chapter 3&4 help II - CHAPTER 5 APPLICATIONS OF...

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I nevitably, some claims for publicly provided social assistance or “welfare” payments involve misrepresentation or fraud. The proportion across Canada has been estimated to be as high as 2 percent of total social assistance payments. Consider a provincial government elected on a platform of “downsizing government” and “end- ing welfare fraud.” As part of their mandate to downsize government, they downsize the welfare fraud investigation unit. Not only does this step reduce government expen- ditures, but as a result of the increased zeal and productivity of the remaining inves- tigators, the next year witnesses a decline in welfare fraud. Or does it? Certainly the number of cases of fraud uncovered and investigated has declined. But an alternative explanation is that the total number of cases of potential fraud that can be investigated is roughly proportional to the number of investigators assigned to the detection and documentation of fraud. If a stable proportion of these potential-fraud investigations turn up evidence of actual fraud, then the reality is quite different from what the data suggest. With fewer investigators to do the legwork, a larger proportion of cases of actual welfare fraud goes undetected. Several related misconceptions are at work here. The first is, “If we don’t know about it, it’s not happening.” The second is that “Information is a free good.” How- ever, the gathering and production of information consumes resources, particularly when people have a vested interest in concealment. The third related misconception involves treating welfare fraud investigators exclusively in terms of their cost , while neglecting the benefits that flow from their work. If an additional fraud investigator, costing $80,000 per year, including overhead expenses, can produce annual welfare cost savings of $300,000, then the marginal net “benefit” of laying off that investiga- tor is minus $220,000. And this loss is not the end of the story. If laying off fraud inves- tigators increases the likelihood that attempts at welfare fraud will succeed, then we would expect the number of fraudulent claims to increase. Shortsighted downsizing in this case is thus false economy with a vengeance. APPLICATIONS OF RATIONAL CHOICE AND DEMAND THEORIES C H A P T E R 5
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CHAPTER PREVIEW The case of welfare fraud investigation shows the importance of rational choice the- ory. In this chapter we take up a variety of applications and examples involving the rational choice and demand theories developed in Chapters 3 and 4. We begin with two examples a gasoline tax and school vouchers that illustrate how the rational choice model can shed light on important economic policy questions. Next we con- sider the concept of consumer surplus, a measure of how much the consumer bene- fits from being able to buy a given product at a given price. And we shall see how the rational choice model can be used to examine how price and income changes affect welfare.
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