Overview
This lecture introduces public choice theory, explaining how economic principles apply to government decisions, focusing on incentives, rent seeking, and unintended policy consequences.
Public Choice Theory and Incentives
- Public choice applies economic analysis to government, treating government actors as self-interested individuals.
- Government officials, like anyone else, respond to incentives in their decision-making.
- Policies can be influenced to benefit small groups at the expense of the majority.
Rent Seeking and Special Interests
- Rent seeking is when individuals or firms use government action to gain profits above normal market levels.
- Special interest groups lobby for legislation that benefits them, even if it harms the broader public.
- Lawmakers may support special interest legislation in exchange for campaign contributions or political support.
- Example: Taxi commissions restrict ride-share companies to limit competition and maintain higher profits.
Concentrated Benefits vs. Diffuse Costs
- Policies often have concentrated benefits for a few and diffuse costs spread across many.
- Example: U.S. sugar quotas raise prices slightly for all consumers but greatly benefit a few sugar producers.
- Diffuse costs are small and often go unnoticed, leading to little public opposition.
Rational Ignorance
- Most people remain uninformed about specific policies because the personal cost of becoming informed outweighs the small individual harm.
- Special interests, with much to gain, stay highly informed and active in lobbying.
The Knowledge Problem and Unintended Consequences
- Central planners can't access all needed information due to decentralization ("knowledge problem").
- Hayek argued policymakers overestimate their understanding—the "fatal conceit."
- Example: The British bounty on cobras in India led people to breed cobras, worsening the problem when the program ended.
Weighing Regulation Costs and Benefits
- Regulations come with costs that must be compared to their benefits.
- Even well-intended policies may fail due to misaligned incentives or lack of information.
Key Terms & Definitions
- Public Choice — the application of economic analysis to government decisions.
- Rent Seeking — using government policies to obtain economic gains beyond normal market profits.
- Concentrated Benefits — large gains enjoyed by a small group.
- Diffuse Costs — small losses spread across a large population.
- Rational Ignorance — when people choose not to be informed because the cost of information exceeds the personal benefit.
- Knowledge Problem — difficulty central planners have in accessing all necessary, localized information.
Action Items / Next Steps
- Review notes on public choice theory and its implications for government policy.
- Be prepared to discuss examples of rent seeking and rational ignorance in class.