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Public Policy Midterm II: Flashcards By Vanessa Sochat

Option 1: The Pareto Principle

• The pareto principle
o Make pareto improvements!
o If everyone is at least well off, then
What is the pareto principle? there is no question that social welfare
has improved

Option 2: Voting
• voting to reveal welfare
o individuals judge their own interests
How can voting reveal welfare? o majority may be better off

• voting
• pareto principle
• potential compensation (Kaldor-Hicks)
What are the three ways to represent the
public interest?
• Potential Compensation (Kaldor-Hicks)
o If we could pay the losers from the
What is potential compensation? gains of the winners then the policy is
a kaldor hicks improvement
o Government favors groups that get
them elected!
• Social Benefit Cost Analysis: employs potential
compensation criterion
• Does not address equity questions

Reached agreement today. Talks teetering on brink of collapse

because of disagreement of what should be guaranteed to NK for ending
nuclear program. Was making excessive demands electricity and oil… but
we don’t have option of walking away. Out BATNA is so bad that we MUST
Talk about North Korea talks settle within the ZOPA. They demanded 2 million tons heavy fuel oil. They
have record of starting from unrealistic bargaining position – this is where
history of negotiations comes in. We have history so we know this is
excessive demand that is going to be coming down. This negotiation went
on for 16 hours… NK agreed to shut down facilities for 1 million. They got
half of what they asked for. Deal sends wrong signal around world – if you
hold along long enough in negotiation, you are rewarded. So we damaged
our reputation. The US had to say that we are going to walk away.

1) Look at one issue at a time (marginal analysis)

How do governments make social 2) Place value on outcomes
judgments? 3) Weigh costs vs benefits

What is the basis of cost benefit analysis? Maximizing net benefits

Model the Global Warming Decision

• Analysis: “do nothing or “do this”

• Identify costs and benefits
What are the steps of the decision process? • Value costs and benefits
• Choose option with highest net benefit

What are costs and benefits a measure of?

People’s willingness to pay!

What is the trouble with a fee/tax in Even though a fee does not affect net benefits, it
measuring net benefit? may be higher than the lower end of willingness to pay
and change behavior to change net benefits
Full employment: labor is a COST, could be
working elsewhere – opportunity cost

When is a labor a cost, transfer, or benefit? Unemployment – transfer

Fees from outsiders: benefits

Fees from standing: transfer

How are fees counted to outsiders, and how WTP people with standing: benefits
are WTP of people with standing counted? WTP people w/o standing: not counted

We push our models to edges, change something,

and see if our decision changes

What is sensitivity analysis? To calculate switchpoints, set branches equal to

each other and calculate probability that would
change decision

The future costs less because…

• we want to consume NOW

How are costs in the future compared to • inflation
costs now? • interest is the opportunity cost of money – we
can do things now to make it more money
How do we calculate interest rates? • $Y next year = $X today *(1+i)
• $X today = $Y next year /(1+i)

What is the formula for the discount rate? A[1-(1/1+r)(n+1)]


opportunity cost versus preference for current consumption

think of how society as a whole benefits from consuming today vs
common real discount rates 3-7%
What are issues in choosing a discount rate? RPA tend to think of future and natural resources – may put a higher
premium than other agencies
Issue: is this a question of standing? Type of discount rate can be an
issue of standing
Thinking of future generations- thinking of different individuals in
Net present value is important
For benefit need to place more value on future – will have a lower dr
If costs far into future may use higher dr

• pension reforms: if the dr is increased, future liabilities decrease

and companies can pay less into their pension funds and reduce
the gaps in projected funds
What are the politics of DR choice? • calculating costs of tax cuts depends on dr
• social security- like pensions- how to fund in future tends to turn
on dr need to figure out where it switches
• discount rate chosen by organization doing a cost benefit
• OMB may suggest/recommend rate as a guideline.
How do you calculate present value of A in
year n?

the program only covered basic health for poor people, not her
if it did cover transplants, would become a black hole of funding
What were problems with Diana Brown plus lots of transplants fail, so there is no guarantee
the cost of the procedure is a lot, but clearly less than the value
case? we put on life (in cost benefit analysis)
then why not just fund it?
Money could be used elsewhere – many more units of pre-natal care,
for example
There are inescapable tradeoffs: it isn’t just how much we value
something, but what else we could do with the money
There is a constrained pool of money

A statistical life
the question is NOT what is your life worth to you?
Rather the question IS what is it worth to you to reduce chance of
What is the value of life? What is it worth to society to reduce chance of death?
think of all we could do to save lives (ex: ban cars) but is it worth it?
What is our willingness to pay?

• market value (discounted future earnings)

• revealed preference
wage premiums for risky jobs
What are the techniques for valuing life? price premiums for safer products
• willingness to pay surveys
how much pay to extend life 1 yr?
• ignores self valuation of life (volunteer)
• ignores non market production
• reproduced wage discrimination (women earn
What are problems with discounted future less men)
earnings? • ignores altruistic issues (maybe we value the
welfare of others)

• Wage compensation for riskier jobs

• price premiums for safety devices

What are examples of revealed preference?

o Workers may not be free to choose  wages then

would not reflect the risk
o Workes may be misinformed
o Maybe paying for factors other than mortality
What are problems with revealed  Ex: broken leg – health risks, but not life
o Consumers may be misinformed
preference? o Equity: the poor count less
 Reproduced valuations based on initial
endowments  depends on how much
money you have

o phasing of survey affects the response
o information/knowledge affects response
o strategic misrepresentation
What are problems with measuring WTP o low probabilities are hard for us to think about
(contingent valuation?) o equity: poor count less
o chance of death is 2%- how much are you willing to
pay for a program which will improve neonatal care
and reduce risk of morality by 6%
 never really less than 1 million
discounted future earnings: low estimates depending on age ~ 1
million (in 1990 dollars) for an infant
Revealed preference for consumers (?): approximately 1 million (in
How do we estimate the value of a life? 1990 dollars)
Revealed preference for wages for labor risks: < 1 million to > 3
million (1990 dollars)
Willingness to pay for safety < 1 million to > 15 million (1990 dollars)
Vicusi (1993)  reasonable studies cluster in the 3 million to 7 million
Government agencies use a variety of estimates
o EPA  6.1 million
o DOT (includes FAA)  3 million
FDA  5 million
COPENHAGEN CONSENSUS  ranked world problems in order of
return to investment
Assumption: we have a fixed pie of resources to allocate to world
What are inescapable tradeoffs in valuing Winners: AIDS, vaccinations, malaria, water
Losers: global warming
life? (talk about Copenhagen Consensus0 Very controversial because this affects everyone: AIDS does not
had an operating value of ONE LIFE – not valuing a western life
more than an African life
people got very upset because a lot of problems (many in Africa) got
more attention/would get more money than ones that affect us

o calculated how much it costs to save a life in many

different programs  sometimes it costs less or
o discovered that we are not actually on the efficient
frontier in terms of lives saved nwith the money we
Talk about Harvard Life Saving Study
o if we chose policies on whether the were effective at
saving lives we could be DOUBLE the amount of lives
ex: it costs a lot more to save 1 life by installing seatbelts in the rear
middle seat of all cars than by administering AIDS tests

o Market Value- complication to put a value on a life,

discounted future earnings used
o Revealed preferences
 Wage premiums for risky jobs
What are 3 ways to think about valuing life?  Price premiums for safer products
o willingness to pay surveys
 contingent valuation to get people to put
monetary value on life
• Technique for modeling decisions under
What is decision analysis? • Uncertainty modeled as a probability – out a
figure estimate on what we think an event will

if switchpoint is far from estimated value, decision

is robust. Will have to change probability a lot before
changing decision. Value of 50 million vs 200 million
What is the difference between sensitive would need to be wrong in original assumption to
and robust? have a robust value

if switchpoint is close to estimated value –

decision is sensitive- close to assumption

problem: dependence on imported oil makes the US vulnerable to

question: should the US spend money to maintain a national pet
Talk about national petroleum reserve as a Ultimate ?: in thorough analysis would indicate amount to be stored
Choice node would be reserve vs not reserve
double risk dilemma 2nd cut analysis national petroleum reserve
• issue: all embargos are not alike
• can be partial or total
• partial embargos are much less costly
3rd cut analysis: the national energy plan
what if having a reserve has a deterrent effect- that is having a
reserve makes it less likely that other countries will embargo?

What is compound probability?

* events must be independent!

What is the difference between
independent and conditional probabilities?

Three Choices
Do nothing
Invest in stock market (to try and increase value of
What are our choices and uncertainties with holdings, support ore ppl)
social security? Privatize (no longer government’s responsibility)

Key Uncertainties
o Future stock returns
o Future economic growth

What are the four rules of probability?

What is Bayes Theorum?

the probability of two events occurring together (in
conjunction) will always be lower than the probability of
either one occurring alone (assuming either probability is
What is conjunction fallacy? not zero)
• Other biases
False consensus effect – of course you think like me!
Positive outcome bias – we overestimate the
probability of good outcomes happening to us, optimistic,
dangerous from a policy perspective.
If there is evidence in a story, we tend to think it is
more probable to happen

• Judgmental: Subjectivity estimated for unique

What are the two types of probability? events
• Relative Frequency: Empirically derived for
repeated events

most of time we have complex, non repeated

Probability of troops leaving Iraq in
What is judgmental probability? less than 6 months
Probability of Hillary Clinton getting Democratic
nomination (we can’t attach probabilities because
we’ve never had a woman before)

Cognitive biases
What are problems with soliciting opinions
(judgmentsl, probabilities) from experts?
What is the CME?
The certain monetary value – the money we are
willing to take FOR SURE rather than taking the

What is the difference between risk averse Risk averse means we like to AVOID risk – so our
and risk seeking? CME is lower – you don’t have to pay us as much to
avoid the risk

Risk seeking means we like risk, so you have to pay

us MORE to avoid the risk

CME – certain monetary value

EMV – expected monetary value
Compare CME and EMV
When CME is greater than EMV then we are
risk averse

When CME is less than (to right of) EMV then

we are risk taking

Might be risk seeking if we MUST make certain

threshold money
Richer people might be more risk seeking because
Why might a government official be risk isn’t as big a cost
loving with tax payers dollars? If it isn’t our money, we might take more chances
We might not act in a risk averse way if the
What is the anomaly with low probabilities? probability of winning big is really small. If we pay
MORE than a dollar (for .01 chance winning $100) we
would pay MORE for that chance.
We are willing to take risks when amounts/stakes
are low and probabilities are low, then we become risk

We put less and less value on money the more we

What does it mean in words that the EMV have. So giving tax breaks to rich people – they don’t
line starts to slope downward? value it as much if you gave same amount to poor

We are more risk averse

o The larger the stakes
o The higher the odds of losing
When are we more risk averse, vs more risk We are more risk seeking
seeking? o When we are playing with “house”
money (money that isn’t mine)
o When facing gains rather than when
looking at losses… losses are scary!

• Stakes for each government decision are relatively small for the
• Exception: war, social security
• When should governments accept risk aversion of citizens?
Should governments be risk averse? • When should governments act risk neutral?
• Are governments risk averse?
o Are politicians risk averse, are bureaucrats risk

• Zambia government didn’t want to take genetically modified

grain. If they introduced them into their market, the European
Union (which bans the grain) would say in the future “we don’t
want to trade with you, you are risky to us”
o So EU and US had different attitudes regarding risk…
Europeans are MUCH more risk averse regarding
food. We
o We have people who are dying TODAY but if we
accept food we are in danger of breaking ties with EU
in future
• Stakes are high in most government decision making
• Government is playing with taxpayers money, so should take
that attitude, so we’re risk averse so we should be that way
• We might need to be risk loving in certain situations, for moral
reasons, etc.
• If we are going to die, we might be risk loving. (present is more
important than future)
• GOVERNMENTS are making lots and lots of decisions, so they
are going to win some and lose some. They are more like Bill
Gates… has a lot of money to play with, and do it again and
again, so governments mostly are risk neutral.