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Part 2 – Public Expenditure: Public Goods and Externalities

Chapter 6 – Political Economy

Brief Outline
1. Direct democracy
a. Unanimity Rules
b. Majority Voting Rules
c. Logrolling
d. Arrow’s Impossibility Theorem
2. Representative Democracy
a. Elected Politicians
b. Public Employees
c. Special Interests
d. Other Actors
3. Explaining Government Growth
a. Conclusion

Answers to End-of-Chapter Questions

1.
a. Below, the preferences for each person.

Person 4
1 Person 5 Person 3

2
Person 1

4 Person 2

A B C D

b. C wins in every pair wise vote. Thus, there is a stable majority outcome, despite
the fact that persons 1, 2, and 3 have double-peaked preferences. This
demonstrates that although multi-peaked preferences may lead to voting
inconsistencies, this is not necessarily the case.

2. The passage of the agriculture bill in 2007 is consistent with the logrolling model.
Because the members of rural areas were able to trade votes with those in urban areas

3.
a. Neither issue would pass with majority voting as in both cases, two voters of the
three would vote against the each issue because they receive negative net benefits.

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 Chapter 6 – Political Economy

This is not efficient because issue X has a positive total net benefit and should be
funded.

b. With logrolling, voters A and B can trade votes. A will vote for issue Y if B votes
for issue X, but C will not vote for either project. Both issues will pass with two
votes for and one against. This is not efficient because issue Y has a negative
total net benefit.

c. If side payments were allowed A could pay B to vote for issue X (A would not
pay C because C would require a higher payment than B), and B could pay A or C
to vote for issue Y. This would result in the same inefficient outcome as in b.

d. If side payments were allowed A would have to pay B at least 1 to vote for issue
X. A would only be willing to pay less than 6. B would have to pay A or C at
least 3, but no more than 4 to entice him to vote for issue Y.

4. Yes, it is consistent, because the theory says that when unanimity is required, no
decisions are likely to be made. A majority system might be more suitable, although it is
subject to cycling and other problems.

5. When the policy changed to allow and encourage female voting, female voters became
the majority, so it is sensible that the median voter is now a woman. Given this, the
median voter theorem suggests that politicians should shift their positions to more closely
align with the views of women.

6. When there is a vote over five options, there is the chance that a potential majority vote is
split between four relatively preferred options, and the fifth option wins. The winning
option may have been voted down if it had been a two-way vote with any of the other
options. Further, if preferences are not single-peaked, cycling and inconsistent public
decisions may emerge.

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Part 2 – Public Expenditure: Public Goods and Externalities

7. On the graph below, the price of taxi rides would increase from PC to PMed and the
number of taxi rides would decline from QC to QMed. This would result in a deadweight
loss to society of triangle dce.

$
f

b c
PMed

a d e
PC S=MC

Qmed QC
Number of taxi rides
8. MR
a. With the demand curve of Q=100-10P and a perfectly elastic supply curve at P=2,
the milk is sold at a price of $2, and a quantity of 80 units is sold.

b. The marginal revenue curve associated with the inverse demand curve P=10-
(1/10)Q is MR=10-(1/5)Q, while the marginal cost curve is MC=2. The cartel
would ideally produce a quantity where MR=MC, or 10-(1/5)Q=2, or Q=40. The
price associated with a cartel quantity of 40 units is P=10-(1/10)*40, or P=6.

c. The rent associated with the cartel is the product of the marginal profit per unit
and the number of units produced. The marginal profit per unit of milk is $4 (=$6
price - $2 marginal cost), while 40 units are produced. Thus, the rents equal
$160.

d. The most the cartel would be willing to contribute to politicians is the full
economic rent of $160. The cartel situation, the quantity of milk produced is too
low from society’s point of view. The deadweight loss triangle is computed using
the difference between the cartel output and competitive output as the “base” of
the triangle, and the difference between the cartel price and competitive price as
the “height.” Thus, the triangle is equal to (1/2)*(80-40)*($6-$2)=$40.

e. As Figure 6.5 in the textbook shows, the deadweight loss could now go as high as
the sum of the conventional deadweight loss and the rents, or $160 rents + $80
DWL = $240. This is because, as noted in the text, “rent-seeking can use up

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 Chapter 6 – Political Economy

resources – lobbyists spend their time influencing legislators, consultants testify

before regulatory panels, and advertisers conduct public relations campaigns.
Such resources, which could have been used to produce new goods and services,
are instead consumed in a struggle over the distribution of existing goods and
services. Hence, the rents do not represent a mere lump-sum transfer; it is a
measure of real resources used up to maintain a position of market power.”

9. This is an example of possible rent-seeking. If Philip Morris supports limited cigarette

advertising, it is unlikely that there will be new entrants in the cigarette market because
establishing business would be more difficult with reduced advertising. Philip Morris
will maintain or develop market power.

10.
a. The outcome of the first election (M vs. H) is M. The outcome of the second
election (H vs. L) is L. The outcome of the third election (L vs. M) is M.
Majority rule leads to a stable outcome since M defeats both H and L. Giving one
person the ability to set the agenda would not affect the outcome in this case.

b. With the change in Eleanor’s preference ordering, majority rule no longer

generates a stable outcome. In a vote between M and H, the outcome is H. In a
vote between H and L, the outcome is L. In a vote between L and M, the outcome
is M. So, giving one person the ability to set the agenda affects the outcome. For
example, Abigail prefers H, so she might pit L against M first in order to
eliminate L and avoid having L defeat H.

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