Overview: The Government and Economic Efficiency

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Although the development of economic thought has focused on how a market economy functions, economists have always given some attention to the economic consequences of government. The government spends and transfers; it raises funds by taxation, borrowing, or printing money; and it regulates a wide range of activity. Economists have always understood that government activity could have unintended consequences. As the government has grown larger in recent years, the importance of those unintended consequences, and hence economists' interest in them, have also grown.

Economics is the study of choice and though many social choices are made in the market, many others are made through a political process. It is natural to wonder how these systems of public choice work and how their results compare to the results of "dollar voting." In addition, economics is built on the assumption of self-interest, assuming that consumers maximize utility and businesses maximize profits. It is natural to ask if the same motive of self-interest drives legislators and bureaucrats. Can we build a theory of government on an assumption of self-interest? If not, why are those in the government special?

This group of readings begins by looking at problems that a one-person one-vote scheme has. It then asks what assumption of behavior fits those in government, and contrasts a view that has been termed the "public-interest" view of government with the "private-interest" theory of government. Next it examines what the private-interest view of government suggests for taxes and also the economic efficiency effects of one tax--the excise tax. It closes by introducing what may be the logical conclusion of the private-interest view of government--what economists call rent seeking.

After you complete this unit, you should be able to:

  • Explain why dollar voting may not be economically efficient.
  • Explain why a one-person, one-vote rule may not be economically efficient in determining the amount of a public good.
  • Define progressive, regressive, and proportional taxes.
  • Define tax incidence and shifting of taxes.
  • Explain why profit-seeking is usually socially useful, while rent-seeking is not.
  • Show using a graph why an excise tax creates a welfare loss.
Copyright Robert Schenk