You Must Turn in the Exam Questions with Your Answers

Exam #2 EC493/PSC 403k Spring 2008

INSTRUCTIONS a. The following questions can be answered fairly briefly. Put your answers on separate sheets of paper. b. This is an open note and book exam. c. You must turn in the exam questions with your answers.

1. A valuable resource which typically cannot be allocated by the market is a person’s vote. That is, you are not permitted to sell your vote. The implication of this is that the allocation of votes may be inefficient and a Pareto improvement (or a Kaldor-Hicks improvement) could result if we were to allow a legal market for votes. a. [5 points] What would you predict the impact of legalizing formal markets for vote trading would be? Do you think it would have any impact on political outcomes, i.e., election results? Why or why not? b. [5 points] Is it bothersome that there is a wide disparity in income and wealth among participants in this potential market? If so, why is it any more bothersome in this market than any other, for example, the market for gasoline? If not, why not? c. [5 points] Who would benefit from a market for votes and how? Who would be hurt? There are no correct answers to these questions, your answers can only be judged in terms of their reasonableness. Here is my answer: a. Currently, billions of dollars in political contributions are spent by candidates and on behalf of ballot measures to influence voters to vote and how to vote. These funds are spent for advertising, polling, campaign managers, workers, etc., or generally speaking, political “hacks”. The major impact of making votes salable would be to divert some, if not most of these funds from the political hacks to voters who choose to sell their votes. Since voters could choose not to sell their votes and they could choose whom to sell their votes to, it is doubtful that selling votes would have much impact on political outcomes. For example, you might be willing to sell your vote to the candidate you like for less than you would sell it to a candidate you don’t like. Selling your vote to a candidate you like just eliminates the transactions cost of voting. Hence, such a system would economize on transactions costs and redistribute wealth from political hacks, who would oppose it of course, to voters. b. I don’t find it bothersome at all. No one is compelled to sell their vote if they don’t want to and the poor are likely to be the biggest beneficiaries of vote selling. Millionaires like George Soros (who reportedly gave more than $20 million to the Kerry campaign and related groups in the last election) and many others give money to political campaigns that would end up in the pockets of voters of all income levels but would disproportionately benefit the poor. It would also avoid people taking off work to vote which hurts the poor more than the wealthy. c. Politically, the beneficiaries would be the candidates who can raise the most money. But these are the same people who benefit from the current system. Economically, the beneficiaries would be voters who currently don’t vote, don’t care about voting and politics, and the poor. Candidates that cannot raise money would be disadvantaged, but they already are, so it is hard to see what difference it would make.

2. The starting point for most analyses of public economics is that “markets fail”. Markets fail because of things like excessive market power of some buyers and sellers (monopolies, e.g.), non-rivalry and non-excludability in consumption of certain goods, and problems associated with asymmetric information. a. [5 points] Explain how government intervention resolves problems associated with excessive market power and how it fails to resolve problems associated with excessive market power. Government has anti-trust laws and lots of regulations concerning the conduct of virtually every industry. Many of these laws and regulations no doubt benefit the “public interest” – whatever that is. However, at the same time, not only is it difficult to determine what the “public interest” is, these special interests have disproportionate influence in the policy making process. b. [5 points] Explain how government intervention resolves problems associated with non-rivalry and non-excludability in consumption of certain goods and how it fails to resolve problems associated with non-rivalry and non-excludability in consumption of certain goods. The government provides public goods like roads and bridges, education, health services for the poor, etc. It resolves the free rider problem by public financing through general taxation. One could argue that the government fails in many ways but the most obvious is the failure to provide the “right” amount of these services. Many people believe that it provides too much while many believe it provides too little and the “right” amount is objectively indeterminable. c. [5 points] Explain how government intervention resolves problems associated with asymmetric information and how it fails to resolve problems associated with asymmetric information. The problem of asymmetric information largely involves consumer fraud. Government deals with these kinds of problems by enforcing contracts, requiring warranties, “lemon laws” and other mechanisms that protect parties to contracts. The government fails to deal with these problems because of the kinds of issues raised in part a, above. Car dealers, airlines, etc., are all special interests. And, the government itself is subject to problems of asymmetric information: we have “lemon” politicians, etc. 3. The debate over the effects of democracy (simple majority rule) on income redistribution by the government has gone on for at least a couple of centuries and shows no sign of being resolved. a. [5 points] The simple minded argument is that 50% + 1 voters will vote to take the income or wealth of the 50% - 1 voters, but this has never been observed. From the standpoint of maintaining a minimum winning coalition why is this result unlikely? A minimum winning coalition is not stable. A small number of members of the minimum winning coalition can be bribed or persuaded to join the minority. Another limiting factor is that if the majority tries to take the income or wealth of the minority, the minority can simply leave – “vote with their feet” – or not produce anything to take. b. [5 points] In the context of the U.S. political system, what institutional factors (meaning a constitutional federalist system with semi-autonomous states, etc.) make income and wealth redistribution envisioned by the simple minded argument unlikely? The reference to semi-autonomous states was a hint. If one state wants to take more of your wealth than you are willing to give, you “vote with their feet” and leave. Other factors like separate branches of government, bi-cameral legislatures, the rule of law, etc., are other institutional factors that restrict wealth redistribution. c. [5 points] Given that simple confiscation of income and wealth is unlikely, what form of redistribution is more likely? Wealth is most easily redistributed through the provision of public goods like public education, health benefits, economic stabilization policies, farm subsidies, steel tariffs, social security benefits, etc. d. [5 points] In the context of a political system without strong constitutional protections of property and civil liberties (pick one: Russia, Cuba, Indonesia, Saudi Arabia, etc.), is income or wealth redistribution more or less likely than in a political system like the U.S.? Why or why not? Political systems without protections of property and civil liberties are more likely to be societies where wealth is redistributed from the many to the few – unlike the kind of wealth redistribution we see in economically developed representative democracies. In the kind of countries named we tend to see a very small number of extremely wealthy people and a very large number of extremely poor people.