Chapter 05 - Government's Role and Government Failure

Solution Manual for Macroeconomics 21st Edition

McConnell Brue Flynn 1259915670
9781259915673
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Chapter 05 - Government's Role and Government Failure

McConnell Brue Flynn 21e

DISCUSSION QUESTIONS

1. Why might citizens interested in maximizing economic efficiency be happy to invest their
government with the right to coerce them in at least some situations? LO1

Answer: The government’s ability to coerce allows it to correct for market failures and to
enforce laws that reduce risks for those engaging in economics transactions. With respect
to market failures, the government can use its power to tax, to collect the money
necessary to pay for public goods and to subsidize the production of products that offer
positive externalities. With respect to reducing risk, the government can use its power to
coerce, to both threaten and then punish those engaging in fraud, extortion, and other
unethical business practices as well as to enforce environmental, health, and safety
regulations.

2. Jean Baptiste Colbert was the Minister of Finance under King Louis XIV of France. He
famously observed, “The art of taxation consists in so plucking the goose as to obtain the largest
possible amount of feathers with the smallest possible amount of hissing.” How does his
comment relate to special interests and the collective-action problem? LO2

Answer: The logic above applies to special interests and collective action as well. In the
case of special interest and collective action, the large gains to the smaller group

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Chapter 05 - Government's Role and Government Failure

motivates these individuals to be more active politically and financially than the larger
group who faces small losses at the individual level. That is, the smaller group will
extract resources from the larger group until it is no longer politically feasible.

3. What is rent seeking and how does it differ from the kinds of profit maximization and profit
seeking that we discussed in previous chapters? Provide an actual or hypothetical example of rent
seeking by firms in an industry. By a union. By a professional association (for example,
physicians, school teachers, or lawyers). Why do elected officials often accommodate rent-
seeking behavior, particularly by firms, unions, and professional groups located in their home
states? LO2

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Chapter 05 - Government's Role and Government Failure

Answer: Rent-seeking is an appeal to the government for special benefits at taxpayers or

someone else's expense. The term 'rent' refers to any payment is excess of the minimum
amount that is necessary to keep the resource employed in its current use.
Rent-seeking is different from profit maximization because rent-seeking attempts to
influence the political process to gain increased profit or income. Standard profit
maximization and profit seeking is driven by market forces, such as new products, cost
minimization, etc...
Examples will vary. An industry may try to block imports explicitly or implicitly using
tariffs and/or non-tariff barriers. Canada's beef producers might argue that they are
concerned about mad-cow disease to block imports of U.S. beef. A union may restrict
access to employment or negotiate as a block to keep wages higher than the market wage.
Professional associations may require certification and testing to actively participate in
the market.
These groups tend to be politically more active and willing to spend resources supporting
individuals who support their respective objectives. Thus, a politician is likely to support
their activities.

4. How does the problem of limited and bundled choice in the public sector relate to economic
efficiency? Why are public bureaucracies possibly less efficient than firms? LO2

Answer: Limited and bundled choice in the political process tends to reduce economic
efficiency because blocks of public goods and social programs are provided. That is,
instead of evaluating each public good and social program on its respective costs and
benefits the politician chooses all programs together. Some of these goods and programs
may benefit society (positive net benefits), but others may hurt society (negative net
benefits).
The private market is driven by profit. If a company continues to lose money or produces
a good that society does not want it goes out of business. If the public sector, a
bureaucracy, fails to use its resources efficiently then the market is not there to discipline
it. In this case, the bureaucracy continues to operate inefficiently and may actually grow
in size in an attempt to 'fix' the inefficiency. However, we need to look carefully at the
logic underlying this argument. Most bureaucratic operations do not provide private
goods. They provide public goods and social services that correct potential market
failures through regulation and direct provision. Thus, the market analogy may not
apply.

5. Discuss the political incentives that helped motivate federal politicians to approve budget
deficits in all but five years between 1960 and 2015. LO2

Answer: Voters like the benefits of increased government spending, but do not like
having to pay the taxes necessary to fund all the costly government programs that they
like. So, politicians have a political incentive to support high levels of spending by only
moderate levels of taxation. A common result is budget deficits, as those political
tendencies promote situations in which spending exceeds tax revenues. To bridge the
gap, governments borrow money, usually by selling bonds.

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Chapter 05 - Government's Role and Government Failure

6. Explain: “Politicians would make more rational economic decisions if they weren’t running
for reelection every few years.” LO2

Answer: Because political officeholders must seek voter support every few years, they
favor programs with immediate and clear-cut benefits and with vague or deferred
costs. Conversely, politicians will reject programs with immediate and easily identifiable
costs but with long term, less measurable benefits. Such biases can lead politicians to
reject economically justifiable programs and to accept programs that are economically
irrational.
Politicians may make these and other irrational decisions in order to curry favor with the
voters. But what kind of irrational decisions might be made by politicians who did not
have to face the voters again and stand for reelection?

7. Critique: “Thank goodness we have so many government regulatory agencies. They keep Big
Business in check.” LO2

Answer: Government regulatory agencies sometimes fall under the sway of the
industries that they are supposed to be regulating. Those instances of “regulatory
capture” imply that this statement is overly confident in the ability of government
regulatory agencies to keep powerful businesses in check. If regulatory capture occurs,
the captured regulator ceases to be a truly independent watchdog looking out for the
better interests of the public. Instead, it often imposes regulations that reduce
competition and promote high levels of profit in the “regulated” industry.

8. LAST WORD How do the concepts of pork-barrel politics and logrolling relate to the
items listed in the Last Word?

Answer: Both of these political techniques are examples of special interest

effects. “Pork-barrel” politics refers to the practice that congressional
representatives follow when they obtain unneeded benefits for their own districts,
and “logrolling” is a related practice whereby one group of legislators helps
another with the understanding that at some point in the future they, in turn, will
be helped.
The Last Word contains some examples of public spending that undoubtedly
resulted from such practices. These include the purchasing of equipment that is
not asked for by the military and buying equipment from a single firm both to
benefit particular Congressional districts; building projects that are outlandishly
costly; and appropriations bills that are so large, contain so much detail, with
provisions that benefit small groups or individuals.

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Chapter 05 - Government's Role and Government Failure

REVIEW QUESTIONS

1. Select all of the following that are true. To an economist, a coercive government can be useful
in order to: LO1
a. Reallocate resources in order to improve efficiency.
b. Fight negative externalities.
c. Ensure low gasoline prices.
d. Provide a low-risk economic environment for individuals and firms.

Answer: The government's ability to coerce allows it to correct for market failures and to
enforce laws that reduce risks for those engaging in economic transactions.

2. To an economist, any government program is too big if an analysis of that program finds that
MB _______ MC. LO1
a. Is greater than
b. Is less than
c. Is equal to
d. Is less than twice as large as
e. Is more than twice as large as

Answer: a, less than.

As with other resource allocation decisions, government programs should only be
expanded up to the point where MB=MC. They are expanded further so that MB<MC,
then they are too big and should be shrunk.

3. Tammy Hall is the mayor of a large U.S. city. She has just established the Office of Window
Safety. Because windows sometimes break and spray glass shards, every window in the city will
now have to pass an annual safety inspection. Property owners must pay the $5-per-window
cost—and by the way, Tammy has made her nephew the new head of the Office of Window
Safety. This new policy is an example of: LO2
a. political corruption
b. earmarks
c. rent seeking
d. adverse selection

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