The Microeconomics of Public Policy Analysis


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(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 Function (S) Summary 66 Exercises 68 Appendix: Calculus Models of Consumer Exchange O 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 Restrictions S 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 Efficient S 113 Summary 118 Exercises 120 Appendix: The Mathematics of Income and Substitution Effects O 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 Summary 158 Exercises 160 Appendix: An Exercise in the Use of a Social Welfare Function as an Aid in Evaluating School Finance Policies O 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 Legislation S 193 Problems with Measuring Individual Benefit S 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 Welfare O 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 Individual Investment and Consumption Choices The Demand and Supply of Resources for Investment Individual Choices in Multiperiod Models Choosing a Discount Rate Uncertain Future Prices and Index Construction 299 Summary 307 Exercises 309 Appendix: Discounting over Continuous Intervals O 310 PART THREE: POLICY ASPECTS OF PRODUCTION AND SUPPLY DECISIONS Chapter 9: The Cost Side of Policy Analysis: Technical Limits, Productive Possibilities, and Cost Concepts 317 Technical Possibilities and the Production Function 320 The Production Function Is a Summary of Technological Possibilities Efficiency, Not Productivity, Is the Objective Characterizing Different Production Functions Costs 335 Social Opportunity Cost and Benefit-Cost Analysis Accounting Cost and Private Opportunity Cost An Application in a Benefit-Cost Analysis Cost-Output Relations Joint Costs and Peak-Load Pricing S Summary 362 Exercises 363 Appendix: Duality-Some Mathematical Relations between Production and Cost Functions O 365 Chapter 10: Private Profit-Making Organizations: Objectives, Capabilities, and Policy Implications 373 The Concept of a Firm 374 The Private Profit-Maximizing Firm 377 Profit Maximization Requires that Marginal Revenue Equal Marginal Cost The Profit-Maximizing Monopolist Types of Monopolistic Price Discrimination Normative Consequences of Price Discrimination The Robinson-Patman Act and the Sherman Antitrust Act Predicting Price Discrimination Alternative Models of Organizational Objectives and Capabilities S 397 Objectives Other than Profit Maximization Limited Maximization Capabilities Summary 411 Exercises 414 Chapter 11: Public and Nonprofit Organizations: Objectives, Capabilities, and Policy Implications 417 Nonprofit Organizations: Models of Hospital Resource Allocation 419 Public Bureaus and Enterprises 429 Empirical Prediction of Public Enterprise Behavior: The Pricing Decisions of BART 432 A Normative Model of Public Enterprise Pricing: The Efficient Fare Structure 440 Summary 449 Exercises 450 Apppendix: The Mathematics of Ramsey Pricing O 452 PART FOUR: COMPETITIVE MARKETS AND PUBLIC POLICY INTERVENTIONS Chapter 12: Efficiency, Distribution, and General Competitive Analysis: Consequences of Taxation 461 Economic Efficiency and General Competitive Equilibrium 462 Efficiency in an Economy with Production Competitive Equilibrium in One Industry The Twin Theorems Relating Competition and Efficiency General Competitive Analysis and Efficiency 481 Partial Equilibrium Analysis: The Excise Tax General Equilibrium Analysis: Perfect Competition and the Excise Tax Lump-Sum Taxes Are Efficient and Most Real Taxes Are Inefficient Summary 499 Exercises 500 Appendix: Derivation of the Competitive General Equilibrium Model 502 Chapter 13: The Control of Prices to Achieve Equity in Specific Markets 507 Price Support for Agriculture 508 Apartment Rent Control 514 Preview: Economic Justice and Economic Rent Dissatisfaction with Market Pricing during Temporary Shortage of a Necessity A Standard Explanation of the Inefficiency of Rent Control Rent Control as the Control of Long-Run Economic Rent The Relation between Rent Control and Capitalized Property Values The Supply Responses to Rent Control The Effects of Rent Control on Apartment Exchange Recent Issues of Rent Control A Windfall Profits Tax as Rent Control 542 Summary 544 Exercises 547 Chapter 14: Distributional Control with Rations and Vouchers 550 Ration Coupons 551 Vouchers and Ration-Vouchers 557 Rationing Military Service 561 The Utility Value of Work Conscription versus the All-Volunteer Military Income Effects of Rationing Methods S Rationing Gasoline during a Shortage 572 Other Rationing Policies 583 Summary 586 Exercises 588 PART FIVE: SOURCES OF MARKET FAILURE AND INSTITUTIONAL CHOICE Chapter 15: Allocative Difficulties in Markets and Governments 593 Market Failures 595 Limited Competition Owing to Scale and Scope Economies over the Relevant Range of Demand Public Goods Externalities Imperfect Information Second-Best Failures Government Failures 606 Direct Democracy Representative Democracy Public Producers Summary 613 Exercises 615 Chapter 16: The Problem of Public Goods 617 The Efficient Level of a Public Good 617 The Problem of Demand Revelation 619 The Housing Survey Example 621 Mechanisms of Demand Revelation 623 The Public Television Example 626 Summary 631 Exercises 633 Chapter 17: Externalities and Policies to Internalize Them 635 A Standard Critique of Air Pollution Control Efforts 637 The Coase Theorem 638 Efficient Organizational Design and the Degree of Centralized Decision-Making 641 Reconsidering Methods for the Control of Air Pollution 647 Summary 657 Exercise 658 Chapter 18: Industry Regulation 660 Oligopoly and Natural Monopoly 661 Rate-of-Return Regulation 671 Franchise Bidding: The Case of Cable Television 677 Incentive Regulation 687 Summary 692 Exercise 695 Chapter 19: Policy Problems of Allocating Resources over Time 696 Perfectly Competitive and Actual Capital Markets 698 The Social Rate of Discount 700 Education as a Capital Investment 702 The Market Failures in Financing Higher Education Investments Income-Contingent Loan Plans for Financing Higher Education The Allocation of Natural Resources 707 Renewable Resources: Tree Models A Note on Investment Time and Interest Rates: Switching and Reswitching The Allocation of Exhaustible Resources Such as Oil Summary 721 Exercises 723 Chapter 20: Imperfect Information and Institutional Choices 724 Asymmetric Information 725 Adverse Selection, Market Signals, and Discrimination in the Labor Market Moral Hazard and Contracting The Nonprofit Supplier as a Response to Moral Hazard Nonprofit Organizations and the Delivery of Day-Care Services 734 The Value of Trust 746 Summary 747 Exercises 751 AUTHOR INDEX 753 SUBJECT INDEX 757

Promotional Information

Teachers and students alike will be thanking Lee Friedman for accomplishing what all too few textbook authors do: breathing the vibrant life of practical examples into the abstract principles of economic analysis. This book links sound economic theory to scores of policy problems, presented in rich institutional detail. It will engage, enlighten, and captivate participants in both public policy and mainline economics courses for years to come. -- Henry J. Aaron, Brookings Institution Getting the economics right is one of the first tasks to getting public policy right. In Lee Friedman's new text, we now have the thorough and thoughtful treatment we need to train the next generation of policymakers and their advisors. Friedman makes sure the student sees the strengths and weaknesses of each tool in the economist's kit. To Harry Truman's chagrin each application and substantive topic gets a balanced 'pro vs. con' presentation. And today's policy analysts, myself included, need this book within easy reach, on the shelf between Varian and Rawls. -- Robert P. Inman, University of Pennsylvania An important book. It should have a major impact in schools of policy, planning, and administration, and even in some economics departments. Friedman does a great job of applying the theory to important real-world problems. -- David Howell, New School University The Microeconomics of Public Policy Analysis will quickly become the most widely used text in graduate schools of public affairs and will be an attractive text for use in advanced undergraduate economics courses. The main argument is that microeconomic theory provides a strong and persuasive foundation for designing policies to achieve efficiency and equity in market and nonmarket settings. This text is significant ... the best to bring together economic rigor and policy applications. -- Samuel L. Myers, Jr., Roy Wilkins Professor of Human Relations and Social Justice, Hubert H. Humphrey Institute of Public Affairs, University of Minnesota Lee Friedman's new text is just what's needed to prepare the next generation of policy analysts for the challenges ahead. It provides a strong foundation for a public-policy course that could serve either as a complement or substitute for a traditional intermediate microeconomics course. Friedman is superb at developing extended real-world examples that provide a grounded sense of both the power and the limitations of economic analysis. -- Philip J. Cook, Duke University

About the Author

Lee S. Friedman is an economist and Professor of Public Policy at the Goldman School of Public Policy, University of California, Berkeley. A recipient of the David N. Kershaw Award for distinguished public policy research, he is the author of Microeconomic Policy Analysis (McGraw-Hill) and numerous articles in scholarly journals. He is the former editor of the Journal of Policy Analysis and Management, the official journal of the Association for Public Policy Analysis and Management, whose presidency he also held.


"An important book. It should have a major impact in schools of policy, planning, and administration, and even in some economics departments. Friedman does a great job of applying the theory to important real-world problems." - David Howell, New School University "The Microeconomics of Public Policy Analysis will quickly become the most widely used text in graduate schools of public affairs and will be an attractive text for use in advanced undergraduate economics courses. This is one of the few books I know of that a noneconomist can skim through and end up with a reasonable understanding of the key economic concepts central to the study of policy analysis." - Samuel L. Myers, Jr., University of Minnesota

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