Answer to Question #241298 in Macroeconomics for mnb

Question

One of the most important taks of a government bureaucracy is to subcontract, by tender, the provision of goods and sevices. This intervention can give rise to rent-seeking corruption. Explain and graphically illustrate how rent seeking can undermine the efficiency in the economy.

Answer 1

 

Rent seeking is an economic concept where an entity tends to raise its own share of wealth without any reciprocal contribution of productivity or creation of any new wealth. This leads to reduced economic efficiency which is as a result of misallocation of resources, reduced wealth-creation, lost government revenue, elevated income inequality and prospective national decline. Rent-seeking drastically interrupts market efficiencies creating pricing disadvantages to market participants. This causes limited competition and limits entry to the market. The beneficiaries of rent-seeking strategy also receives added economic rents without added duties. This creates unfair advantages by providing wealth to certain businesses that lead to greater market shares at the disadvantage of competitors. Also, rent-seeking is a function of taxpayer funding. These tax revenues are only beneficial for rent seekers but may not produce any profits to taxpayers in general. This leads to downgrading of funds that lack revival and will require higher taxes in the future. There are two sources of waste in rent-seeking and include the deadweight loss that results from lower consumption and the second type of waste is substitution of goods due to higher prices. The dead weight loss is represented by region H in the graph. Q₁ is the quantity of the good that would be sold at price P₁ at a certain level of demand. Q₀ is the quantity of a cheaper good which is imported and is sold at price P₀ in absence of any tariff. The region H is the only loss of welfare resulting from lesser demand due to higher prices resulting from the tariff. The rest of the effect is simply a welfare-neutral transfer of wealth from foreign to domestic producers. The trapezoid formed by region H and T describes the high and socially wasteful costs of rent seeking.