Political Economy and Welfare Concepts: Key Exam Solutions

Posted on Nov 22, 2025 in Business Management

German Electoral Law and Welfare Criteria

German Electoral System Dynamics (Questions 1a–1e)

1a. Second Votes and Candidate Platforms

Due to the Bundestag’s electoral law, the fraction of seats won by political parties is determined by the fraction of so-called second votes received at the national level. The constituency-level election only determines the identity of the elected representative. It follows that the political platforms of the candidates reflect entirely those of their respective parties. For a party, the marginal cost of fielding a candidate in the constituency election is negligible (nil). Fielding a popular candidate in the constituency election may increase the second votes obtained by the party.

1b. Single-Issue Parties and Marginal Gain

For a single-issue party, such as the Animal Protection Party, the marginal gain for presenting a candidate in the constituency election is infinitesimal. This is because the probability of winning the constituency is zero, and voters are likely attracted by the party’s platform rather than the candidate’s characteristics.

1c. Saxony’s Representation Estimate

Saxony accounts for roughly 4.8% of Germany’s population. The estimate for the number of seats is 4.8% of 733, which, when rounded, is 35. (The actual number is 38.)

1d. AfD’s Likelihood of Government Participation

The likelihood of the AfD controlling half of the seats in the Bundestag is zero. Therefore, the AfD may find itself in government only in coalition with other parties. However, since its platform is quite distant from those of the other major parties, it is highly unlikely that any of them will want to form a joint cabinet with the AfD.

1e. AfD’s Influence on Federal Policy

The likelihood of the AfD influencing federal policy directly is very small. An opposition party may influence federal policy directly if it has veto power due to the votes it controls in the Bundesrat. Given the current distribution of AfD voter support across states, the AfD does not have veto power. This is unlikely to change as long as AfD support is mostly confined to the East of the country.

Welfare Economics and Market Efficiency (Questions 2a–2c)

2a. Pareto Optimality of Allocations

All the allocations are Pareto Optimal, since by switching between any two of them, it is not possible to make one type of agent strictly better off without making at least one of the other two strictly worse off.

2b. Kaldor Compensation Test

The transition $X \rightarrow Y$ satisfies the Kaldor Compensation Test. It is sufficient to transfer utility from Agent 1 to Agent 3 in such a way that the latter is equally well off. For example, this goal can be achieved by lowering Agent 1’s payoff from 11 to 9 and raising Agent 3’s payoff from 3 to 4. The remaining three transitions do not satisfy the Kaldor Compensation Test because it is impossible to transfer utility in such a way as to make everybody as well off as in the starting allocation.

2c. Monopoly, Externalities, and Pareto Frontier

A monopolist will produce less than a competitive fringe, which moves in the direction of reducing the externality. However, nothing guarantees that the amount of production will be Pareto Optimal. In general, output in the general equilibrium with monopoly will be either greater or smaller than that selected by a benevolent planner. In either case, the general equilibrium allocation will not be on the Pareto frontier.

Public Choice and Pareto Improvement (Questions 3a–3b)

3a. Interest Groups and Local Initiatives

The initiative involves the following transactions:

  • Members of the interest group stand to gain a park and pay $5,000.
  • Residents of District 21 stand to suffer a marginal increase in taxation but obtain a greater budget for their Community Center.

As long as the two groups are both better off because of these transactions, and the interest group can gather the $5,000, the initiative will lead to a Pareto Improvement.

3b. Re-election Incentives and Pareto Improvement Conditions

If Ms. Hoang’s chance of re-election is larger due to the initiative, the conditions for a Pareto Improvement must account for this political gain:

  1. The members of the interest group must be better off and be able to pay the $5,000.
  2. The gain accruing to District 21’s residents from Ms. Hoang’s re-election (with respect to the alternative scenario where somebody else is elected) must be greater than the loss from the marginal increase in taxation.

Voting Behavior and Welfare Theorems

Argentinian Presidential Election Analysis (Questions 1a–1f)

1a. Expressive vs. Strategic Voting (Scenario 1)

As an expressive voter, Carolina will vote for PB. As a strategic voter, she will still vote for PB. There is no information to infer that SM is more likely than PB to win against JM in the runoff. Given that the expressive component is higher when she votes for PB, she will do so.

1b. Expressive vs. Strategic Voting (Scenario 2)

As an expressive voter, Carolina will vote for PB. As a strategic voter, she may vote for either SM or PB. The instrumental value of voting is higher when voting for SM. Therefore, the overall value from voting for SM may turn out to be higher.

1c. Expressive vs. Strategic Voting (Scenario 3)

As an expressive voter, Carolina will vote for PB. As a strategic voter, she will still vote for PB. Voting for SM would marginally increase the likelihood that JM will win at the runoff.

1d. Runoff Likelihood and Candidate Dynamics

It is unlikely that the President will be elected in the first round. The platform of SM is so distant from those of the other two candidates that those who supported UP at the primary will likely vote for him. To win in the first round, JM needs about 15 percentage points from JC’s voters who change allegiance or from citizens who did not vote at the primary. The runoff is likely going to be between JM and SM because:

  • Supporters of JC that did not vote for PB at the primary may perceive her to be too extreme and abstain.
  • PB’s platform is not very different from JM’s.
  • Voters who abstained at the primary and oppose the current government may perceive JM as more likely to win against SM.

1e. Candidate Platform Steering and Compulsory Voting

It is unlikely that the candidates will steer their platforms toward that favored by the median voter, since they will be afraid to lose supporters on the tails. Note that the fact that voting is compulsory de jure does not imply that people actually vote. From the table (not provided here), it can be inferred that less than 70% of registered voters actually went to the polls for the primary election.

1f. Congressional Control and Coalition Building

Given Argentina’s federal structure and the fact that Congress is largely elected by proportional rule, the Peronists will still have a strong delegation in Congress. None of the three major parties will likely achieve control of the legislature. Votes for the new President’s agenda will have to come from a vast coalition. Change will be difficult to implement and will take time.

Welfare and Market Efficiency (Questions 2a–2c)

2a. Pareto Optimality of Allocations X, Y, and Z

The allocations X, Y, and Z are Pareto Optimal, since it is not possible to make one type of agent strictly better off without making at least one of the other two strictly worse off.

2b. Rawlsian Dictator and Redistribution Efficiency

False. This statement would be true if redistribution were efficient. If redistribution is very inefficient, even for a benevolent Rawlsian dictator, it may be optimal to stop short of making everybody equally well off.

2c. Price Caps and Pareto Efficiency

In general, the market allocation will not be Pareto efficient because the sufficient conditions of the First Welfare Theorem are violated. The policy (price cap) is unlikely to induce a Pareto improvement. For example, if equity in the thermometers’ producers is held by one individual, the price cap will definitely make him worse off.

Public Choice and Political Incentives (Questions 3a–3b)

3a. Petition Approval and Negative Externalities

The petition will likely not be approved. At a cost of 50 cents, only people suffering from the additional negative externality caused by the taller building (less light at street level, more congestion) will vote.

3b. Lobbying Strategies for Pareto Improvement

The likely reason for Mrs. Salah’s opposition is that approval of the petition would alienate some of her constituents, reducing her probability of re-election. Klopp can try different ways to convince Mrs. Salah to change her mind:

  1. Direct Campaign Contribution: Klopp could provide a generous contribution to her election committee. Mrs. Salah will be able to use the funds to offset the negative impact of her pronouncement on her chances of re-election. Such a strategy is not likely to induce a Pareto improvement, since local residents will still be adversely impacted by the taller building.
  2. Community Benefit Contribution: An alternative plan calls for Klopp to contribute financially to the upkeep of a local park. This is more likely to induce a Pareto improvement.

Key Concepts in Political Economy (2018–2022)

Institutional Effects on Political Exchange

  • Secret Ballot: Reduces political exchange (e.g., vote buying/selling).
  • Free-Riding: Worse in large groups due to diffusion of responsibility and lower individual impact.
  • Lobbying: Transfers resources and may cause Deadweight Loss (DWL).
  • Federalism: Central government reduces inter-jurisdictional externalities.
  • Bureaucracy: The sponsor sets the budget, but the bureau possesses informational asymmetry.

Voting Models and Institutional Rules

  • Median Voter Theorem (MVT) (1D, Unimodal): Candidates converge to the median voter position.
  • Plurality Rule: Rational instrumental voters only vote if $P \cdot B > C$ (where P is the probability of being pivotal, B is the benefit, and C is the cost).
  • Multi-seat Proportional Rule: Candidates choose distinct platforms (True).
  • Bureaucrat vs. Sponsor: Characterized by information asymmetry, where the bureau holds superior information.
  • Seniority Rule: Fosters exchange and cooperation, not just senior interests.

Market Failure and Government Intervention

  • Club Goods (Excludable, Non-Rival): Not efficient under private provision; requires government intervention (e.g., property rights definition).
  • Monopoly: Price ($P$) is greater than Marginal Cost ($MC$).
  • Planner vs. Market: Outcomes are aligned only under Competitive Equilibrium (CE) assumptions.
  • Competitive Equilibrium (CE): All agents are rational, and all markets clear.

Core Welfare Theorems and Externalities

  • Pareto Optimality: No feasible reallocation can increase the utility ($u_i$) of any agent without making at least one other agent worse off.
  • First Welfare Theorem (1st WT): Competitive Equilibrium (CE) implies Pareto Optimality if markets are competitive, there are no externalities, and markets are complete.
  • Second Welfare Theorem (2nd WT): Any Pareto Optimal allocation can be achieved via lump-sum transfers, provided preferences and technology exhibit convexity.
  • Coase Theorem: Works if property rights are defined and transaction costs are negligible (zero).

Goods Classification and Government Role

  • Public vs. Private Goods: Club goods are not efficient without government intervention (specifically, defining property rights).
  • Competitive Equilibrium: Requires rational agents and all markets clearing.
  • Government Role: Necessary for efficiency when externalities or monopoly conditions exist.