Political Science 320 B, Fall 2013
Lecture 4, Policy Analysis I: Market Failure
September 17, 2013 PRELIMINARY
Reminder: how to take notes on lectures
Readings: some technical material. Be able to summarize; and
explain major points if asked.
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Introduction: Economic Analysis of Public Policy
Contrast econ analysis with ideological approaches. Liberal and
conservative ideologies use broad values (e.g. equality versus
liberty), and very general ideas (unregulated markets work well
or work poorly). Economic analysis—much more specific ideas
and criteria: markets work well in some circumstances, not
others (market failure). The circumstances, at a conceptual
level, are precisely defined. Govt may be needed when markets
“fail,” i.e., when missing some of the well-defined conditions for
Liberalism vs conservatism is not irrelevant; but plays a more limited
role. We’ll see.
General characterization: economists have developed a body of
theory that is often used to analyze merits of policy. I.e., judge
which policies are appropriate.
Role in government
These analyses are often influential in government. Not always.
Less so in recent years, because politics is more ideological.
Limitations of economic analysis
limited specificity of its judgments: often the decision about
particular policies is indefinite. Applying the principles may require difficult further judgments—especially about what effects a policy
has (and how significant).
It makes some controversial assumptions, i.e. about basic goals, and
about how people behave. Economists are often criticized for these
Overall (my view): econ analysis of policy is compelling for
many questions. Dubious for some. Inconclusive for many.
Discussion (ask for both):
1. Should government regulate rent in a high rent city like
Vancouver (e.g. prohibit increases greater than 3 percent per
year)? Why, why not?
2. Should the government of Vancouver provide a public TV or
radio network to provide programming on local issues
(information on government, employers, business climate,
recreation, social problems)? Why or why not?
Do you give the same answer? Yes, Yes; No, No.
Does econ theory give same answer???
Ethical assumptions of economic analysis: i.e. basic
goals or standards of judgment. There are various basic ethical theories about what decisions
are good or right. Examples of basic ideas:
People have rights; must be respected.
People should be helped to become fully human.
People should be helped to form real communities, to have deep and
valued relationships with each other.
Utilitarianism: people or governments should pursue “the greatest th
happiness of the greatest number.” (quote: Jeremy Bentham, 19
Century British philosopher).
Econ analysis assumes a version utilitarianism—one with
The principle of utility:
We cannot judge “happiness” of people from outside. Bill smiles more
than Sam. Is he really happier??? Bill says he really really wants a
Mercedes Benz. Would it make him happier than it would make Sam?
We should try to increase satisfaction of people’s desires or wants.
“Policy should maximize utility”—satisfaction of wants.
How to tell what people want—revealed preference:
Can you just ask them? No. They may not be accurate!
See what they actually choose (“revealed preferences”)
Economists can verify that I like a peach three times as much as I like an apple,
if they see me trade three apples for one peach, or pay three times as much for a
peach as for an apple.
Econ analysis as such avoids comparisons between people’s happiness
or utility (“interpersonal comparisons of utility”).
They have no way to judge whether I like a peach more that you like a peach.
What choice could reveal that?! Results: econ theory as such does not make judgments about
desirability or justice of the distribution of income or other goods.
E.g., consider raising taxes on the wealthy to help the poor. Does it increase the
happiness or utility of the poor more than it decreases utility of the rich?
Economists would say that economic analysis cannot determine. (Why: Again-
-you can’t judge differences in utility between different people, or thus gains or
Implication: you have to use some other grounds for this question. E.g., use
your ideological values.
Econ analysis uses the concept of Pareto efficiency (or Pareto
optimality). A policy or set of policies is optimal if and only if it results
in a situation where: no change in the use of any resource would make
some people better off (at least one person) and would not make
someone else (at least one person) worse off. Put differently, policy
changes are improvements if they make anyone better off and no one
worse off. Optimal conditions are those where no possible
What if a change makes ten better off, and one worse off? We can’t tell if that’s
an improvement! The effect on the one could be 20 times greater. No way to
Thus does not deal with equity, equality or fair distribution. Most economists say
these are important, but need to be considered separately, based on political
values or ideology. Economic theory can't help. Liberal and conservative
economists differ on what to do about it.
Everyone is the judge of their own utility (i.e., of what is good for them).
How do we know what is good for people? We observe what they choose
(e.g., how much they will pay for some good), as the only reliable
evidence of what they actually want. No authority is allowed to
pronounce that some of people's wants are invalid or irrelevant.
For example, consider the issue of using taxes to discourage cigarette smoking.
Advocates of such a tax say that smoking is harmful to people, even if they
choose to do it. Economic theory would say we have no way to demonstrate that
people are better off not smoking. We can only assume that they like smoking
enough to make the risks acceptable to them. So imposing the tax just makes
them worse off, because poorer. (A lot of individual economists might bail out here, and endorsed the tax--saying
that some people are irrational in this particular matter.)
Public broadcasting—using public funds to put on highbrow shows. Again:
There’s no way to say people benefit more from a subsidized cultural program
(e.g. a play) than from “So you think you can Dance, Canada,” if people prefer
to watch. (Below: economics will use people’s choices to estimate benefits of a
policy. Criticisms and alternatives (some due to different moral
theories). Different critics argue:
individual rights, prohibit nearly all govt intervention (especially
certain other values (for example community) -- should we promote
community (cooperation, feelings of affiliation) even when people
may not want it.
Environmentalism: value of nature for own sake?
BUT: Note the prevalence of utilitarian thinking in many contexts.
Look at typical policy debates: do more for global warming?
Stimulate the economy? Build a