Policy Applications xvii Preface xix For Whom Is This Book Written? xx A Word on Tone and Technicality xx Acknowledgments xxi Introduction 1 (10) Three Goals 4 (1) The Role of Models 5 (2) Why Rationality? 7 (4) I Normative Foundations 11 (86) 1 Normative Frameworks 13 (38) 1.1 What Is a Normative Framework? 15 (2) 1.1.1 Private vs. Public Morality 16 (1) 1.2 Utilitarianism 17 (10) 1.2.1 Why Be a Utilitarian? 18 (3) 1.2.2 Some Problems for Utilitarianism 21 (6) 1.3 Egalitarianism 27 (10) 1.3.1 Equality of Outcomes 28 (4) 1.3.2 Equality of Opportunity 32 (5) 1.4 Kantian Deontology 37 (4) 1.4.1 Deontology and the Challenges to Utilitarianism 39 (1) 1.4.2 Challenges for Deontological Thinking 39 (2) 1.5 Libertarianism 41 (4) 1.5.1 Why Be a Libertarian? 43 (1) 1.5.2 Some Problems for Libertarianism 44 (1) 1.6 Takeaways 45 (1) 1.7 Further Reading 46 (1) 1.8 Exercises 47 (4) 2 Collective Goals 51 (23) 2.1 Rational Individuals 52 (1) 2.2 Aggregation Procedures 53 (2) 2.3 Evaluative Criteria for Aggregation Procedures 55 (5) 2.3.1 Transitivity of Social Preferences 56 (1) 2.3.2 Unanimity 57 (1) 2.3.3 Independence of Irrelevant Alternatives 58 (2) 2.4 Arrow's Theorem 60 (1) 2.5 Social Decisions Instead of Social Preferences 61 (2) 2.6 The Public Interest? 63 (7) 2.6.1 Only Two Alternatives: May's Theorem 63 (1) 2.6.2 Ruling Out Some Collections of Preferences: The Median Voter Theorem 64 (5) 2.6.3 Intensity of Preferences 69 (1) 2.6.4 Agreement 70 (1) 2.7 Takeaways 70 (1) 2.8 Further Reading 71 (1) 2.9 Exercises 71 (3) 3 Pareto Concepts 74 (23) 3.1 Pareto Concepts 75 (1) 3.2 From Pareto Efficiency to Pareto Improvements 76 (1) 3.3 A Model of Policies and Preferences 77 (7) 3.3.1 Actions and Transfers 77 (1) 3.3.2 Quasi-Linearity: A Bridge from Pareto Efficiency to Pareto Improvement 78 (6) 3.4 A Bridge Too Far? 84 (3) 3.4.1 Limited Transfers and Distributional Concerns 84 (1) 3.4.2 Non Quasi-Linear Preferences 85 (2) 3.5 Relationship to Cost-Benefit Analysis 87 (2) 3.6 Are Pareto Improvements Unambiguously in the Public Interest? 89 (1) 3.7 Takeaways 90 (1) 3.8 Further Reading 91 (1) 3.9 Exercises 91 (2) 3.10 Appendix: Proof of Theorem 3.3.1 93 (2) Summing Up Normative Foundations 95 (2) II Social Dilemmas 97 (96) 4 Externalities 99 (51) 4.1 Collective Action 101 (4) 4.1.1 The Social Dilemma 104 (1) 4.1.2 Interpretations 104 (1) 4.2 Public Goods 105 (9) 4.2.1 Comparison to the First Best or Utilitarian Optimum 107 (1) 4.2.2 Interpretation 108 (1) 4.2.3 Concentrated vs. Diffuse Interests 109 (5) 4.3 The Tragedy of the Commons 114 (6) 4.3.1 A Pareto Improvement 118 (1) 4.3.2 The First Best 118 (1) 4.3.3 Interpretation 119 (1) 4.4 Policy Interventions 120 (4) 4.4.1 The Failure of Persuasion 120 (2) 4.4.2 Pigovian Subsidies and Taxes 122 (2) 4.4.3 Regulation 124 (1) 4.5 The Theory of the Second Best 124 (5) 4.5.1 The Second-Best Pigovian Subsidy 126 (3) 4.6 Alternative Responses 129 (15) 4.6.1 Altruism 130 (1) 4.6.2 A Market in Externalities 131 (4) 4.6.3 Ongoing Relationships and Self-Organization 135 (9) 4.7 Takeaways 144 (1) 4.8 Further Reading 144 (1) 4.9 Exercises 145 (5) 5 Coordination Problems 150 (23) 5.1 Coordination Failure 153 (6) 5.1.1 Interpretation 158 (1) 5.2 Coordination Traps 159 (6) 5.2.1 A Basic Model of Coordination Traps: Investment in Developing Countries 160 (2) 5.2.2 A Model of Bank Runs 162 (1) 5.2.3 A Model of Revolutions 163 (2) 5.2.4 Interpretation 165 (1) 5.3 Policy Responses 165 (3) 5.3.1 Communication 165 (2) 5.3.2 Short-Run Intervention 167 (1) 5.3.3 Insurance and the Second Best 167 (1) 5.4 Takeaways 168 (1) 5.5 Further Reading 169 (1) 5.6 Exercises 169 (4) 6 Commitment Problems 173 (20) 6.1 A Model of Conflict 174 (6) 6.1.1 Inefficient Conflict 178 (1) 6.1.2 Interpretation 178 (2) 6.2 The Hold-Up Problem 180 (3) 6.2.1 Interpretation 183 (1) 6.3 Policy Responses 183 (2) 6.4 Takeaways 185 (1) 6.5 Further Reading 185 (1) 6.6 Exercises 185 (6) Summing Up Social Dilemmas 191 (2) III Constraints On Good Governance 193 (142) 7 Strategic Adjustment 197 (21) 7.1 Strategic Adversaries 199 (6) 7.1.1 Do Terrorists Really Strategically Adjust? 201 (2) 7.1.2 The War on Drugs 203 (2) 7.2 Incentivizing Multiple Tasks 205 (8) 7.2.1 High-Stakes Testing 211 (2) 7.3 Takeaways 213 (1) 7.4 Further Reading 214 (1) 7.5 Exercises 215 (3) 8 Dynamic Inconsistency 218 (26) 8.1 Time Inconsistency 219 (8) 8.1.1 The First Best 221 (1) 8.1.2 What Will the Government Do? 221 (1) 8.1.3 How Much Will a Consumer Consume? 222 (1) 8.1.4 Is the Government Time Consistent? 223 (1) 8.1.5 Time Inconsistency and Externalities 224 (1) 8.1.6 Rules vs. Discretion 224 (1) 8.1.7 Applications 225 (2) 8.2 Fiscal Manipulation 227 (5) 8.2.1 The First Best 229 (1) 8.2.2 Electoral Risk 230 (1) 8.2.3 Discounting the Future 231 (1) 8.3 When Policy Affects Future Power 232 (9) 8.3.1 The (Political) Second Best 239 (2) 8.4 Takeaways 241 (1) 8.5 Further Readings 241 (1) 8.6 Exercises 242 (2) 9 The Need for Information 244 (38) 9.1 Auctions 246 (2) 9.1.1 Second Price Auction 247 (1) 9.2 Providing a Public Good 248 (11) 9.2.1 Split-the-Costs 250 (1) 9.2.2 Veto and Split 251 (1) 9.2.3 General Mechanisms 251 (6) 9.2.4 The Second Best 257 (2) 9.3 Regulating a Monopolist 259 (17) 9.3.1 Monopolistic Equilibrium 261 (2) 9.3.2 Regulation with Full Information 263 (1) 9.3.3 Regulation with Uncertainty 264 (7) 9.3.4 An Informed Regulator 271 (5) 9.4 Takeaways 276 (1) 9.5 Further Reading 276 (1) 9.6 Exercises 277 (5) 10 Influence over Elected Officials 282 (23) 10.1 Particularistic Interests 283 (3) 10.2 Special Interests and Campaign Donations 286 (4) 10.3 Electoral Accountability 290 (11) 10.3.1 Rewards of Office 293 (1) 10.3.2 Term Limits 293 (1) 10.3.3 Incentives and Screening 294 (1) 10.3.4 Voter Information 295 (5) 10.3.5 The Risk of Electoral Pandering 300 (1) 10.4 Takeaways 301 (1) 10.5 Further Reading 302 (1) 10.6 Exercises 302 (3) 11 Institutions, Incentives, and Power 305 (30) 11.1 A Selectorate Model 307 (7) 11.1.1 Equilibrium 308 (4) 11.1.2 Outcomes and Institutions 312 (2) 11.2 Institutions and Development 314 (4) 11.2.1 Settler Mortality, Institutions, and the Economy 315 (3) 11.3 Foreign Aid 318 (7) 11.3.1 Poverty Traps and Foreign Aid 319 (1) 11.3.2 Does Foreign Aid Work through Poverty Traps? 319 (2) 11.3.3 Effective Aid? 321 (1) 11.3.4 A Political Economy of Foreign Aid 322 (3) 11.4 Takeaways 325 (1) 11.5 Further Reading 326 (1) 11.6 Exercises 326 (2) Summing Up Constraints on Good Governance 328 (3) Concluding Reflections on Politics and Policy 331 (4) IV Appendices On Game Theory 335 (50) A Utility, Strategic-Form Games, and Nash Equilibrium 337 (25) A.1 Utility 338 (4) A.1.1 Expected Utility 338 (4) A.2 Games in Strategic Form 342 (3) A.2.1 Where to Eat? 342 (1) A.2.2 Matching Pennies 343 (1) A.2.3 Cleaning an Apartment 344 (1) A.2.4 Choosing a Number 345 (1) A.3 Nash Equilibrium 345 (2) A.4 Why Nash Equilibrium? 347 (2) A.4.1 No Regrets and Social Learning 347 (1) A.4.2 Self-Enforcing Agreements 348 (1) A.4.3 Analyst's Humility 349 (1) A.5 Solving for Nash Equilibrium 349 (1) A.6 Nash Equilibrium Examples 350 (8) A.6.1 Where to Eat? 351 (1) A.6.2 Matching Pennies 352 (1) A.6.3 Cleaning an Apartment 352 (4) A.6.4 Choosing a Number with Two Players 356 (2) A.7 Takeaways 358 (1) A.8 Exercises 358 (4) B Extensive-Form Games 362 (23) B.1 Games in Extensive Form 362 (2) B.1.1 A Model of International Crisis 363 (1) B.2 Game Trees 364 (2) B.2.1 International Crisis Game 365 (1) B.2.2 A Budget Game 365 (1) B.2.3 The Centipede Game 366 (1) B.3 Strategies as Complete Contingent Plans 366 (2) B.3.1 International Crisis Game 366 (1) B.3.2 Budget Game 366 (1) B.3.3 The Centipede Game 367 (1) B.4 Representing an Extensive-Form Game as a Strategic-Form Game 368 (1) B.4.1 The International Crisis Game 368 (1) B.4.2 The Budget Game 368 (1) B.4.3 The Centipede Game 369 (1) B.5 Nash Equilibria of Extensive-Form Games 369 (4) B.5.1 International Crisis Game 370 (1) B.5.2 The Budg