Lecture 16 and 17: Public Choice Theory, Hayek, Trade-Offs, and Externalities

Politics Without Romance: Incentives and Outcomes in Democracy

Tom Hanna

Houston City COllege

2025-10-27

Part 1: Public Choice, The Road to Serfdom, and Unintended Consequences

What is Public Choice?

  • Definition: The use of economic tools to study political behavior.
  • Rational Choice Theory: People act in their own interest, weighing costs and benefits.
  • Key Ideas
    • Methodological individualism
    • Incentives matter (for voters, politicians, bureaucrats)
    • Collective action problems
    • Utility Maximization (subjective)

Utility Maximization

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Examples of Public Choice Problems

  • Why do people vote (or abstain)?
  • The main goal of politicians and government officials
  • Bureaucratic expansion
  • Special interest groups and rent-seeking

Rent Seeking

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Discussion Prompt

  • How realistic is it to assume everyone acts out of pure self-interest in politics?
  • What examples of rational self-interest do you see in government or daily life?
  • How does a government provided rent differ from a market earned profit?

Hayek: The Problem of Unintended Consequences

  • Hayek’s Knowledge Problem: Central planners lack access to all relevant, dispersed knowledge.
  • Unintended Consequences: Policies often create unexpected outcomes due to limited information.
  • The Use of Knowledge in Society (1945)

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Real World Examples

  • Price controls leading to shortages
  • Environmental policies causing perverse incentives
  • Tax incentives causing unpredicted behaviors

Videos

Environmental Issues

Discussion Prompt

  • Can policymakers ever “know enough” to avoid unintended consequences?
  • If personal utility is subjective, can even a supercomputer “know enough?”
  • Share an example where a government policy created problems it meant to solve.
  • What happens when a policy leads to unintended consequences?

Hayek: The Road to Serfdom

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The Road to Serfdom

  • Stage 1: Centralized economic planning leads to unintended consequences
  • Stage 2: Unintended consequences lead to calls for more control
  • Stage 3: Increased control erodes individual freedoms
  • Repeat Cycle: The cycle continues, leading to totalitarianism

Social Policy Road to Serfdom

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Review & Discussion

  • Why do big plans sometimes fail?
  • How can we better use dispersed knowledge?
  • What safeguards help reduce unintended consequences?

— END CLASS 1 —

(Take a break or begin next time)

Part 2: Trade-Offs, Externalities, and Solutions

What Are Trade-Offs?

  • Definition: Choosing more of one thing means getting less of another.
  • Examples:
    • Guns vs. butter (military vs. social spending)
    • Efficiency vs. equity

Trade-offs

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Why Are Trade-Offs Politically Difficult?

  • Politicians prefer “win-win” narratives
  • Avoiding hard choices can have costs
  • Voters respond to clear benefits, not necessarily trade-offs

Another Kind of Trade-off

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Discussion Prompt

  • Why do elected officials avoid acknowledging trade-offs?
  • What’s an example of a trade-off in recent government decision-making?

Externalities: Side effects of Transactions

  • Definition: Effects of a transaction on third parties not directly involved (can be positive or negative)
  • Examples:
    • Pollution (negative externality)
    • Herd immunity (positive externality)

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Solutions to Externalities

  • Regulation: Direct restrictions (e.g., pollution limits)
  • Taxes or Subsidies: “Internalize” the externality—make it costly/profitable
  • Voluntary Agreements: Negotiation among affected parties (Coase theorem) - requires property rights

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Discussion Prompt

  • Choose a real-world externality. Which solution seems most effective? Why?
  • Are “win-win” solutions possible? What obstacles exist?

Authorship and License

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