Nova workboard

a blog from young economists at Nova SBE


Democratic Game

Revealed Preferences & Distortions on Public Choice

Voting is the most sensible expression of social will. It enables people to decide and reveal preferences about politicians’ acts, policies’ effects and different levels of public intervention. This post pretends to link some crucial concepts that we study in Microeconomics course, explain why sometimes democracy gives unexpected results and how important are the assumptions of revealed and well-behaved preferences.

Combining equity problems, behavioural distortions and market failures, the Public Choice analysis is one of the most challenging economic exercises which considers an interaction of three different levels:

  • Individuals who have preferences and want to maximize their welfare through public and private consumption (considering a budget constraint in which taxes are included as the indirect counterpart from public provision).
  • The Social Institutions that want to maximize Social Welfare and find an equilibrium, which can be different from the individual optimal solution.
  • Politicians, more benevolent or more selfish, who want to be infinitely re-elected by pleasing their voters (who can punish politicians if they deviate).

Although each politician has its own ideology and ethical belief, economists have tried to find a way to explain people’s desires and performances in the electoral game The rules are simple: citizens have different needs and they are willing to pay for welfare. However, payers and beneficiaries are seldom the same, moreover, free riders and externalities insist on stiffening our problem, which may lead to under-provision.

The most difficult analysis is to reveal preferences and to aggregate them in order to define the most important function, which tells us what people need and how they value it. In the real world, it is completely impossible to design a beautiful utility function or continuous indifference curves, linking bundles with the same value for citizens. Therefore, governments may ask voters to define their preferences (and the easiest way to do so is) by ranking bundles or options with the help of public surveys or referendums. Actually, politicians have the incentive to reveal citizen’s preferences in order to prepare persuasive speeches and move themselves to a good place in the Downs Avenue.

Nevertheless, even if we could solve all these problems and know exactly the marginal value of public provision for all individuals, democracy would still have distortions sorting out electoral choices and ‘right choices’. Therefore, it is relevant to present the most famous Electoral Paradoxes and their contradictory results:

Condorcet’s Paradox, the most popular of all, presents a situation in which a majority election over pairs of alternatives may have no clear winner. Suppose that A, B and C are possible choices and each voter orders his preferences as the following:

Captura de ecrã 2013-10-19, às 06.23.58

After beating the first winner (A), C becomes the final winner. However, would this result be the same if the fist election opposed A and C? No, because C would be the first winner and would lose against B (1+2 vs 3). In the Condorcet’s Election, the Voting Agenda determines the result (the winner is always the last voted choice).

Ostragorki’s Paradox involves the role of political parties as mediators of Public Choice. Supposing two parties (X and Y) and each individual voting for the party whose position is closest to his own:

Captura de ecrã 2013-10-19, às 06.24.06

Issue-by-issue, party X would win on every subject. However, if people choose parties to represent them, a majority of voters will elect party Y. This paradox presents one of the failures of the representativeness of parties.

The Additional Support Paradox considers strategic voting (of 21 voters) in a majority runoff election (the winner must have 11 votes, otherwise there is a second round between the two most voted).

Captura de ecrã 2013-10-19, às 06.24.14

In the first election, there is no absolute majority. Then, a runoff is held between choices B and C. It is easy to conclude that the winner is B (13 – 8).

Now, imagine that B receives the additional support from three ‘C-voters’. Still, we have no majority and the runoff will oppose choices A and B. Now, the final winner is A (11 – 10), despite of the additional support B has received.

When we think about Democracy, we will find many imperfections such as preference revelation problems, free-riding effects, electoral paradoxes, imperfect information problems, crowd psychological effects and general lack of trust on politicians. However, more than failures, these are challenges to solve with perseverance and always keeping in mind Winston Churchill’s words:

“Democracy is the worst form of government, except for all those other forms that have been tried from time to time.”

Dino Alves  # 607

Advertisements


Challenging the Rationality of Economic Agents

Many Macroeconomists defend the idea that micro-founded models, which rely on optimization problems for both households and firms, can be determinant tools for deriving the relationships between macroeconomic variables. However, these models generally have as a starting point some assumptions that are often questioned and sometimes even revised.

In this context, the hypothesis of rational behaviour of the agents has been a topic of disagreement between economists. For instance, Paul Krugman is very reluctant to believe in Milton Friedman`s homo economicus who is able to represent his preferences in terms of a mathematic expression –utility function-, and that his decisions are simply commanded by rational calculations for maximizing utility. Additionally, he argues that choices between any two goods reflect considerations about the marginal utility, that is, the extra benefit that a consumer receives from getting a small amount of his alternatives. Hence Krugman firmly believes that central to economic analysis is to recognize that rationality is merely a strategy to order and simplify the real complexity of economic life.

Concerning the veracity of the hypothesis of rational behaviour, there was this article in The EconomistThe Economics of Watching TV: The Irrationality of Couch Potatoes– that called my attention for the creativity of its economic analysis and the interesting results that come from it. The author describes with humour the return home of a normal worker (again, picture him as Friedman`s homo economicus) after a day full of cost-benefit analysis, and so he sits down in the couch and puts his utility-maximizing feet up. He checks the programs on TV and ranks his channels` options, figuring out his optimal channel preferences according to the level of satisfaction that he obtains from them. One of the conclusions of the article is that people don`t switch to other channel quickly, that is, they would rather putting off switching to a different channel even though they prefer another program. Clearly, in this daily-life example the assumption of perfect rationality breaks down. Possible explanations include imperfect information in the sense that channels advertise the next show between ad breaks, so some viewers stay tuned, the minimization of the costs of finding the optimal channel, or even procrastination.

In fact, Ted O’Donoghue and Matthew Rabin in Economics of Procrastination found out that sometimes standard economic models are not enough to explain the behaviour of economic agents. They introduce the concept of Present-biased preferences to argue that agents have a tendency to postpone hard tasks for the next day despite how small the immediate cost associated with it is. Consequently, people will actually believe that they will accomplish that task in the following day if they are unaware of the precise extent of this bias. Moreover, the authors highlight that this unrealistic optimism about their actions in the future is mostly explained if one considers time-inconsistent preferences, so that one`s choice of future actions depends on the moment you are asked to make that choice.

To sum up, as the Economist Guy Sorman points out in Economics Does Not Lie, it is quite hard to be precise in economic science because it is like a mirror of the imperfections of human nature. As I mentioned above, there are several daily-life events that put at stake the strength of the assumption of Rationality in economic behaviour, but my personal view is that we should not drop this assumption because it is crucial to get other important results out of an economic model. An important point is, however, to understand the limitations of models and sometimes to take them into account in our economic analysis.

Ana Luísa Correia