The Microeconomics of Public Policy Analysis

785 Pages·2002·8.329 MB·English

by  Lee S. Friedman

T H E M I C R O E C O N O M I C S O F
P U B L I C P O L I C Y A N A L Y S I S

T H E M I C R O E C O N O M I C S O F
P U B L I C P O L I C Y A N A L Y S I S
LEE S. FRIEDMAN
PRINCETON UNIVERSITY PRESS
PRINCETON AND OXFORD
Copyright © 2002 by Princeton University Press
Published by Princeton University Press, 41 William Street, Princeton, New Jersey 08540
In the United Kingdom: Princeton University Press, 3 Market Place, Woodstock,
Oxfordshire OX20 1SY
All Rights Reserved
LIBRARYOFCONGRESSCATALOGING-IN-PUBLICATIONDATA
Friedman, Lee S.
The microeconomics of public policy analysis / Lee S. Friedman
p. cm.
Includes bibliographical references and index.
ISBN 0-691-08934-5
1. Policy sciences. 2. Microeconomics. I. Title
H97 .F75 2002
338.5—dc21 2001051156
British Library Cataloging-in-Publication Data is available
This book has been composed in Adobe Times Roman and Futura
by Princeton Editorial Associates, Inc., Scottsdale, Arizona
Printed on acid-free paper. ∞
www.pup.princeton.edu
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
TO JANET, ALEXANDER, AND JACOB,
WHO BRING JOY TO MY LIFE

CONTENTS
(S= Supplementary Section, O= Optional Section with Calculus)
ALTERNATIVE COURSE DESIGNS xv
PREFACE xvii
ACKNOWLEDGMENTS xix
PART ONE
MICROECONOMIC MODELS FOR
PUBLIC POLICY ANALYSIS
Chapter 1
Introduction to Microeconomic Policy Analysis 3
Policy Analysis and Resource Allocation 3
The Diverse Economic Activities of Governments 6
Policy-Making and the Roles of Microeconomic Policy Analysis 9
Organization of the Book 15
Conclusion 18
Chapter 2
An Introduction to Modeling:
Demand, Supply, and Benefit-Cost Reasoning 19
Modeling: A Basic Tool of Microeconomic Policy Analysis 19
Demand, Supply, and Benefit-Cost Reasoning 25
Monday Morning, 6:45 A.M.
Monday Morning, 9:00 A.M.
Summary 33
Discussion Questions 35
Chapter 3
Utility Maximization, Efficiency, and Equity 36
A Model of Individual Resource Allocation 37
Efficiency 45
The General Concept
Efficiency with an Individualistic Interpretation
Efficiency in a Model of an Exchange Economy
A Geometric Representation of the Model
Relative Efficiency
Equity 58
Equality of Outcome Is One Concept of Equity
Equality of Opportunity Is Another Concept of Equity
Integrating Equity-Efficiency Evaluation in a Social Welfare FunctionS
vii
viii Contents
Summary 66
Exercises 68
Appendix: Calculus Models of Consumer ExchangeO 69
PART TWO
USING MODELS OF INDIVIDUAL CHOICE-MAKING
IN POLICY ANALYSIS
Chapter 4
The Specification of Individual Choice Models
for the Analysis of Welfare Programs 79
Standard Argument: In-Kind Welfare Transfers Are Inefficient 81
Responses to Income and Price Changes 85
Response to Income Changes
Response to Changes in a Good’s Price
Response to Price Changes of Related Goods
Choice Restrictions Imposed by Policy 94
Food Stamp Choice Restriction: The Maximum Allotment
Food Stamp Choice Restriction: The Resale Prohibition
Public Housing Choice RestrictionsS
Income Maintenance and Work Efforts
The Labor-Leisure Choice
Work Disincentives of Current Welfare Programs
The Earned Income Tax Credit (EITC)
Interdependent Preference Arguments: In-Kind Transfers May Be EfficientS 113
Summary 118
Exercises 120
Appendix: The Mathematics of Income and Substitution EffectsO 121
Chapter 5
The Analysis of Equity Standards:
An Intergovernmental Grant Application 124
Equity Objectives 124
Intergovernmental Grants 135
Design Features of a Grant Program 136
Income Effects and Nonmatching Grants
Price Effects and Matching Grants
The Role of Choice Restrictions
Alternative Specifications of Recipient Choice-Making
Equity in School Finance 146
The Equity Defects Identified in Serrano
The Design of Wealth-Neutral Systems
Other Issues of School Finance Equity
Contents ix
Summary 158
Exercises 160
Appendix: An Exercise in the Use of a Social Welfare Function as an Aid in
Evaluating School Finance PoliciesO 162
Chapter 6
The Compensation Principle of Benefit-Cost Reasoning:
Benefit Measures and Market Demands 169
The Compensation Principle of Relative Efficiency 171
The Purpose of a Relative Efficiency Standard
The Hicks-Kaldor Compensation Principle
Controversy over the Use of the Compensation Principle
Measuring Benefits and Costs: Market Statistics and Consumer Surplus 179
An Illustrative Application: Model Specification for Consumer
Protection LegislationS 193
Problems with Measuring Individual BenefitS 197
Three Measures of Individual Welfare Change
Empirical Evidence: Large Differences among the Measures
Summary 208
Exercises 210
Appendix: Duality, the Cobb-Douglas Expenditure Function, and Measures
of Individual WelfareO 212
Chapter 7
Uncertainty and Public Policy 220
Expected Value and Expected Utility 222
Risk Control and Risk-Shifting Mechanisms 235
Risk-Pooling and Risk-Spreading
Policy Aspects of Risk-Shifting and Risk Control
Alternative Models of Individual Behavior under Uncertainty 243
The Slumlord’s Dilemma and Strategic Behavior
Bounded Rationality
Moral Hazard and Medical Care Insurance 254
Information Asymmetry and Hidden Action: The Savings and Loan Crisis
of the 1980s and Involuntary Unemployment 260
Summary 263
Exercises 266
Appendix: Evaluating the Costs of Uncertainty 267
Chapter 8
Allocation over Time and Indexation 278
Intertemporal Allocation and Capital Markets 279
Individual Consumption Choice with Savings Opportunities
Individual Consumption Choice with Borrowing and Savings Opportunities