Political economy Flashcards
We have spent time on 3 aspects for the case of government intervention which are what?
1) to redistribute based on social welfare function
2) If there is a public good and externalities there is a case for government intervention
3) People not good at optimising ( decision vs experience utlitiy) there is a case for government intervention
So far what is the assumption we have made about governments?
There is no government failure, that they were work in public interest.
What are 2 main aspects of Political economy that we will look at?
1) Preference Aggregation
2) Constraining power.
What does Preference aggregation?
It determines how individual views and preferences are taken into account to derive the group choice, which is thereafter reflected in policy. This is because its impossible that the government can create a policy which everyone agrees.
What does Constraining power mean?
What guarantees the government is going to operate in the public interest.
What are the 2 effects of government failure
1) Distrubtional issues
2) Efficiency issues
What does Distrubutional issues mean in terms of government not doing its job properly?
Does the government actions conform to normative criteria such as SWF ( so the government is on the side of the elites and not redistubtuting to the poor
What does Efficiency problems mean in terms of government not doing job properly?
Does government spend tax properly?
Government using taxes in a pareto inefficient way?
What is corruption by government
dishonest or fraudulent conduct by those in power, typically involving bribery
What is the problem of corruption?
1) Leads to arbitrary forms of redistubtion via the state ( towards those with political connections ( bribery)
2) Can increase the costs of delivering public projections ( hence taxes might be higher to support this)
When a country wants to do policy, they have to accept that agreement isn’t possible. So princple role of government is to find a way through disagreement?, who first looked at this and what did he say?
Kenneth Arrow - He pointed out the construction of a social welfare function of peoples preferences is an impossible task. There is no such thing as a perfect voting system ( a way of aggregating peoples preferences to come up with a group preference.
Suppose there are some government policies and suppose that individuals have preferences over the policies, and we want to rank the individuals preferences to get to a social welfare function, then Arrow stated there are 4 conditions for reasonable aggregation of a voting system, which are what?
Unrestricted domain
Non-dictatorship
Pareto princple
Independence of Irrelevant activties.
What does Unrestricted Domain, Pareto principle and non-dictatorship mean?
Unrestricted domain = In the aggregation process, all rational preferences are considered, without restrictions on the domain.
Pareto principle = if everyone prefers one policy to another, then the ranking should prefer that policy to another.
Non-dictatorship = we cannot have a ranking that is simply one persons ranking.
What does Independence of Irrelevant Alternatives mean?
you cannot change the outcome of a vote, by adding or changing an option which was never a contender)
What is a borda count?
Take 5 individuals i ∈ {V1, V2, V3, V4, V5}, who have to rank 5 alternatives, a, b, c, d & e. The score of each alternative is thus added up, with the ‘winner’ being the alternative with the lowest score.
Using the borda count, suppose their are 5 judges ranking candidates what is the order?
C3(12) > C1(13) > C2(14) > C4(17) > C5(19)
Now suppose the judge change their preferences only over the pairs [C2, C4], [C2,C5] AND [C4,C5] what is the ranking now and how is this a violation of IIA?
C2(11) > C3(12) > C1(13) > C5(19) > C4(20).
The judges change their preferences only over the pairs [C2, C4], [C2,
C5] and [C4, C5].
BUT
The choice has changed the ranking of [C2, C1] and [C2, C3].
This violates IIA
C2 now wins instead of C3, even though no voter changed their
preference over [C2, C3]!
Thus to summarise what is arrows impossibility theorem stating , what could be do to potential remedy?
it is impossible to have a social choice function that satisfies unrestricted domain, Pareto efficiency, independence of irrelevant alternatives, and non-dictatorship.
So we face a dilemma
1) Maybe we throw out one of the axioms?
2) People do often use the Borda count which violates IIA ( so instead of using cardinal utility, we use ordinal utility.
What is majority rule?
A decision is made if it gets more than half of the votes.
What is the instability of the majority rule?
there may be a situation whereby even though each individual has rational preferences (that is, preferences that are complete and transitive), this may not hold for group preferences (with more than two alternatives offered). That is, collective preferences may cycle.
Explain why this shows the instability of the majority rule?
In this example 2 people will always pick 1 over 2, 2 people will always pick 2 over 3 and 2 people will always pick 3 over 1. So majority rule doesn’t yield consistent outcomes.
Give an application of the instability of the majority rule and what could of solved the problem?
n example of this is the 2016 Brexit Referendum, which presented British citizens with three key alternatives:
Deal Brexit
No-deal Brexit
Remain
Based on polling data, there was a situation of a condorcet cycle, whereby:
Deal > Remain > No-deal > Deal
In this instance, there lacked a Condorcet winner since group preferences were intransitive: there was no majority for any alternative over any other alternative. As a result, then Prime Minister Theresa May was unable to get a deal through parliament for a significant amount of time, despite controlling the agenda.
Rule out no deal and only have 2 options, deal or remain. Hence the problem with majority rule, is that there can be too many choices.
APPLICATION: PROVISION OF PUBLIC GOOD
Suppose that there are 3 median equal sized groups of individuals ( A B C)? and they all have different valuations of the public good where C values public good the most and A the least. ( disagreements of how much public good should be provided) They are deciding how much of the public good G to have in society. Suppose the public good is funded by taxes and everyone has same income.
1) what is the budget constraint or preference of consumer
2) is taxes paid by everyone and what do we denote to show taxes
So we will see in the next flashcards G^b prevails so its G^b over C
APPLICATION: PROVISION OF PUBLIC GOOD ( Downisan level of public good )
Suppose that there are 3 median equal sized groups of individuals ( A B C)? and they all have different valuations of the public good where C values public good the most and A the least. ( disagreements of how much public good should be provided) They are deciding how much of the public good G to have in society. Suppose the public good is funded by taxes and everyone has same income
Write the utility function and find the optimal amount of public good spending?
1) we assume they all contribute to public good so have to pay tax to fund public good and they get m.
so you the FOC with respect to G
Suppose there are 2 parties competing to win an election, and there are 3 groups of people voting. What level of public good wins?
The optimal strategy is to converge on offering the median voter outcome of the 2 possible level of public good.
G^B, is a condorcet winner ( based on majority rule, so group B preferences prevails.
This is one way to solve arrows impossibility theorem.
Why is G^b the level of public good that wins?
If one party offers G^b (2) if other party offers G^a (1) then group C would rather would rather vote for G^b than a ( as 3 is closer to 2 than 1) so Gb commands 2/3 of voters ( majority rule).
Equally you don’t win the election offering G^c over G^b because only group c prefers G^c, group A vote would G^b.
We are now going to compare political equilibrium with the utilitarian social welfare function and see how the level of public good you get with SWF is different with downisan competition?
1) Suppose that the social welfare function is Utilitarian, find sum of average voter
2) then Give theta bar = the sum of average voter then find ultity function ( average value of public good across population - average per capital tax to fund public good
3) maxmise the function with respect to G to find level of public good spending.
Is the median voter outcome a welfare optimium?
No if we recall the level of public good that maximised the average utlitiy was theta b/ c and b isn’t the average voter. So politics delivers what the median voter wants, not the average ( SWF).
( EXAMPLE OF GOV NOT WORKING IN BEST INTEREST OF SOCIETY) Suppose the government can spend taxes on either B ( transfers to the ruling elite( building palaces) or G public good
What are preferences of citizens, elite ( supposing citizens are identical and value public goods equally and government budget constraint?
What do we assume about the elite
Now we have the preferences of citizens and elite, what is the budget constriant of the ruler/gov, what type of maxmiser are they and find out how much they spend on public good?
What would citizens like?
Ruler is a utility maxmiser. So those in power maxmise utility such that they chose how much to tax revenye is raised that it is spendo n public good and transfers.
Show a diagrammatical representation of this, explain it?
Ruling elite budget constraint is light blue colour. The ruler picks a point that is tangenitical to the budget constraint.
The IC is vertical for citizens, hence higher leave of utility, when G increases ( IC shift out.
Is this Pareto efficient, what about from distributional point of view?
Yes it is because you cannot make both the ruiling elite and citizens better off. From efficiency point it is given tax revenue, BUT IT IS NOT FAIR FROM A DISTRUBTIONAL POINT OF VIEW. THUS GOVERNMENT FAILURE IS BASED ON NOT BINDING TO THE SWF.
To see whether raising taxes leads to a pareto optimal improvement what are we going to do?
1) Write down the optimal amount of spending on public good before constraint and write down the utility function when they spend an additional amount of revenue for public good.
Again assuming, citizens are identical and value public goods equally?
They get G + R in public goods now and pay a bit more tax which reduces their income.
Is V(R) increasing in R AND PARETO IMPROVEMENT? Differentiate the function with respect to R, then substitute G and evaluate at 0. When is V(R) high?
As first derative is positive then the function is increasing in R, hence increasing R at the level Theta / 1 + Theta T a little bit more spending on public good financed by taxation is attractive to citzens
Yes it is a pareto improvement because ruiling elite no worse off and Citizens better off.
When T is low enough ( this means originally a few public goods, hence at the margin utility is higher) and theta is high.
Now we want to show a diagramatical representation of how can increase in additional taxes, generates new levels of public spending and leads to pareto improvement. Show the pareto improvements and shifts on this diagram and explain?
1) Budget constraint shits out for ruiling elite, IC doesn’t change, also IC for citizen shifts out as G increases.
2) The possibility of Pareto improvement is the green line. If you end up in the green section, both citizens and ruiling elite are better off.
What is the best possible outcome for citizens for Given R ( i.e. parliament control make sure this is maximum?
