NPTEL-Economics-Public Economics

Module 5 DIFFICULTIES IN PUBLIC GOODS PROVISION Lectures (21- 23) Topics 5.1 Median Voter Theory 5.2 Potential Inefficiency of the Median Voter Outcome 5.3 Inefficiency of the Median Voter Outcome: Intuition 5.4 Representative Democracy: Vote-Maximizing Politicians 5.5 Vote-Maximizing Politicians 5.6 Median Voter Choice: Evidence 5.7 Assumptions of the Median Voter Model 5.8 Complication of Public Provision: Crowd Out 5.9 Optimal Second Best Provision of Public Goods 5.10 The Problem of Crowd-Out 5.11 Bergstrom, Blume, and Varian (1986) Model of CrowdOut 5.12 Private Responses to Public Provision: Partial Crowd-Out 5.13 Public Goods with Endogenous Private Provision 5.14 Empirical Evidence on Crowd-Out 5.15 Kingma 1989 5.16 Kingma 1989(Contd…) 5.17 Hungerman 2005 1 Indian Institute Of Technology, Kanpur

NPTEL-Economics-Public Economics

5.18 Andreoni 1993: An Experimental Test of the CrowdingOut Hypothesis 5.19 Andreoni 1993

2 Indian Institute Of Technology, Kanpur

NPTEL-Economics-Public Economics

Module 5 Lecture 21 Topics 5.1 MEDIAN VOTER THEORY When preferences are single-peaked, then majority voting will deliver a consistent aggregation of preferences of the individual voters. The Median Voter Theorem states that majority voting will yield the outcome preferred by the median voter if preferences are single peaked. – The median voter is the voter whose tastes are in the middle of the set of voters, so an equal number of other voters prefer more and prefer less of the public good. Voting equilibrium is characterized by preferred level of voter whose preferred level of PG spending is at the median of the distribution – Compute preferred spending for each individual, Gh – Majority voting will select median of distribution of Gh

Figure 21.1

3 Indian Institute Of Technology, Kanpur

NPTEL-Economics-Public Economics

5.2 POTENTIAL INEFFICIENCY OF THE MEDIAN VOTER OUTCOME Thus, the voting would suggest that the government only needs to find the preferences of the median voter, and implement that level of public goods. In general, median voter equilibrium is not Pareto efficient: Suppose Voting outcome: Samuelson rule:

[Note that:

]

Difference between median and mean determines degree of inefficiency

5.3 INEFFICIENCY OF THE MEDIAN VOTER OUTCOME: INTUITION It does not account for intensity of preferences. So it does not follow that the social marginal benefits equal the social marginal cost. – For example, if small numbers of individuals derive enormous benefits from the public good, this should be accounted for in the total social marginal benefits. – But in Median voter rule this is not accounted for. For example, imagine that there are 1,001 voters in a town, who are considering building a Road that costs Rs40.040 (Rs40/person). – Assume all 1,001 voters have single-peaked preferences, so the median voter will determine the outcome. If 500 citizens value the Road at Rs100 each, and the other 501 value it at Rs0, then the social marginal benefit is Rs50,000, far greater than the cost. However, the road doesn’t get built.

5.4 REPRESENTATIVE DEMOCRACY: VOTEMAXIMIZING POLITICIANS In practice, citizens do not vote on every bill; elect representatives to do so.

4 Indian Institute Of Technology, Kanpur

NPTEL-Economics-Public Economics

In a standard (Hotelling) model, median voter theorem predicts that candidates will implement median voter's preferences when elected Move toward centre to win election – If politicians care about maximizing the number of votes they get, they choose the outcome preferred by the median voter.

5.5 VOTE-MAXIMIZING POLITICIANS Suppose the public good in question is education; The key question is what fraction of the budget (say, 0% to 50%) should be spent on education? Voters are uniformly distributed on this continuum. Two parties, A and B, are running for office and vying to maximize their votes.

Figure 21.2 A is trying to appeal to those who don’t want much education spending, so he places himself at A1. While B chooses a much higher level of education, B1. In this case, the candidates split the vote equally. But now imagine that A changes his position to A2. By doing so, A now gets a majority of the votes. But now imagine that B changes his position to B2 in response to A2. By doing so, B now gets a majority of the votes. This process will continue until the median voter’s preferences are arrived at. 5 Indian Institute Of Technology, Kanpur

NPTEL-Economics-Public Economics

5.6 MEDIAN VOTER CHOICE: EVIDENCE In a standard (Hotelling) model, median voter theorem predicts that candidates will implement median voter’s preferences when elected Does this happen in practice? Empirical Evidence: – Lee, Moretti, and Butler 2004 : Evidence on Congressional voting sharply contradicts prediction of median voter theory Cannot rely on median voter logic to implement efficient choice even if mean and median are close

5.7 ASSUMPTIONS OF THE MEDIAN VOTER MODEL The median voter model is a powerful tool, but relies on a number of assumptions worth mentioning: – Single-dimensional voting: Voters only care about one issue.(but in practice the median voter in one issue could be different from the median voter in another issue) – Only two candidates: With a 3rd candidate, there is no stable equilibrium. – No ideology or influence: Assumes politicians only care about votes, not ideological positions. – No selective voting: All citizens actually vote. – No money as a tool of influence. – Perfect information along three dimensions: voter knowledge of the issues, politician knowledge of the issues, and politician knowledge of voter preferences.

6 Indian Institute Of Technology, Kanpur

Module 5 DIFFICULTIES IN PUBLIC GOODS PROVISION Lectures (21- 23) Topics 5.1 Median Voter Theory 5.2 Potential Inefficiency of the Median Voter Outcome 5.3 Inefficiency of the Median Voter Outcome: Intuition 5.4 Representative Democracy: Vote-Maximizing Politicians 5.5 Vote-Maximizing Politicians 5.6 Median Voter Choice: Evidence 5.7 Assumptions of the Median Voter Model 5.8 Complication of Public Provision: Crowd Out 5.9 Optimal Second Best Provision of Public Goods 5.10 The Problem of Crowd-Out 5.11 Bergstrom, Blume, and Varian (1986) Model of CrowdOut 5.12 Private Responses to Public Provision: Partial Crowd-Out 5.13 Public Goods with Endogenous Private Provision 5.14 Empirical Evidence on Crowd-Out 5.15 Kingma 1989 5.16 Kingma 1989(Contd…) 5.17 Hungerman 2005 1 Indian Institute Of Technology, Kanpur

NPTEL-Economics-Public Economics

5.18 Andreoni 1993: An Experimental Test of the CrowdingOut Hypothesis 5.19 Andreoni 1993

2 Indian Institute Of Technology, Kanpur

NPTEL-Economics-Public Economics

Module 5 Lecture 21 Topics 5.1 MEDIAN VOTER THEORY When preferences are single-peaked, then majority voting will deliver a consistent aggregation of preferences of the individual voters. The Median Voter Theorem states that majority voting will yield the outcome preferred by the median voter if preferences are single peaked. – The median voter is the voter whose tastes are in the middle of the set of voters, so an equal number of other voters prefer more and prefer less of the public good. Voting equilibrium is characterized by preferred level of voter whose preferred level of PG spending is at the median of the distribution – Compute preferred spending for each individual, Gh – Majority voting will select median of distribution of Gh

Figure 21.1

3 Indian Institute Of Technology, Kanpur

NPTEL-Economics-Public Economics

5.2 POTENTIAL INEFFICIENCY OF THE MEDIAN VOTER OUTCOME Thus, the voting would suggest that the government only needs to find the preferences of the median voter, and implement that level of public goods. In general, median voter equilibrium is not Pareto efficient: Suppose Voting outcome: Samuelson rule:

[Note that:

]

Difference between median and mean determines degree of inefficiency

5.3 INEFFICIENCY OF THE MEDIAN VOTER OUTCOME: INTUITION It does not account for intensity of preferences. So it does not follow that the social marginal benefits equal the social marginal cost. – For example, if small numbers of individuals derive enormous benefits from the public good, this should be accounted for in the total social marginal benefits. – But in Median voter rule this is not accounted for. For example, imagine that there are 1,001 voters in a town, who are considering building a Road that costs Rs40.040 (Rs40/person). – Assume all 1,001 voters have single-peaked preferences, so the median voter will determine the outcome. If 500 citizens value the Road at Rs100 each, and the other 501 value it at Rs0, then the social marginal benefit is Rs50,000, far greater than the cost. However, the road doesn’t get built.

5.4 REPRESENTATIVE DEMOCRACY: VOTEMAXIMIZING POLITICIANS In practice, citizens do not vote on every bill; elect representatives to do so.

4 Indian Institute Of Technology, Kanpur

NPTEL-Economics-Public Economics

In a standard (Hotelling) model, median voter theorem predicts that candidates will implement median voter's preferences when elected Move toward centre to win election – If politicians care about maximizing the number of votes they get, they choose the outcome preferred by the median voter.

5.5 VOTE-MAXIMIZING POLITICIANS Suppose the public good in question is education; The key question is what fraction of the budget (say, 0% to 50%) should be spent on education? Voters are uniformly distributed on this continuum. Two parties, A and B, are running for office and vying to maximize their votes.

Figure 21.2 A is trying to appeal to those who don’t want much education spending, so he places himself at A1. While B chooses a much higher level of education, B1. In this case, the candidates split the vote equally. But now imagine that A changes his position to A2. By doing so, A now gets a majority of the votes. But now imagine that B changes his position to B2 in response to A2. By doing so, B now gets a majority of the votes. This process will continue until the median voter’s preferences are arrived at. 5 Indian Institute Of Technology, Kanpur

NPTEL-Economics-Public Economics

5.6 MEDIAN VOTER CHOICE: EVIDENCE In a standard (Hotelling) model, median voter theorem predicts that candidates will implement median voter’s preferences when elected Does this happen in practice? Empirical Evidence: – Lee, Moretti, and Butler 2004 : Evidence on Congressional voting sharply contradicts prediction of median voter theory Cannot rely on median voter logic to implement efficient choice even if mean and median are close

5.7 ASSUMPTIONS OF THE MEDIAN VOTER MODEL The median voter model is a powerful tool, but relies on a number of assumptions worth mentioning: – Single-dimensional voting: Voters only care about one issue.(but in practice the median voter in one issue could be different from the median voter in another issue) – Only two candidates: With a 3rd candidate, there is no stable equilibrium. – No ideology or influence: Assumes politicians only care about votes, not ideological positions. – No selective voting: All citizens actually vote. – No money as a tool of influence. – Perfect information along three dimensions: voter knowledge of the issues, politician knowledge of the issues, and politician knowledge of voter preferences.

6 Indian Institute Of Technology, Kanpur