ECON 356 - Outline Seven

More Applications of the Rational Choice Model

Application:  Paying for Garbage

The Borough of Perkasie, a small Pennsylvania town, had a problem:  throughout the 1980s its trash collection costs rose rapidly.  The local government devised an innovative solution to the problem by changing the way residents paid to have their trash picked up. 

Historically, Perkasie residents paid a fixed annual fee of $120 per residence for garbage collection. 

Under the new plan introduced in 1988, there is no annual fee but garbage is picked up only when it is placed in specially marked, black plastic bags.  The bags are sold by the town at a price greater than their cost.  The net revenue from the sale of the bags is used to finance the town's trash collection services.

What happened?  The amount of trash collected per person dropped nearly 50%, the average household spent about 30% less on garbage collection, and the town saved 40% on its garbage collection costs.

Why did these changes occur?

Answer lies in looking at incentives -- how would you respond?  Hint:  think about marginal cost or price per unit of garbage.

Can you put this in terms of the rational choice model?  Try this yourself. 

To get you started:  put the composite good on one axis and garbage disposal consumed per household on the other.  What would your budget constraint look like with the $120 annual fee (regardless of how much trash collection your consumed)?  Hint:  remember -- once the fee is paid, any marginal amount of trash collection consumed is done so at no cost -- which means no composite good is given up.

Where would your highest indifference curve most likely be?

Graph:

Now how would the situation change when the town introduces the bag system?

Assume that if the household generates the same amount of trash that it is doing under the current system, it will pay the same amount with the fee.  Therefore, your budget constraints will cross at that point.  Will they likely consume the same amount of trash collection though -- or is there an incentive to consume less?  Where would your new indifference curve lie that will maximize utility?

Does your graph explain the results seen in Perkasie?

Does Everyone Benefit?

So would anyone object to this new system that leads to less garbage and also benefits people? 

Will all households benefit?

Assume that two households have the same income -- but one generates a lot more garbage than the other.  How might one household benefit from the new system -- while the other might lose from it?  Can you put their indifference curves on your graph?

Graph:

Can you think of other unintended consequences from the "per bag" price policy (either positive or negative)?

    Recycling?

    Illegal dumping?

Application:  National Health Care

It has been proposed that the United States go the way of some other countries and change to a national health care system.  Under this system, all health care costs would be paid for by the government.  But, in reality, where does the government get its money?  Taxes -- so taxpayers will pay - most likely through an increase in payroll taxes.

So what would our rational choice model say about the consumption of health care under the current system vs. a national health care system?

First assume that a person pays for their own medical care.  Graph this person's budget constraint and indifference curve.  Assume he is paying $40 per doctor visit (put this on your axis - number of doctor visits per year).

Graph:

Now -- how would this change with national health care?  The person's budget constraint is altered in two ways:

1)  his disposable income would fall by the amount of increase in taxes and

2)  the price of visits to a doctor would fall to zero.   So how would the budget constraint look?

Assume that the person's tax = the person's initial spending on health care (prior to national health care) - such that the consumer's horizontal budget constraint goes through his initial point of consumption.  Is the consumer going to stay there now?  No -- not on highest budget constraint.

So would our current system be overwhelmed with demand?

How else would, then, the good be rationed?

Now consider a system where the health care is rationed via the price system - markets - but there are many people (not all) in the system where government does pick up the tab (or a majority of it) and others are covered with private insurance.

What effect does this have on the price of health care?

Market Supply and Demand Graph: