Public Economics

Chapter 5
PUBLIC CHOICE

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CHAPTER 5: PUBLIC CHOICE

5.1. Public resource allocation mechanisms

5.2. Inefficiency of majority rules
5.3. Inefficiency of administrative system
5.4. Rent-seeking
5.5. Interest groups
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5.1. Public resource allocation mechanisms

5.1.1. Differences between private and public

mechanisms in allocation
5.1.2. Difficulties in preference identification
and aggregation
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5.1.1. Differences between private and

public mechanisms in allocation
 Public choice: a scientific discipline that uses economic
methods and tools to study the practice of politics and
government to uncover the causes of inefficiencies,
effectiveness and propose the basis for institutional
adjustment to optimize social welfare.
 Issues related to “public choice”:
 Who choose?
 What to choose?
 How to choose?
 The basics of “public choice”: constitutional and post-
constitutional problems
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5.1.1. Differences between private and

public mechanisms in allocation
Decision making mechanism in the private sector
 Objects of decision-making: decisions about provision of
goods and allocation of resources
 In the private sector: decision-making on private provision
of goods is made through the market and is guided by a
price system.
 The role of prices: transmitting information, regulating the
behavior of producers and consumers; linking production and
consumption.
 Nature of decision making: individuality; voluntary
transactions; satisfying personal preferences, not ignoring
minority interests.
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5.1.1. Differences between private and

public mechanisms in allocation
Decision-making mechanism in the public sector
 Objects of decision-making: provision of public goods
and allocation of corresponding resources; public
policies
 Decisions about resource allocations in the public sector
are made through voting for elected representatives;
these elected representatives, in turn, vote for a public
budget; and the money itself is spent by a variety of
administrative agencies.
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5.1.1. Differences between private and

public mechanisms in allocation
 Direct democracy model: difficult to implement when the
community is large, the costs of negotiation, settlement,
and supervision are high.
 Indirect democracy model:
 Persons directly involved in decision making:
representatives of the people (politicians)
 Decision-making mechanism: collective decisions are made
through voting mechanism or majority voting.
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5.1.2. Difficulties in preference

identification and aggregation
 Aggregate demand for public goods with the majority rule
Single-peaked and multi-peaked preferences

A. Single-peaked preferences B. Multi-peaked preferences

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5.2. Inefficiency of majority rule

5.2.1. Median voter

5.2.2. Voting paradox
5.2.3. Arrow’s impossibility theorem
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5.2.1. Median voter

 The median voter is the voter whose preferences lie in the

middle of all voters’ preferences. Half of the voters want
more than the median voter wants, half want less.
 If the preferences of individuals are single-peaked, the
majority vote will be determined by the preferences of the
median voter.
 If they capture the preferences of the median voter,
politicians easily find the maximum support and are more
likely to win the election.
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5.2.1. Median voter

 Median Voter Theorem: When the alternatives
presented for selection can be arranged in a linear order,
and the preferences of the voters are all single-peaked
preferences, majority voting always yields a stable result.
The alternative selected is the most preferred by the
median voter.
 E.g.: There are (2n + 1) voters, each one has a most
preferred alternative. The alternatives are arranged in a
left-to-right order (alternative m is to the left of alternative
n if m < n). Suppose that voter k’s most preferred
alternative is alternative k.
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5.2.1. Median voter

→ The median voter is the voter n +1.
→ Compared to any other alternative k, alternative (n +1)
is always winning alternative in majority vote.
Reason: (n+1) always get at least (n+1) votes (out of a
total of 2n +1 votes)
 Results:
 There is only 1 winning alternative.
 That alternative is the most preferred by the median voters.
 Alternative (n+1) mostly preferred by the median voter
reflects his or her optimal choice. It allows for the
maximization of his or her net benefit. But that is not
definitely an effective alternative for society.
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5.2.1. Median voter

 Conditions for the median voter theorem to be valid:

 The alternatives are considered on a single characteristic
(one-dimensional space) → can be arranged in an order
from left to right.
 The number of voters is odd and everyone participates in
voting.
 If the number of voters participating in voting is even → the
alternative chosen is indeterminate.
 Voters’ preferences are single-peaked.
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5.2.2. Paradox of voting

3 students who are representatives of a class are

interviewed for the final exam method: A: written exam;
B: essay; C: oral exam. Which method will be chosen
with the majority rule?

Alternative ST 1 ST 2 ST 3
Preference 1 A C B
Preference 2 B B C
Preference 3 C A A
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5.2.2. Paradox of voting

Pairwise voting: vote between 2 alternatives, then the
winning choice votes again with the remaining choice
A vs B: B wins
B vs C: B wins
 B wins
How to choose another pairwise voting
A vs C: C wins
C vs B: B wins
 B wins
Overall conclusion: despite changing the pairwise
voting sequence, the final result is the same
 The phenomenon of “Majority voting equilibrium”
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5.2.2. Paradox of voting

 Suppose that there are 3 people who need to make a

common decision: choosing a place to go on a group tour.
The ranking of each person's preferences is shown in the
table below. In this case: which place will be chosen by
majority voting?

Preference Voter A Voter B Voter C

First Sa Pa Do Son Tam Dao
Second Tam Dao Sa Pa Do Son
Third Do Son Tam Dao Sa Pa
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5.2.2. Paradox of voting

Cử tri A
2
Cử tri B
Cử tri C

1
Sapa Tam Đảo Đồ Sơn
 Preference Voter A 18
Voter B Voter C
First Sa Pa Do Son Tam Dao
Second Tam Dao Sa Pa Do Son
Third Do Son Tam Dao Sa Pa

 Firstof all, comparing TD and DS, we find that TD is

preferred over DS because A and C vote TD as a higher
choice than DS (2/3 votes).
 Compare DS and Sapa, we find that DS is preferred
over Sapa because B and C vote DS as a higher choice
than Sapa (2/3 votes).
 Compare Sapa and TD, we find that Sapa is preferred
over TD because A and B vote Sapa as a higher choice
than TD (2/3 votes).
→ Tam Dao > Do Son > Sapa > Tam Dao
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5.2.2. Paradox of voting

Conclusions:
1. No one single outcome is selected
2. The outcome chosen depends on the voting sequence
3. Dominating the voting sequence can influence the voting
results.
→ Individual choice is consistent, but community choice is
inconsistent. That is voting paradox, or the paradox of
voting.
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5.2.2. Paradox of voting

Related concepts
 Majority voting equilibrium: A situation in which
majority voting finds a final alternative whose voting
results are consistent and independent of the voting
sequence.
 Paradox of voting: A situation that occurs when
selection by simple majority rule does not find a final
winning alternative that is consistent with all voting
sequences.
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 When double-peaked preference exists, paradox of

voting is possible.
 The order of arranging the alternatives from left to right is
Sapa, Tam Dao, Do Son, then voter A, C has a single-
peaked preference, voter B has a double-peaked
preference.
 If B's preference is 1. Do Son; 2.Tam Dao; 3. Sa Pa → B's
preference is single-peaked. Paradox does not happen.

Preference Voter A Voter B Voter C

First Sa Pa Do Son Tam Dao
Second Tam Dao Tam Dao Do Son
Third Do Son Sa Pa Sa Pa
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5.2.2. Paradox of voting

Cử tri A
2
Cử tri B
Cử tri C

1
Sapa Tam Đảo Đồ Sơn
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5.2.3. Arrow’s impossibility theorem

Kenneth Joseph Arrow (1921- 2017)

Institution Stanford University, New
York City, USA
Awards:
 John Bates Clark Medal (1957)
 Nobel Prize in Economics (1972)
 von Neumann Theory Prize (1986)
 National Medal of Science (2004)
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5.2.3. Arrow’s impossibility theorem

‘Impossibility’ theorem
 “If we exclude the possibility of interpersonal
comparisons of utility, then the only methods of
passing from individual tastes to social preferences
which will be satisfactory and which will be defined for
a wide range of sets of individual orderings are either
imposed or dictatorial.”.
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5.2.3. Arrow’s impossibility theorem

An ideal political mechanism should have four
characteristics:
 Transitivity. If the rule shows that A is preferred to B, and
B is preferred to C, then A should be preferred to C.
 Nondictatorial choice. There is a simple way of avoiding
voting cycles: give all decision-making powers to a
dictator.
 Independence of irrelevant alternatives. The outcome
should be independent of irrelevant alternatives;
 Unrestricted domain. The method should yield the same
result whenever applied to a set of preferences.
→ Arrow proves there does not exist a majority voting
mechanism that satisfies all the desired properties.
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Consider the following example, where voters were asked

to rate their preference for candidates A, B, and C:
45 votes A> B> C (45 voters prefer A over B and prefer B
over C)
40 votes B> C> A (40 voters prefer B over C and prefer C
over A)
30 votes C> A> B (30 voters prefer C over A and prefer A
over B)
Candidate A has the most votes, so he or she will be the
winner. However, if there is no B then C will be the winner,
as more people prefer C to A. (A will have 45 votes and C
will have 70 votes).
This result is a demonstration of Arrow's theorem.
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5.2.3. Arrow’s impossibility theorem

 Arrow’s Impossibility Theorem: If there are at least

three alternatives, then no electoral system can satisfy
all of the above principles.
 Implications:
 Rational individuals → consistent decision making
 The state is not an individual. Collective decisions can
be inconsistent.
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5.3. Inefficiency of administrative system

5.3.1. Administration system and budgeting process

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5.3.1. Administration system and

budgeting process
Public decision making chart
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Organizational differences
 Soft budget constraints: government agencies are not
driven by the profit motive, they have little incentive to
maximize productivity (government subsidies, no
bankruptcy)
 Personal restriction: public employees might abuse their
position and power; it is difficult for a government agency
to fire an incompetent worker
 Procurement restrictions: procedures have been
designed to ensure that the government is not taken for a
ride, but their effect is often to raise costs.
 Budgeting restriction: hard to do long-term budgeting
required for large capital investments
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5.3.1. Administration system and

budgeting process

Individual differences
 Absence of incentive pay, difficulty of firing reduces
incentives (removes carrots and sticks)
Bureaucratic procedures and risk aversion
 Principal–agent problems
Pursuit of bureaucratic objectives—maximizing size of
organization
 Excessively high levels of risk aversion—leading to a
focus on following procedures (red tape)
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5.3.1. Administration system and

budgeting process

Alternative organizational forms

 Private firms
 Government corporations
 Performance-based organizations
 Conventional government agencies
 Public-private partnerships
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5.4. Rent-seeking

5.4.1. Identification and conditions of rents

5.4.2. Inefficiency due to rent seeking
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5.4.1. Identification and conditions of

rents

 Rent-seeking is an attempt to obtain rents, i.e. the portion

of income paid for a factor of production in excess of its
present necessity, by changing the social or political
environment in which economic activity occurs, not by
creating new wealth/values. Rent seeking implies
extracting value from others (without compensation,
without making any contribution to productivity).
 Some rent-seekers profit through illegal ways - such as
bribery, corruption, smuggling, and black market trading.
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5.4.1. Inefficiency due to rent seeking

Rent-seeking reduces economic efficiency because of

• Inefficient resource allocation
• Reduce wealth creation
• Loss of government revenue
• Income inequality
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5.5. Interest groups

5.5.1. Interest groups in a democratic society

5.5.2. Interest groups and resource allocation
efficiency
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5.5.1. Interest groups in a democratic

society
 Interest group is a group of people in society with
significantly superior benefits due to the influence of
group factors, formed by one or more common causes
and exist in a certain period.
 Interest groups vs. political parties: The basic difference
between interest groups and political parties is that
interest groups merely seek their own interests in the
political process, whereas, political parties seek to control
the political process.
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5.5.1. Interest groups in a democratic

society

 Interestgroups are found in all countries, however, they

tend to be more limited in non-democratic societies. Non-
democratic systems are generally not subject to
opposition of any kind, and the tasks of groups are likely
to be decided by the government.
 Indemocratic societies, such groups are the primary
mechanism for representing public opinion and/or the
needs of a particular group.
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5.5.1. Interest groups in a democratic

society

Features of interest groups

1. Interest groups are not necessarily organizations that are
structured and operate consciously.
2. Interest groups are identified by the superior benefit of a
group member in comparison with the case the group
factor is not involved.
3. The superior benefit due to the influence of the group
factor must originate from one or more common causes.
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5.5.1. Interest groups in a democratic

society

4. Interest groups are a historical phenomenon, its

formation and dissolution depends on the existence of
group interests.
5. Interest groups can have a positive or negative influence
on socio-economic development.
6. Interest groups are a cause for concern to researchers
and policy makers only when they may lead to social
welfare losses.
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5.5.1. Interest groups in a democratic

society
Classification of interest groups
 Based on characteristics and ability to influence
 Privileged groups
 Disadvantaged groups
 Interest groups are also named according to their main
goals, for example: public interest groups, private interest
groups, ideal groups, etc.
 For analysis purposes: characteristics classified
according to natural conditions, administrative
geographical boundaries, or personal characteristics such
as gender, age, occupation, ethnicity, etc.
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5.5.2. Interest groups and resource

allocation efficiency

Consequences of unequal resource/income

distribution
 Reduce the creativity and enthusiasm of the
disadvantaged groups to contribute, even increase the
risks of conflict, civil war in certain cases.
 Reduce social efficiency.