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Chapter 20: Political Economy and Public Choice
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A good incentive system aligns self-interest with social interest.
- When does the self-interest of politicians and voters align with the social interest and
when do these interests collide? This question is at the heart of political economy, or
public choice, which is the study of political behaviour using the tools of economics.
Economist say that voters are rationally ignorant about politics because the incentives to
be informed are low -> rationally ignorant occurs when the benefit of being informed are
less than the costs of becoming informed
Ignorance about political matters is important for at least 3 reasons
1. Voters who think that the unemployment rate is much higher than it actually is are
likely to make different choices than if they knew the true rate
2. Second, voters who are rationally ignorant will often make decisions on the basis of
low-quality, unreliable, or potentially biased information.
3. The third reason that rationally ignorance matters is that not everyone is rationally
ignorant
Sugar producers, unlike sugar consumers, have a lot of money at stake so they have
a strong incentive to be rationally informed.
The costs of the sugar quota are diffused over 100 million consumers, so no consumer has
much of an incentive to oppose the quota. But the benefits of the quota are concentrated on
a handful of producers; they have strong incentives to support the quota.
External costs = costs of a good are paid for by other people
When the government makes it possible to push the costs of a good onto other people - to
externalize the costs we get too much of the good. In this case we get too many bridges.
When benefits are concentrated and costs are diffuse, resources can be wasted on projects
with low benefit and high costs
Rational ignorance and another factor, voter myopia, can encourage politicians to boost the
economy before an election to increase their changes in reduction
More specifically, the incumbent party wins election when personal disposable
The median voter is defined as the voter such that the other voter wants more, spending and
half wants less spending.
The Median voter theorem says that under these conditions, the median voter rules! Or put
it more formally, the media voter theorem says that when voters vote for a policy that is
closest to their ideal point on a line, then the ideal point of the median voter will beat any
other policy in a major.
,The median voter theorem = the media voter tells us in a democracy, what counts are no.
The median voter theorem does not always apply.
On a similar weekend, when there is more than one dimension to politics, no policy may
exist that beats every other policy.
As a predictive theory of politics -> the median voter theorem is applicable in some of but
not all circumstances. The theorem, however, does remind us that politicians have
substantial incentives to listen to voters on issues.
Control of ragional ignorance has axectly the effect we would expect. Beslet and Burgess
find that greater political competitions is associated with higher levels of public
One reason for the good record of democracy on economic growth may be that the only way
the public as a whole can become rich is by supporting efficient policies that generate
economic growth.
-> In other words -> the greater the share of the population that is brought into power, the
more likely that policies will offer something for virtually everybody, and not just riche for a
small elite
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Chapter 26: GDP and the measurement of progress
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As a rough way of summarizing change in economic output and the standard of living,
economists look at a country’s GDP and its gross domestic product per capita, two statistics
designed to measure the value of economic production.
GDP = the market value of all finished goods and services produced within a country in a
year. GDP per capita = GDP divided by population of a country
GDP measures an economy’s total output, which includes millions of different goods and
services.
What is a finished good or service? -> Some goods and services are sold to firms and then
bundled or processed with other goods or services for sale at a later stage. These are called
intermediate goods and services. We distinguish these from finished goods and services,
which are sold to final users and then consumed or held in personal inventories.
=> The output of an economy includes both goods and services.
The sale of an old house does not add to GDP because the house was not produced in the
year in which it was sold.
, Within a Country:
U.S. GDP is the market value of finished goods and services produced by labor and capital
located in the U.S, regardless of the nationality of the workers or the property owners.
Gross national product (GNP) = very similar to GDP but GNP measures what is produced by
the labor and property supplied by U.S. residents wherever in the world that labor or capital
is located, rather than what is produced within the U.S. border.
A GDP tells us how much the nation produced in a year, not how much the nation has
accumulated in its entire history.
Nominal versus Real GDP:
Nominal GDP is calculated using the prices at the time of sale -> so without inflation.
If we want to compare GDP over time, we should always compare real GDP, that is, GDP
calculated using the same prices in all years. Interestingly, it doesn’t matter how much prices
we use to calculate real GDP, so long as we use the same prices all year.
-> A real variable = one that corrects for inflation, namely a general increase in price over
time. They have been adjusted for changes in prices by using the same set of prices in all
time period
GDP deflator:
The GDP deflator is a price index that can be used to measure inflation.
GDP Deflator = Nominal GDP
------------------- X 100
Real GDP
Real GDP Growth:
If pressed to choose a single indicator of current economic performance, most economist
would probably choose Real GDP growth
Growth in real GDP per capita is usually the best reflection of changing living standard.
Growth in real GDP typically gives the same broad idea of how economic conditions are
changing as growth in Real GDP per capita, but there can be big differences for countries
with rapidly growing populations.
Recession = significant, widespread decline in real GDP and employment -> Lasting more
than a few months, normally visible in Real GDP
=> We call the fluctuations of real GDP around its long-term trend, or ‘’normal’’ growth rate,
business fluctuation or business cycles.
