The economic analysis used in Module 7 employs a highly simplified model. Like all such models the advantages of constructing a logical framework in order to offer relevant propositions for testing are incurred at the cost of neglecting aspects of real situations. The conclusions drawn from the model may be logically correct but may not conform with experience. In the case of the economic analysis of bureaucracy we may look at the model in Section 7.2.1 as the point of departure in a continuous discussion between the sponsor (principal) and the bureau. It may not inflict too much violence on reality to assume that the ‘opening bid’ by the bureau for funding is really a ‘probe’ to discover how skilful the sponsor is likely to be at examining the bureau's budget and whether the sponsor's motivation is designed to minimise the cost of the bureau's output. In the longer run, it is reasonable to suppose that if the sponsoring department is motivated by the desire to control spending, then it will be unwilling simply to accept on trust the budget proposals of the bureau without further investigation.
Recall that the bureau's strong position arises from three factors: (a) it is a monopolist; (b) it is the sole source of information about its costs; and (c) it knows the demand schedule of the sponsor and therefore the maximum amount the sponsor is willing to pay rather than do without the service. Let it be accepted that the sponsor can do nothing about the first two factors. If the output of the service were capable of being identified the sponsor might be able to reduce the power of the bureau in the following way: it can insist that the bureau must announce in advance the price per unit of its output. The purpose of this question is to test your knowledge of the bureaucracy model by introducing this modification into the original conditions governing the sponsor-bureau interface.
There is a presumption that the announcement in advance of a price per unit of output could lead to situations where the bureau would have to reveal its true costs if it is to maximise its budget. If the elasticity of demand of the sponsor were high over the relevant range of output, then stating a price well above costs might price the bureau out of the market. On the other hand, if the elasticity of demand of the sponsor were low, then quoting a high price in relation to costs seems likely to pay off because any loss of revenue from a fall in the quantity demanded would be more than compensated by the rise in price above costs.
These observations can be tested by a modification of the model in Section 7.2.1 which you are asked to devise. The first stage of the exercise is to draw a diagram with a conventional demand curve which is straight and downward sloping (see Figure 7.3). It has an important characteristic, namely that the elasticity of demand varies from infinity to zero as we move down the curve, and with the elasticity of demand (Ed) = 1 at the midpoint. You can check this proposition by reference to an elementary economics textbook.
Figure 7.3 Price elasticity of demand and the demand curve
The second stage of the exercise is to specify two different cost curves, both of which display the condition that marginal = average costs per unit of output, i.e. they are both parallel with the horizontal axis. Cost curve 1 is drawn so that it is below the point on the demand curve where the elasticity of demand = I and cost curve 2 is drawn so that it is above that point.
Prove that in the case of cost curve 1, the bureau will maximise its budget by overstating its costs, and that, in the case of cost curve 2, it will maximise its budget by telling the truth about its costs.
Compare the results obtained in (a) with the results obtained in the model employed in Section 7.2.1.
Imagine that you are an adviser to the Minister of Education in a high-income country called Eutopia. (S)he is concerned about the growing cost of state school education and the lack of interest shown by parents in the education of their children. The Minister decides that the solution might lie in the privatisation of the school system, but realises that the political change involved requires careful attention to the conditions attached to privatisation. The Minister sends you a memorandum as follows:
As you know, it is our policy to develop an efficient and equitable system of school education. It seems to me that there is no reason why school education should not be subject to market forces in order to ensure efficiency in provision, provided that certain important safeguards are built into the system. Therefore, certain conditions must be fulfilled in any system of privatisation. The conditions are that:
Schools must be self-financing.
Standards of education must not fall.
Education must remain compulsory for children up to the age of 16.
It follows from (i) that parents must pay for their children’s education.
Notwithstanding (iv), there must be no adverse effects produced in the distribution of income which would prevent poorer persons from being able to pay for their children’s education.
What I am asking you to do is to outline proposals which are compatible with the new role of the Eutopian Ministry of Education as a regulator, and if necessary, as the source of finance of education, rather than as the provider of educational facilities. You should not hesitate to inform me of any problems which may be encountered in trying to fulfil the conditions listed above.
Write a reply of not more than 1000 words to the Minister's request. You may feel that you lack the necessary background to offer a satisfactory reply, in which case you would be in good company. The official who would have to answer a memorandum of this kind would no doubt send for a suitable bibliography which might include the following works: Privatisation and the Welfare State (Le Grand and Robinson 1984), see particularly the chapters by Maurice Peston and Mark Blaug; The Riddle of the Voucher (Seldon 1986).
