Economics for Leaders
Lesson 8: Costs & Benefits
Of Government Action
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Institutions Shape
Incentives
Having the RIGHT INSTITUTIONS in place.
Rule of Law
Private Property Rights
Open, Competitive Markets
Interaction & Exchange (information & competition)
Entrepreneurship and Innovation
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Institutions Shape
Incentives
Institutions are the formal and informal rules
of the game that shape incentives and outline
expected and acceptable forms of behavior in
social interaction.
Incentives are the rewards and penalties that
influence people’s choices and behavior.
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Institutions Shape
Incentives
The rules of the game shape decisions.
Decisions result in outcomes.
People respond to incentives in predictable
ways.
INSTITUTIONS MATTER!
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How do we evaluate government’s
role in the economy?
Use economic reasoning to…
INVESTIGATE!
Data
Knowledge
Evidence
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The Role of Government
(Founding Fathers)
limit power of central government
life, liberty, pursuit of happiness (self interest,
profit, well-being – not selfish)
establish and enforce the protection of private
property rights
government should do what citizens cannot do!
The Role of Government
Layered Opportunity Cost
of Government Spending?
The opportunity cost of government spending
is private spending.
The opportunity cost of government spending
on a particular program is the foregone
benefit of the other program where the
money could have been spent.
What else could we do?
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Government should act when:
MB ≥ MC
When is this most likely to be the case?
public goods
externalities
monopolies
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Public Goods
Non-rivalrous in consumption
Non-exclusive in consumption
Guns or Butter
Negative Externalities
Positive Externalities
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Price
Discrimination
???
Health &
Medicare
Inc. & Soc.
Security
Net
Interest
on Debt
Year
Defense
1940
16%
15%
11%
1950
31%
11%
13%
1960
50%
2%
20%
9%
1970
41%
7%
22%
9%
1980
23%
9%
35%
9%
1990
24%
12%
32%
15%
2000
16%
20%
37%
15%
2008*
23%
25%
37%
10%
Source: Economic Indicators, Council of Economic Advisors
Source: US Office of Management & Budget
The Mix of Government Expenditure
budget deficit: gov’t spending > tax revenue
Source: http://www.whitehouse.gov
(millions of dollars)
budget deficit: gov’t spending > tax revenue
Source: http://www.whitehouse.gov
(millions of dollars)
budget deficit: gov’t spending > tax revenue
Source: http://www.whitehouse.gov
National Debt =
 deficits
Debt Clock: http://www.brillig.com/debt_clock/
MB vs. MC?
What else could we do?
Investment or Consumption Party?
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Public Choice Theory:
The power of Special Interest Groups derives
from the distribution of benefits and costs
Like private individuals, elected officials act in
their best interests.
Elected officials’ abilities to accomplish their
goals depend on being elected (and re-elected).
Elected officials have an incentive to pay more
attention to those constituents who are able and
likely to influence the election.
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Concentrated Benefits and
Diffuse Costs?
Big benefit to a small but
organized group of
voters
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Small cost to a large
number of unorganized,
sometime voters
Rational Ignorance
Do you know your US Senators?
Do you know your US Congressional
representative?
What did they do today?
What will they do tomorrow?
They spend your (our) money!
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Big Ideas
Government facilitates wealth-producing
voluntary exchange by establishing and
enforcing the rules of the game that secure
property rights and provide incentives.
The opportunity cost of government
spending is private spending/what else
could have been done.
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Big Ideas
The marginal benefit of government
involvement in the economy may outweigh
the marginal costs when significant
externalities exist or in the case of public
goods and monopolies.
The incentive to expand government
activities beyond the point where MB = MC
is explained by public choice theory and
rational ignorance.
Economics for Leaders
U.S. Injects $30 Billion & Will Own
60% of GM
“The sale likely will save more than 3,000 U.S.
jobs in manufacturing and engineering, and at
various Hummer dealerships.”
“This is a great opportunity for US agriculture
and would also mean more food for the Cuban
people.”
Not to mention the cigars!
I can’t believe I have to breathe their smoke.
There should be a law!
A law banning smoking will hurt my business!
ERP-5: Understanding based on knowledge
and evidence imparts value to opinions.
Opinions matter and are of equal value at the
ballot box. But on matters of rational deliberation
the value of an opinion is determined by the
knowledge and evidence on which it is based.
Statements of opinion should initiate the quest for
economic understanding, not end it.
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