Public choice and welfare
Week 1
• Welfare: traditional economic view of a government that aims to increase welfare by
correcting market failures and income distribution
– Focus on Market Failures
• Public Choice: Government is not a benevolent social planner in practice, and can therefore
also fail
– Focus on Government Failure
Public choice
• 1986 Nobel prize for James Buchanan, largely for his contributions to the field of public
choice.
• ‘’Public choice is best defined as the application of the rational choice model to non-market
decision making. In a more general sense, it has meant the application of economics to
political science.’’ (Hill, 1999, p1)
• Prior to the public choice revolution most analysts tended to think of government as simply a
mechanism that would do good if given enough resources (Hill,1999)
• Social Welfare Function (SWF) theory developed the idea of societal decision making, Public
Choice responded with a methodological individualism in which the unit of the analysis was
always a person, even if the decision-making process involved collective action.
• The two perspectives can give different results on the same topic
• Goal of course is not to determine which perspective is right, rather to realize both are good
tools of analysis with mixed results in terms of whether they are ‘’right’’/ realistic.
Public choice and welfare?
• Example: If there are no problems left in the electricity market, the policy makers can be
fired to increase welfare (=welfare). But when they are the ones to conclude this, would they
really report that to their minister and lose their jobs? (=public choice)
• Example: A minority might get things done against the general interest. Scottish members of
the UK Parliament had their own interest in regulations around Heatrow Airport and
exercised enormous pressure, more than the people they represent might have cared for
Three perspectives
Traditional welfare economics
– Public sector economics
– Public economics
– Public finance
– SWF theory (SWF= Social Welfare Function)
Public choice
Real world perspective
,Pareto efficiency
• How do we value the utilities of all individuals in society and how can we determine what a
‘good’ outcome is?
• Pareto improvement: improving the utility of at least one person, without decreasing the
utility of any other individual
• When pareto improvements are possible, the economy is not (pareto) efficient, i.e. (pareto)
inefficient
• When there are no pareto improvements possible, the economy is (pareto) efficient
Advantage:
– We don’t need to compare welfare between persons
– Underpins the idea that people can improve welfare themselves through trading and
stop when they can’t improve anymore (the pareto efficient allocation)
– (interesting side-step: Mueller 2003 shows that this is not the case when stealing is
possible)
Disadvantage:
– This means that Bill Gates getting richer can be efficient
– It says nothing about fairness
First welfare theorem
A market economy with perfect competition leads to a (Pareto-) efficient allocation (under certain
conditions)
• Through the market, scarce resources find the best allocation, because:
– Producers produce the efficient output with minimal costs (to undercut
competitors), using all available production factors
– Consumers only buy what they like, as cheap as possible, given their income
(preferences are revealed through
the price meganism)
– Producers produce what
consumers demand
• Economists take the ‘perfect market’ as
benchmark
, Improving welfare with optimal production Improving welfare through trading
Welfare improvement Second welfare theorem
Formalising equity
Week 1
• Welfare: traditional economic view of a government that aims to increase welfare by
correcting market failures and income distribution
– Focus on Market Failures
• Public Choice: Government is not a benevolent social planner in practice, and can therefore
also fail
– Focus on Government Failure
Public choice
• 1986 Nobel prize for James Buchanan, largely for his contributions to the field of public
choice.
• ‘’Public choice is best defined as the application of the rational choice model to non-market
decision making. In a more general sense, it has meant the application of economics to
political science.’’ (Hill, 1999, p1)
• Prior to the public choice revolution most analysts tended to think of government as simply a
mechanism that would do good if given enough resources (Hill,1999)
• Social Welfare Function (SWF) theory developed the idea of societal decision making, Public
Choice responded with a methodological individualism in which the unit of the analysis was
always a person, even if the decision-making process involved collective action.
• The two perspectives can give different results on the same topic
• Goal of course is not to determine which perspective is right, rather to realize both are good
tools of analysis with mixed results in terms of whether they are ‘’right’’/ realistic.
Public choice and welfare?
• Example: If there are no problems left in the electricity market, the policy makers can be
fired to increase welfare (=welfare). But when they are the ones to conclude this, would they
really report that to their minister and lose their jobs? (=public choice)
• Example: A minority might get things done against the general interest. Scottish members of
the UK Parliament had their own interest in regulations around Heatrow Airport and
exercised enormous pressure, more than the people they represent might have cared for
Three perspectives
Traditional welfare economics
– Public sector economics
– Public economics
– Public finance
– SWF theory (SWF= Social Welfare Function)
Public choice
Real world perspective
,Pareto efficiency
• How do we value the utilities of all individuals in society and how can we determine what a
‘good’ outcome is?
• Pareto improvement: improving the utility of at least one person, without decreasing the
utility of any other individual
• When pareto improvements are possible, the economy is not (pareto) efficient, i.e. (pareto)
inefficient
• When there are no pareto improvements possible, the economy is (pareto) efficient
Advantage:
– We don’t need to compare welfare between persons
– Underpins the idea that people can improve welfare themselves through trading and
stop when they can’t improve anymore (the pareto efficient allocation)
– (interesting side-step: Mueller 2003 shows that this is not the case when stealing is
possible)
Disadvantage:
– This means that Bill Gates getting richer can be efficient
– It says nothing about fairness
First welfare theorem
A market economy with perfect competition leads to a (Pareto-) efficient allocation (under certain
conditions)
• Through the market, scarce resources find the best allocation, because:
– Producers produce the efficient output with minimal costs (to undercut
competitors), using all available production factors
– Consumers only buy what they like, as cheap as possible, given their income
(preferences are revealed through
the price meganism)
– Producers produce what
consumers demand
• Economists take the ‘perfect market’ as
benchmark
, Improving welfare with optimal production Improving welfare through trading
Welfare improvement Second welfare theorem
Formalising equity
