Unit 10 Women’s right to vote and the reduction in child mortality in the United States

10.12 Economic infeasibility

Many important economic actions cannot simply be enforced by the government. The government can use its powers of tax collection to provide schooling, and order that all children must attend those schools until age 16. But it cannot mandate that students study hard and learn a lot, or that teachers teach effectively.

Working hard, and investing, are examples of important but ‘difficult to command’ economic activities. Governments do not have the information or the legal authority to command wealthy individuals to use their financial resources to invest in infrastructure (other than in excep­tional circumstances such as wartime).

But there are other ways of changing behaviour through public policy. In addition to regulation and public provision of services, as outlined in Section 10.2, the government can provide incentives (through the tax system) and information, with the intention of leading people to act in a way consistent with its objectives.

For example, it can impose a tax on fuel to alter the opportunity cost of driving, providing people with an incentive to drive less. Or the central bank can lower the interest rate at which it lends to commercial banks, with the intention of inducing them to lend to households and businesses at a lower rate, and, in this way, to incentivize higher spending. Providing information about health consequences has been shown to reduce consumption of harmful products such as tobacco and alcohol.

How policies work by shifting the Nash equilibrium

Understanding how private actors respond to public policy is essential when addressing social and economic problems. Incentives matter—not only because they can be intentionally created, but because almost all government policies affect the incentives facing individual citizens, who may then change their behaviour in ways that were not intended or anticipated when the policy was designed.

For example, suppose a city government decides to impose a rent ceiling for private accommodation, with the intention of making rents more affordable for tenants. While some tenants will benefit, landlords may be less willing to make tenancies available; if so, other tenants will no longer be able to find any accommodation. (Read Section 8.13 of the microeconomics volume for an analysis of this situation.) If the incentives for landlords are not addressed, such a policy could result in a housing crisis.

Nash equilibrium

A Nash equilibrium is an economic outcome where none of the individuals involved could bring about an outcome they prefer by unilaterally changing their own action. More formally, in game theory it is defined as a set of strategies, one for each player in the game, such that each player’s strategy is a best response to the strategies chosen by everyone else. See also: game theory.

ceteris paribus

Economists often simplify analysis by setting aside things that are thought to be of less importance to the question of interest. The literal meaning of the expression is ‘other things equal’. In an economic model, it means an analysis ‘holds other things constant’.

economic feasibility

For a policy to be economically feasible, its desired outcome must be a Nash equilibrium, in which private economic actors have no incentive to undo the desired effects.

To be economically feasible, the outcome of the policy must be a Nash equilibrium, and the equilibrium must fulfil the policymaker’s objectives. In the rent control example, a situation in which rents are lower and the number of tenancies is the same as before is not an equilibrium; and if the equilibrium outcome is a housing crisis, it fails to improve the welfare of many tenants. Many of the models economists use include the ceteris paribus condition, which means other things being equal. But as economists like to point out, in many important applications of economic theory, ‘ceteris ain’t paribus’. All other things aren’t ever equal before and after the policy is implemented. Checking whether a policy is economically feasible means relaxing the ceteris paribus condition to consider all actors affected and the full set of strategies available to actors under the new circumstances.

Economic feasibility: Using food taxes to promote health

For a list and map of where nutrition taxes have been introduced, read: Global Food Research Program. 2025. ‘Sugary Drinks Taxes Around the World’, and for a specific map visit Global Food Research Program. 2025. ‘Fiscal Policies: Sweetened Beverage Taxes’. For visualizations of global data on obesity, visit World Obesity. 2024. ‘Prevalence of Obesity’.

Around 100 countries and jurisdictions around the world have introduced taxes intended to reduce the consumption of unhealthy food and drink. Many studies have found worrying increases in adult and childhood obesity, with the worldwide prevalence of obesity more than tripling from 1975 to 2022.¹ In 2022, 1 in 8 people in the world were living with obesity.

price elasticity of demand

The percentage change in demand that would occur in response to a 1% increase in price. We express this as a positive number. Demand is elastic if this is greater than 1, and inelastic if less than 1.

If the government puts a tax on a particular good, the tax will raise the price paid by consumers. Ceteris paribus, the effect would depend simply on the price elasticity of demand, which is measured as the percentage fall in the quantity demanded when the price rises by 1%.

• If demand is highly elastic: A tax will cause a large reduction in sales. In this case the tax is likely to be successful if the objective is to reduce consumption, but not as a means of raising government revenue.
• If the demand elasticity is low: A tax will have only a small effect on sales. This is desirable if the government wants to raise revenue, but the tax will be ineffective for reducing consumption.

But before deciding whether to tax (say) sugary drinks, it is important to consider who responds to the tax, and what consumers buy instead if they reduce consumption of the goods that are taxed.

In terms of who responds to the tax, the policymaker doesn’t just want to reduce total consumption, they want those people who suffer the worst health consequences to reduce consumption. In the case of sugary drinks this is primarily heavy consumers, and young people. Research by economists², and common sense, suggests that people who consume the most sugar are people who really like sugar a lot, and so are less likely to switch away from sugary drinks in response to a tax. The exception to this is young people, who tend to be highly responsive to prices.

In terms of what people substitute, if they buy fewer sugary drinks but switch to sugary snacks that aren’t taxed, then the tax will not help to reduce the negative health effects of consuming too much sugar. Economists Matthew Harding and Michael Lovenheim³ used detailed data on the food purchases of US consumers to estimate elasticities of demand for different types of food, to investigate the effects of food taxes. They divided food products into 33 categories and used a model of consumer decision-making to examine how changes in their prices would change the share of each category in consumers’ expenditure on food, and hence the nutritional composition of the diet, taking into account that the change in the price of any product would change the demand for that product and other products too.

The estimated demand elasticity for sugary snacks was relatively low, suggesting that it might be quite hard to discourage consumption by raising the price. However, Harding and Lovenheim examined the effects of 20% taxes on sugar, fat, and salt on the overall consumption of food products. (A 20% sugar tax would increase the price of a product that contains 50% sugar by 10%.) The sugar tax was found to have the most positive effect on nutrition. It would reduce sugar consumption by 16%, while also reducing fat by 12%, salt by 10%, and calorie intake by 19%.

The evidence from countries that have implemented a tax on sugary drinks is that taxes generally lead to higher prices, and a reduction in purchases of the taxed goods. In the UK, the design of the tax on sugary drinks led drinks producers to reduce the sugar content in their products, which led to larger reductions in sugar than in locations where firms have not responded in this way. Firms may also react to taxes in other ways, for example, changing their advertising strategies. If they decide to advertise more, this might offset the effects of the tax, but if they advertise less this would mean the tax had a bigger effect. Research by economists suggests that consumers in the cola market who are relatively more sensitive to advertising tend also to be particularly sensitive to prices. This means that the effect of a tax increasing prices is that advertising becomes less effective because it no longer works on the people who have already left the market due to the higher price. Since firms get less return on their advertising, they may reduce advertising.

Economic feasibility: An example from Chile

A very different illustration of the concept of economic feasibility comes from Chile and its stock market. In 1970, the socialist Salvador Allende was elected president of Chile in a surprise victory, on a platform promising greater public services and nationalization of many of the privately held firms in the country.

The reaction of the wealthy is captured in the stock market prices, shown in Figure 10.19. A stock (or share) is a share in the ownership of a company, and its price measures how much it is worth to own part of that company and as a result receive a share of its profits, and benefit in the future from selling it to another person.

Share prices rise when, taking everything into account, owners or potential buyers of shares think that the company will be more profitable in the future. When a socialist president was elected in Chile, wealthy people were worried about higher taxes, policies favouring their employees that would mean paying them higher wages, and the possibility that the government or even workers might expropriate (take over the ownership of) the firm’s assets.

These worries created a limit to the policies that would prove economically feasible for the Allende government. If the wealthy thought that the firms they owned would be less profitable in the future, they would have no incentive to invest in increasing the assets of the firm. Rather than invest in these firms, the wealthy might then just consume more or invest in another country (known as capital flight).

As Figure 10.19 shows, stock prices plummeted straight after Allende’s election day. We will pick up the Chile story in the next section: political interests as well as economic infeasibility can limit what a democratically elected government can do.

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https://core-book-server.vercel.app/macroeconomics/10-government-as-economic-actor-12-economic-infeasibility.html#figure-10-19

Figure 10.19 Stock market prices in Chile: the democratic election of a socialist president, 1970.

Proprietary data from the Santiago stock market. Time zero is the first trading day on the Santiago stock market following the election. Daniele Girardi and Samuel Bowles. 2018. ‘Institution Shocks and Economic Outcomes: Allende’s Election, Pinochet’s Coup, and the Santiago Stock Market’. Journal of Development Economics 134: pp. 16–27.

Question 10.9 Choose the correct answer(s)

Note: This question requires you to understand how to find a Nash equilibrium. Review these concepts by reading Sections 4.2 and 4.3 of The Economy 2.0: Microeconomics .

The figure shows pay-offs from the interaction between a government and a firm. Each party has two options: the government can either set moderate taxes or high taxes on the firm owner’s profits; the firm can either pay taxes at the statutory (government-intended) rate, or hire tax lawyers to exploit loopholes in the tax laws to minimize the tax it pays. The government aims to maximize tax revenue while the firm aims to maximize its after-tax profits. Based on this information, read the following statements and choose the correct option(s).

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• The outcome due to the policy is a Nash equilibrium and is Pareto efficient.
• The government’s tax policy is economically feasible.
• If lawyers became more expensive to hire, then outcome B might be the final outcome.
• If the government closed most of the tax loopholes, then outcome B might be the final outcome.

• It is true that outcome D is a Nash equilibrium. However, outcome A is better for both the firm and the government compared to outcome D, so outcome D is not Pareto efficient.
• To be economically feasible, the outcome of the policy must be a Nash equilibrium, and the equilibrium must fulfil the policymaker’s objectives (maximize tax revenue). Neither condition holds in this case.
• For example, if the cost of hiring a lawyer exceeded the savings ($40 million), then firms would choose not to hire lawyers, resulting in B being a Nash equilibrium.
• If the firms saved less in taxes than they would spend in hiring a lawyer to identify the loopholes, then firms would choose not to hire lawyers, resulting in B being a Nash equilibrium.