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Political Science
PSCI 231
Brent Needham

Spring 11 PSCI 231: Government and Business Ingrid Liu and 9 for course readings5 (Page 81-86), 6 (Page 133-138), 12, 15, 16, 10 (Page 231-249), 11, 8 U n i v e r s i t y o f W a t e r l o o CHAPTER 1 OBJECTIVES AND OVERVIEW 1.1 Introduction Government policies directed towards business Important focus of political debate Questions of analysis: 1. What should role of government be? 2. What factors explain actual conduct of government? 1.2 Normative Approach to Policy Analysis Normative analysis starts with assertion that government policy should seek to promote public interest Set of goals of government attention: 1. Economic efficiency 2. Macroeconomic stabilization and growth 3. Fairness (equity) 4. Other social objectives (ex. Promote national unity or national culture) 1.3 Positive Approach to Policy Analysis Focuses on: 1. Objectives 2. Behaviour 3. Interaction Of individuals and groups who influence policy decisions Important influence on policy decisions: voting 1.4 The Major Policy Areas Major policy areas:  International trade policy  Environmental policy  Competition policy  Price and entry regulation  Public enterprise and Crown corporations  Macroeconomics stabilization policy and public debt Some directed towards specific firms and industries Others are framework or background policies 1.5 Air Canada, the Airline Industry, and Public Policy Sept 2004 – Air Canada emerged from bankruptcy to make fresh start as Canada’s major airline  Air Canada created by Government of Canada in 1937 under Trans-Canada Airlines (TCA)  Owned by gov’t – crown corporation or public enterprise  Profits and losses belong to government 1.6 Globalization, Internationalization, and Canada’s Role in the World Economy Emergence of global financial markets has reduced the ability of any one government to control domestic financial events Global Production – production structures in which single final product draws on production activities carried out in a wide variety of countries Ex. Car produced in Canada may have parts from other countries Globalization The increasing significance of global processes and activities Processes and activities that often transcend national boundaries CHAPTER 2 FOUR USEFUL ECONOMIC CONCEPTS 2.1 Introduction Normative and positive analysis of public policy Both depend on 4 concepts:  Opportunity cost  Marginalism  Incentive effects  Economic efficiency 2.2 Opportunity Cost Opportunity Cost Value of best-foregone alternative Project should be carried out only if its value exceeds the value of alternative projects 2.3 Marginalism Paradox of value Price is determined not by total value, but by marginal value Marginal value of water is the value of a little more water – the price that a consumer is willing to pay for a litre of water depends on the marginal value of the next litre Marginalist Principle Any policy or activity should be carried out as long as the marginal benefit exceeds the marginal opportunity cost Optimum = when marginal benefit = marginal cost 2.4 Economic Efficiency Two concepts of efficiency:  Management efficiency (production efficiency): each economic activity is managed so efficiently that cost is minimized for output levels chosen  Pareto efficiency (allocational efficiency): resources are allocated in such a way that it is impossible to make anyone better off without making someone else worse off Management Inefficiency: resources wasted – firm or other organization uses more inputs than necessary Deadweight Loss Net gain or surplus that could be generated, without harming anyone, by moving from inefficient allocation of resources represented by output level Qa, to Pareto efficient allocation, Q*. Potential Pareto Improvement Taken place if gainers have gained enough to be able to fully compensate the losers and still be better off Efficiency is as follows: 1) If situation is efficient, means Pareto efficient 2) If situation is inefficient, means Pareto inefficient 3) If one situation is more efficient than another, or there has been improvement in efficiency, means potential Pareto criterion satisfied 4) If management efficiency discussed, then that term or production efficiency, will be used 5) Both allocational efficiency and economic efficiency are used as synonyms for Pareto efficiency CHAPTER 3 THE NORMATIVE ANALYSIS OF GOVERNMENT 3.1 Introduction Any normative view on government policy must be based on mental philosophy 3.2 Philosophical Foundations of Government Policy toward Business Different sets of values will give rise to different views of legitimate role of policy Consumer Sovereignty Each individual has right to his/her own preferences and tastes, insofar as those tastes do not impinge directly on rights of others Government role: Not to question or change these tastes, but to create environment in which individuals can purse their own objectives as efficiently and effectively as possible 3.3 Private Enterprise and Individual Sovereignty Philosophies based on primacy of individual are popular because associated forms of economic organization have performed well Reason why China has been able to perform well in recent years: - Ability to control its population growth 3.4 Adam Smith and the Competitive Paradigm Smith argued that market transactions, undertaken through motive of self-interest, promote social welfare to greater extent than do rival systems of organizing production, such as command systems Private enterprise can be expected to work out well, but only if markets are reasonably competitive 3.5 The Meaning of Competition Competition  Rivalry among sellers (or buyers) in the market  Conscious striving against other firms for sales, possibly on basis of price, but also on basis of advertising, research and development, product quality, and other business variables Perfect Competition 1) No buyer or seller has control over prices, which therefore are taken as given or exogenous by individual firms 2) There is free entry and exit in long run 3) Buyers and sellers have access to all information relevant to their production and consumption decisions 3.6 Normative Reasons for Government Intervention Concerns about market performance:  Efficiency and Market Failure  Macroeconomic Stabilization  Fairness and Equity  Other 3.7 Efficiency and Market Failure Market Failure Situation in which private markets fail to achieve allocative (or Pareto) efficiency Four major sources of market failure:  Imperfect competition  Public goods  Externalities  Informational problems 3.7.1 Imperfect Competition Perfect competition is efficient Individual firms have considerable control over market price, and there may be barriers to entry 3.7.2 Public Goods Public goods and its characteristics:  Public good is nonrival in consumption: even though one person consumes the good, others may also consume it  Public good is nonexclusive: impossible to exclude anyone from consuming the good 3.7.3 Externalities Externalities are third-party effects Arise when some person or group is affected by economic activity of others, without markets to price the effect 3.7.4 Informational Market Failure Perfectly competitive model of business presumes all parties to transaction have access to relevant information In practice, people are frequently underinformed. Imperfect information causes variety of market failures Main problem: less informed party will not know true marginal benefit to be derived from transaction as clearly as the more informed party 3.8 Macroeconomic Stabilization and Economic Growth Three basic facts about market-based economies: 1. Business activity is cyclical 2. Significant but variable fraction of labour force is always unemployed 3. Price level is usually rising 3.9 Other Rationales for Policy Intervention Normative or public interest objectives that do not fit into standard rationales for policy Sources of policy intervention  Cultural policies  Paternalism 3.10 Cost Benefit Analysis Trying to add up costs of a project, add up to benefits of project -> compare them Can be applied to: Projects Programs Regulations Other government actions CHAPTER 4 FAIRNESS AND PUBLIC POLICY 4.1 Introduction Perceptions of fairness dominate discussion of public policy Objective – establish general principles of fairness 4.2 What Is Fairness? Three central principles that underly the debate: 1. Benefits Principle 2. Sanctity of Life Principle 3. Freedom from Discrimination Principle 4.2.1 Benefits Principle Ultimate test of fairness of policy depends on distribution of net benefits to affected parties 4.2.2 Sanctity of Life Principle All human life is precious Every individual is entitled to receive whatever treatment is necessary to preserve and extend that person’s life 4.2.3 Nondiscrimination Principle Discrimination itself is not a bad thing 4.3 Moral Relativism and Conflicting Values Prevent us from criticizing what appear to be obviously unacceptable practices Eliminates concept of moral progress 4.4 Major Philosophical Approaches to Fairness Major systematic approaches to fairness:  Utilitarian approach  Social contract approach  Procedural fairness (rights approach) Each of these implies rejection of cultural relativism Each suggests a set of absolute standards or criteria by which we may judge fairness 4.4.1 Utilitarianism Utilitarianism Refinement of the benefits principle Flaws:  Assumes that utility or happiness is comparable across individuals  Unfairly favour people who have greater capacity for happiness  Offer weak protection for individual rights 4.4.2 Social Covenants and Contracts Fair system is one we would all voluntarily agree to join Thus, system is viewed as social contract we have all agreed to accept In original position, people are behind a veil of ignorance Maxi-Min principle: society should be ordered so as to maximize the well-being of the worst-off person 4.4.3 Procedural Fairness or Rights? Appeal of social contract approach not based on an evaluation of benefits, but on idea that fairness is whatever derives from fair procedures *** Not the same as distributive fairness, which focuses on ends or results of some process 4.5 Individual and Group-Based Fairness Human beings seem to have natural tendency to identify strongly with group membership, and to define themselves in part by group identify Ex. Members of one sex Particular racial or ethnic group Religious group Social class Union or management Basis of physical disabilities And etc. Problem: group fairness can readily conflict with individual equality of opportunity CHAPTER 5 THE POSITIVE THEORY OF GOVERNMENT 5.1 Introduction Normative analysis of government concerned with what governments should do Positive analysis of government tries to explain why governments choose the policies they do Positive theory sometimes referred to as public choice theory 5.2 Voting Two approaches to how voting can be translated into policy: 1. Direct democracy 2. Representative democracy 5.2.1 Representative Voting Three reasons why it differs from direct democracy:  Expert judgement – representative governments have capacity to obtain expert judgements and may therefore be in position to make more informed judgements about some policy matters  More subject to interest-group lobbying than private individuals  Representatives different from population at large – higher incomes, better educated, come from more advantaged backgrounds than average citizen 5.2.2. Hotelling’s Theory of Political Parties Assumptions of theory: 1. There are two parties 2. Each party wishes to maximize no. of votes it receives 3. Votes are uniformly distributed over single left-right dimension CHAPTER 6 FIRMS AND MARKETES 6.6 The Legal Environment 6.6.1 The Rule of Law Legal environment crucially important for efficient operation of market economies Implications of the rule of law:  There must be a legal system in place to govern economic, political, and social actions  Civilization is the “rule of law, not of men” – laws should be clear, well-understood, and applicable to everyone  Even government is subject to law Two features fundamental to rule of law  Protection of private property through property rights  Enforcement of contracts Efficiency of competitive markets is based on principle of voluntary exchange 6.6.2 The Corporate Legal Form Modern corporate form of business organizations:  Limited liability  Recognition of corporation as legal entity distinct from owners or senior managers Disadvantages of partnerships:  Unlimited liability (like sole proprietorships)  Possibility firm can be dissolved due to private activities of a single partner 6.6.3 Corporate Governance Relationship between shareholders and senior execs is in the general class of “agency” relationships Think of senior execs as the “agents” of shareholders Board of Directors  Elected by shareholders to monitor decisions of senior management  Various responsibilities to shareholders including duty of care and duty of loyalty CHAPTER 7 THE CANADIAN BUSINESS ENVIRONMENT 7.1 Introduction This chapter introduces to:  Population and demography  Recent macroeconomic trends  Industrial structure  Role of government 7.2 Population and Demography Most of Canada’s population (32M by 2004) is in Ontario and Quebec (38% and 24% respectively) BC 13%, Manitoba and Saskatchewan together 7% Important demographic factor for public policy analysis and strategic planning in business – age structure 7.3 Macroeconomic Trends Environment of business determined largely by macroeconomic conditions (State of business cycle) Macroeconomic environment refers to three variables:  Inflation  Unemployment  Per capital real Gross National Product (GNP) or Gross Domestic Product (GDP) Other variables include: interest rates and exchange rates Objectives of policy:  Keep unemployment rate low  Keep inflation rate low  Promote growth in real incomes GDP total value of goods and services produced in Canada, measured at market prices 7.4 Industrial Structure 7.4.1 Sectoral Shares of Business Activity Three categories of business activity:  Primary sector o Direct use of major physical natural resources o Ex. Fishing, farming, energy, mining, forestry  Secondary sector o Manufacturing and fabrication of physical goods  Tertiary sector o Service sector o Includes finance industry, civil service, personal and business service industries, retail and wholesale sales or trade GDP shares indicate strong shift into services Strong shift away from primary and secondary industries toward employment in tertiary or service parts of the economy 7.4.2 Market Structure Market Structure Degree and type of competitiveness Concentration Ratio: share of industry accounted for by the largest firms in industry 7.5 The Role of Government Emphasizes data describing size of government and evolution of public debt Between mid 1970s and mid 1990s
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