7/18/2004

Welfare and Spending

Last year when I was in a class with Professor Baker.  He showed us, prior to class, a graph that I thought was very interesting.
 
He told us, that the best way money is spent is person 1 buys something for person 1.
 
The 2nd best way was when Person 2 buys something for person 1, (like a present).  The welfare decreases, because the person may or may not want this present.
 
The worst way money is spent is by Person 1 giving money (to an unknowing third party) Person 3 to spend on Person 2.  The chances that Person 2 will receive what he/she wants decreases the welfare even further.
 
This analogy helped me understand the disincentives of higher taxes.  It seems logical to me, but or there any other thoughts on this analogy?

2 comments:

Dr. Tufte said...

I actually posted this story at the beginning of the first summer session (don't worry, you'll still get credit).

The version that I heard attributed this to Milton Friedman, a 1976 Nobel Prize winner, and source for a whole bunch of ideas that show up in both principles of micro and macro texts. The next one that we will see is in Chapter 14; Friedman was a major voice suggesting that the Phillips Curve was not a stable phenomenon that could be exploited by policy makers.

Dr. Tufte said...

Spelling mistakes in Kamm's comment.

Good comments.

WRT Lizzie's comment, society appears to do better when everyone acts in their own self-interest. However, that principle seems to work the best when there are property rights and markets in everything. The Tragedy of the Commons experiment we did was one in which there were poor property rights.

C-Dizzle's comment illustrates something that Basquiat (the 19th century French economist, not the 20th century Haitian-American grafitti artist) called the broken window effect. Breaking a window will cause GDP to rise when it is fixed, but it is not a sound strategy for improving our lot in life.

Kid's and Kamm's post really get at the heart of macroeconomics - following the logic out until it is complete, and figuring out what all the costs and benefits are.