ECON101: Principles of Microeconomics

According to public interest theory, decision-making is a technical matter. The task of government officials and policymakers is to locate efficient solutions and find ways to move the economy to that point.

For a public good, efficient solutions occur at the point where the demand curve (reflecting social benefits) intersects with the supply curve for producing the good. In other words, the solution at quantity Qe and price P₁ in Panel (a) of the figure below.

Because the marketplace does not reveal the true demand curve for a public good, government officials are tasked with estimating these curves and making sure suppliers produce the optimum quantity. For this purpose, economists employ a cost-benefit analysis, which aims to quantify the costs and benefits of an activity. Public officials use cost-benefit analysis to identify the most efficient solution – the intersection point where the net benefit of the activity is maximized.

Public sector intervention to correct market failure indicates that market prices do not always reflect the true societal benefits and costs of a particular activity. Suppose the prices the market generates are perfectly competitive. In this case, the failure of prices to convey information about costs or benefits suggests a free-rider problem exists on the demand side or an external cost problem on the supply side. In both situations, the government is tasked with estimating all of the costs and benefits that the marketplace may fail to consider.

The public interest perspective suggests an approach where policymakers identify instances of potential market failure and look for ways to correct them. Public choice theory, on the other hand, considers what motivates or incentivizes policymakers when they make policy choices.

The Public Choice Perspective

Public choice theory discards the notion that people in the public sector aim to maximize net benefits to society as a whole. Rather, it assumes that each public sector participant seeks to maximize their own utility or best interest. Let's examine two important arguments of the public choice approach: why many people abstain from voting and why legislative choices usually serve special interests.

Economics and Voting: The Problem of Rational Abstention

Public choice theory argues that individuals exclusively act in their own self-interest when they enter the voting booth – this includes their decision on whether they should go to the polls at all. This assumption of utility maximization by voters explains why many people stay home and fail to vote in most elections.

Suppose your state is conducting a referendum on whether to expand state recreation areas financed by an increase in the state sales tax. You support the program due to your love for hiking and your expectations regarding how the tax will affect you. According to your calculations, the current value of your net benefits from the environmental program is $1,000. Will you vote?

If you are a utility maximizer, you will vote if the marginal benefits of voting exceed the marginal costs. You may decide that a benefit of voting is the possibility that your vote will cause the measure to pass. That would be worth $1,000 to you. But $1,000 is a benefit of voting only if your vote determines the outcome.

The probability that one vote will decide any statewide election is effectively zero. Close state elections are subject to several recounts (which will produce different results). The courts or legislative bodies will ordinarily decide elections that remain so close. Consequently, the $1,000 benefit you expect to receive should not factor into your decision about whether to go to the polls on Tuesday. As a utilitarian, you should consider the other benefits of voting, such as the satisfaction you receive from performing your civic duty in a free, democratic country or the possibility of meeting your neighbors during your visit to the polls. The opportunity cost of voting is the value of the best alternative use of your time, together with possible transportation costs.

Since one vote probably will not determine the election outcome, voting decisions rest on individual satisfaction assessments versus the costs of voting. Since most eligible voters do not vote, most people find the costs too great. Public choice analysis suggests this choice is rational. We call your decision not to go to the polls because the marginal costs outweigh the marginal benefits of rational abstention.

Rational abstention suggests there is a public sector problem of external benefits. Elections assess voter preferences in terms of alternative outcomes. They do a better job reflecting voter preferences when more people vote. However, the benefits of obtaining an outcome that reflects the entire community's preferences do not rest on the shoulders of any one voter. Voters face only some of the benefits of casting a ballot and essentially all of the costs. Consequently, voter turnout is likely to be lower than is efficient economically.

Source: University of Minnesota (adapted by Saylor Academy), https://open.lib.umn.edu/principleseconomics/chapter/15-1-the-role-of-government-in-a-market-economy/#rittenecon-ch15_s02_s01_s04_f01
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