No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Eighteen: The “macro” view of the economy 447 beneficial results. To help us flesh this out economically, we can think of the aggregation of each individual’s view of the relative costs and benefits of government action as leading to a political demand curve as well as a political supply curve for government, as in Figure 18.1 . If we assume that government uses resources that otherwise could have been used by the private sector, there is an opportunity cost of government, as represented by the upward sloping supply curve. It is upward sloping because as the government grows, it will increasingly take resources away from more highly valued private sector uses. For the demand curve, we only need to assume that government uses productive resources in their most highly valued use first and then applies additional resources to less valued collective goods and services. So perhaps you think that the most valuable use of government might be to provide defense or police and judicial systems, with government support of the National Endowment of the Arts much further down the curve. This leads to a conceptual optimality in the size of government, represented by G* in Figure 18.1 . It is conceptual in that the costs and benefits are subjective, and subjected preferences cannot be aggregated—thus impossible to know. Further, as our public choice chapter shows, there are political economy reasons to suggest why some government programs whose benefit is less than its cost will nevertheless be funded. Yet this simple supply and demand curve for government is a useful starting point for thinking about macroeconomic policy. Figure 18.2 provides another conceptually useful way to think about government policy. The economy as a whole has a fixed amount of resource inputs (Land, Labor, Capital, and Entrepreneurship—see chapter 7), which can be used to produce goods and services in either the public or the private sector. If government is expanded, the private sector must necessarily shrink, and, conversely, if government shrinks, the private sector can grow. In this model, there is no free lunch (hey, that’s a great line for a textbook title!); there is an opportunity cost for any resource use. If resource inputs (Land, Labor, Capital, and Entrepreneurship) are used in one sector of the economy, they obviously cannot be used in the other sector. While this statement is true, the reverse is not necessarily true: If resources are not used by one sector of the economy, their use will not be guaranteed by the other sector. This is the heart of Keynesian macroeconomics—a world we’ll explore below— C/B G G * C/B* S D Figure 18.1, Conceptual Equilibrium in Government. Government provides benefits (B) by providing collective goods and services, but the resources used come at an increasing opportunity cost (C) from the private sector. This model only assumes that collective action through government applies resources to the most urgent need first, and that the resources taken for use from the private sector are taken from the least costly use. This will result in the usual downward sloping curve (representing the benefits of government services) and upward sloping supply curve (representing the increasing opportunity cost from diversion of productive inputs from the private sector to the public sector). The political process will conceptually tend to drive the quantity of government to where the benefits of government are equal to the costs, at G*.