Policy Issues

There are some types of policy issues where economists believe strongly in a policy that may or may not appeal to the general public. For example, economists believe that we benefit from free trade, even though the public sometimes resents foreign imports. Here are some classic policy issues where economists tend to have a consensus opinion.

Economists are in favor of ticket scalping. When the price of a ticket is fixed, the price may be too low, and there are more people who want to attend the event than the number of seats available at that price. In that case, the equilibrium price would be higher. Scalpers help to raise the price to the right level. If the market-clearing price is $50, then someone who only wants to pay $40 should miss the event. Scalpers help take tickets from people who do not want to pay the market-clearing price and put tickets in the hands of people who most want to attend the event.

Cities sometimes adopt rent controls, where they place a ceiling on rents for apartments. Economists believe that a price ceiling will create a shortage. In fact, cities that have rent control find that apartments are in short supply. This leads to a "black market" in which one renter might pay another in order to live in a scarce rent-controlled apartment.

Rent controls provide a short-term benefit to some lucky renters. However, other would-be renters are unable to get housing entirely. Moreover, apartment owners let their buildings deteriorate, because with rent control they are unable to raise rents to recover the costs of maintenance and improvement. Thus, if rent controls are kept in place for a long time, they can lower the quality of life for everyone.

Montgomery County passed a "living wage" law, requiring that workers who provide government services must be paid at least a minimum amount per hour. Minimum wage laws tend to be harmful, even for the poor people that they are intended to help.

If the minimum wage is higher than the marginal productivity of an an individual, then the result of the minimum wage law is to make it uneconomical to hire that person. Instead of earning a sub-minimum market wage, the person is unemployed. Instead of hiring unskilled workers at the minimum wage and losing money, employers subsitute capital and highly-skilled workers for low-skilled workers.

Montgomery County's "living wage" law applies to workers who provide government services. It will raise the cost of those services, which will reduce the capacity of the government to provide them. Since many government services go to aid the poor, the "living wage" law will have the same effect on the poor as a broad-based budget cut.

When people decide to buy cars, they have to decide between fuel economy and other features. It is argued that there is a "public good" issue because high fuel consumption causes pollution and also adversely impacts our ability to conduct foreign policy free from the influence of oil-producing countries.

A policy response has been Corporate Average Fuel Economy, or CAFE standards. These require auto manfacturers to achieve certain average standards for fuel economy. Economists think that this approach is ineffective, for a number of reasons.

Instead of fuel economy standards, economists would prefer to raise the tax on gasoline. A higher gasoline tax would directly discourage gasoline consumption. It would allow consumers to choose the most efficient means to economize on fuel, which might be obtaining newer cars, driving fewer miles, or switching to cars with better fuel economy.

The approach that economists recommend involves tradable pollution rights. The government can auction off the right to emit a certain level of pollution. A firm is only allowed to emit as much pollution as it has acquired the right to emit, either through the auction or by trading with other firms. This allows for greater substitution and flexibility in meeting a given national goal for pollution control. For example, some firms might find it cheapest simply to shut down certain plants and build new ones, and they can sell pollution rights to firms that would find it expensive to undertake a short-run conversion.

Perhaps the most common thread in these policies issues is that economists are focused on the principle of substitution. That principle says that individuals will respond to incentives by substituting low-cost methods for high-cost methods. If you want the principle of substitution to work for you, then you should apply taxes directly to the activity that you want to discourage. If you want to discourage gasoline consumption, then tax gasoline.

Policies that do not permit substitution are inefficient. For example, forcing a pollution limit on every industrial plant is less efficient than allowing plants to trade rights to produce the same aggregate amount of pollution.

The most ineffective policies are policies that will be undermined by the principle of substitution. If you impose a minimum wage, then businesses will substitute away from low-skilled workers. If you try to regulate fuel economy, people will substitute exempt cars (such as old automobiles) and drive more miles.

When I decide to get on the Beltway at rush hour, I add to the congestion. My decision to take the Beltway does not take into account the cost to others of the additional congestion that I cause.

This can be thought of as a situation involving public goods. What is the public good in this case?
Economists would argue that if tolls can be collected costlessly (by electronic tolltakers, rather than toll booths), then tolls are the best solution for road congestion. Explain how tolls use the principle of substitution. List three alternatives to tolls for relieving road congestion, and describe how the effectiveness of those alternatives would be affected by substitution.