggers and Baptists

Answer 20

Benefits one side. Moral high ground on on side while the other side wants cheaper products for financial gain

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Question 21

Status Quo Minus Fallacy

Answer 21

is a particular variant of the status quo fallacy. It proposes that we consider the status quo, eliminate one element of it, and conjecture that this removed element will have only a direct effect which will never be compensated for.

As applied to regulation, those who suffer from the status quo minus fallacy think that if a regulation is
removed that the only effect will be on the previously regulated behavior, so that a bad behavior will flourish
and a good behavior will disappear.

Question 22

Law of Unintended Consequences

Answer 22

is the warning that intervening in a complex system may
create unanticipated and often undesirable outcomes

How people adjust to the rules