Summary

Public and not-for-profit organizations face many of the same problems that challenge companies in the for-profit sector. Competing demands on public funds and not-for-profit organization budgets force responsible managers to consider the marginal social benefits and marginal social costs of each alternative program and investment project. Like managers of companies in the forprofit sector, government officials and managers of not-for-profit organizations must optimize resource use under a variety of operating constraints.

• A traditional rationale for public management of economic resources is the perception of private market failures to efficiently provide and equitably allocate economic goods and services. If the consumption of a product by one individual does not reduce the amount available for others, the product is referred to as a public good. A private good is one where consumption by one individual precludes or limits consumption by others. The distinguishing characteristic of public goods is the concept of nonrival consumption. In the case of public goods, use by certain individuals does not reduce availability for others. A good or service is characterized by the nonexclusion concept if it is impossible or prohibitively expensive to confine the benefits of consumption to paying customers.

• A free-rider problem often materializes in the case of public goods because each consumer believes that the public good will be provided irrespective of his or her contribution toward covering its costs. A hidden preferences problem also emerges in the provision of public goods because individuals have no economic incentive to accurately reveal their true demand for public goods.

• Public choice theory is the philosophy of how government decisions are made and implemented. The study of public choice theory considers how government and the political process actually work, rather than how they should work. It explicitly recognizes the possibility of government failure, or circumstances where public policies reflect narrow private interests, rather than the general public interest.

• Voters in the political process are the counterpart of consumers in the marketplace. According to public choice theory, voters are less informed about political decisions than about market decisions due to their rational ignorance. Because elected officials act for the community as a whole, high information costs and each individual's low ability to directly influence public choices, voters often find it sensible to remain relatively uninformed about public policy decisions. Politicians are the political system counterpart of entrepreneurs and managers in the private market system. Special-interest groups are organized lobbyists that actively support the passage of laws and regulations that further their own narrow economic interests. According to public choice theory, public employees, or bureaucrats, are not passive executors of adopted policies; they actively seek to influence these policies to further personal interests.

• If investment in a public project makes at least one individual better off and no one worse off, then the project is described as Pareto satisfactory. When all such government programs and investment projects have been undertaken, the situation is deemed to be Pareto optimal. In practice, it is often deemed adequate when public programs and projects meet the criteria of a potential Pareto improvement, in which there are positive net benefits.

• The marginal social costs of any good or service equal the marginal cost of production plus any marginal external costs that are not directly borne by producers or their customers. Production costs that are borne by producers and their customers represent private economic costs; external costs include the value of foregone alternative goods and services. In the absence of marginal external costs, marginal private costs and marginal social costs are equal at all levels of output. Marginal social benefits are the sum of marginal private benefits plus marginal external benefits. Marginal private benefits are enjoyed by those who directly pay for any good or service; marginal external benefits are enjoyed by purchasers and nonpurchasers alike and are not reflected in market prices. When no externalities are present, marginal social benefits equal marginal private benefits.

• The social rate of discount is the interest-rate cost of public funds. According to the social net present-value (SNPV) criterion, social programs and public-sector investment projects are acceptable if the present value of marginal social benefits is greater than or equal to the present value of marginal social costs. Benefit-cost (B-C) ratio analysis shows the relative attractiveness of any social program or public-sector investment project, or the present value of marginal social benefits per dollar of marginal social cost. The social internal rate of return (SIRR) is the interest or discount rate that equates the present value of the future receipts of a program to the initial cost or outlay.

• Once the resource allocation decision has been made, the purpose of cost-effectiveness analysis is to determine how to best employ resources in a given social program or public-

sector investment project. With privatization, public-sector resources are sold or otherwise transferred to the private sector in the hope that the profit motive might spur higher product quality, better customer service, and lower costs for production and distribution.

• Monetary policy refers to actions taken by the Federal Reserve (the Fed) that influence bank reserves, the money stock, and interest rates. Fiscal policy refers to the spending and taxing policies of the federal government. The business cycle refers to fluctuations of output around a long-term trend, or recessions followed by recoveries and expansions. Recent reductions in the volatility of economic activity may be due to the development of stabilization policy designed to offset temporary economic disruptions. Automatic stabilizers act as buffers when the economy weakens by automatically reducing taxes and increasing government spending. Discretionary policy refers to new changes in spending and taxes.

• International trade, or the voluntary exchange of goods and services across national boundaries, increases the well-being of all participants by promoting economic efficiency in a variety of ways. The Eurodollar market is a market in which banks outside the United States accept deposits and make loans denominated in dollars. Eurodollar markets have developed into Eurocurrency markets with transactions in a variety of currencies in addition to dollars.

• Although sometimes effective, changes in economic expectations and certain indirect effects of government actions place severe limits on the effectiveness of fiscal and monetary stabilization policy. The reduction in private investment associated with an increase in government spending is known as the crowding out phenomenon. Change in incentives that results from the purchase of insurance is known as the moral hazard problem, or the difficulty encountered when the full costs of economic activity are not directly borne by the consumer.

During the 1990s, microeconomic and macroeconomic policies were employed by all levels of government as a means for improving upon private-sector price and output decisions. At the same time, government agencies and not-for-profit organizations found themselves besieged by competing demands for scarce goods and services. This chapter illustrates how the tools and techniques of managerial economics can be employed to improve decision making in the not-for-profit sector and refine the management of scarce public resources.

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