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Subject ECONOMICS

Paper No and Title 7: Theory of Public Finance

Module No and Title 14: Voting Systems; revealing social preferences through
majority voting-Arrow impossibility theorem
Module Tag ECO_P7_M14

ECONOMICS Paper 7: Theory of Public Finance

Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem
____________________________________________________________________________________________________

TABLE OF CONTENTS
1. Learning Outcomes
2. Introduction
3. Voting Systems
4. Direct Democracy
5. Representative Democracy
6. Leviathan Hypothesis
7. Arrow’s Impossibility Theorem
8. Summary

ECONOMICS Paper 7: Theory of Public Finance

Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem
____________________________________________________________________________________________________

1. Learning Outcomes
After studying this module, you shall be able to

 Know the collective decisions about public finance and public finance made by
voting
 Understand why democratic voting is superior to randomly select a person from
the society where he/she will be expected to make collective decisions on behalf
of everyone
 Understand the concept and meaning of Direct Democracy
 Know about the representative Democracy
 Understand the Leviathan Hypothesis and Arrow’s impossibility theorem

2. Introduction
Voting represents collective decisions. While studying the allocation of public good
(Samuelson, 1955) we assume that somehow the policymakers will be able to estimate
the marginal benefit curve of the consumers (of public good), which will be nothing but
vertical summation of demand curve (i.e., marginal benefit curve) of each and every
consumer. Such a demand curve is called as pseudo-demand curve.
But at the same time it is acknowledged by public economists that it is misleading to
conclude that the social goods can be provided by market mechanism of demand and
supply. As social goods are typically non-rival in consumption(a non-rival good is a good
which may be consumed by many at the same time at no additional cost -- for example,
national defence or a piece of scientific knowledge.) exclusion is not possible and hence
the consumers will not reveal their preferences voluntarily. Furthermore, the will be
convinced that their decision of not contributing towards the provision cost, will have no
effect on provision because number of consumers will be very large.

ECONOMICS Paper 7: Theory of Public Finance

Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem
____________________________________________________________________________________________________

In this type of situation, use of political process becomes a must. The political process
can help in two ways:
 Through political process, preferences can be revealed and government can
decide for the provision of public good i.e., which public good people really want
 As provision cost will be involved, political process can further suggest the course
of revenue generation for the provision.
In this context, Musgrave and Musgrave (1973) write, “ Individuals, knowing that they
must comply with the majority decision, will find it in their best interest to vote for that
solution which will move the outcome closer to their own desires, and in this way, they
will be induced to reveal their preferences.”

3. Voting Systems

While casting a vote, people may or may not be aware of the enormous responsibility it
involves. According to Hillman (2003), “ ...because the probability of one person’s vote
being decisive in large voting populations is effectively zero, the reason why people vote
may not be that they expect to influence the outcome of voting. Voting may be
expressive: voters may express themselves by identifying with a policy or with a
candidate, as they might, for example, cheer for and identify with a sports team and be
happy or sad according to whether “their” team wins; or, by expressing support for a
candidate or political party, a voter may be communicating with and seeking approval
from other people. People may also vote as an act of civic duty: they have been taught
that taking the time to vote is correct pro-social behavior. Their utility from voting may
be from democratic participation.”
But in an ideal set-up, if voting is to be used as an efficient mechanism for preference
revelation, the revenue generation decision and the public spending decision, both should
be linked to it. Voters are then confronted to choose from various budget proposals each
of which will carry a price tag in terms of their own contribution.
ECONOMICS Paper 7: Theory of Public Finance
Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem
____________________________________________________________________________________________________

Another option can be that instead of democratically choosing to make the collective
decisions on public policy and finance through voting (mainly on what to provide and
how to finance the provision), we can randomly select a person from the society and
he/she will be expected to make collective decisions on behalf of everyone. Will such a
randomly selected representative person make better decisions as compared to the
collective decision of voters? Or is democracy more desirable? Answer to this type of
dilemma can be found in Condorcet jury theorem, given by Marquis de Condorcet
(1785).

The Condorcet jury theorem presupposes that all voters have the same objectives and the
only question concerns how an agreed common objective can best be achieved. For
example, there are two alternative proposed means, A and B, of seeking to achieve
efficiency. One means is correct and the other incorrect. The correct choice is A.
However, there is uncertainty or imperfect information among voters, who only know
that A is the correct decision with some probability. Under the conditions of the
Condorcet jury theorem, the probability is taken to be the same for everyone and exceeds
0.5. The commonly held probability that A is the correct choice might, for example, be
0.6. Voters then randomize (as in the case of mixed strategies) and vote for alternative A
with 60 percent probability (and for alternative B with 40 percent probability). The
collective decision is determined as the alternative with the majority (more than 50
percent) of votes. The Marquis de Condorcet showed that if everyone votes without being
influenced by how others vote, then – as the number of voters increases – the likelihood
that the correct decision A will have majority support increases. As the number of voters
becomes very large, the likelihood that the majority makes the correct decision
approaches certainty.
Though as concluded by Hillman (2003), “The Condorcet jury theorem is not applicable
to many of the questions that we generally confront in the study of economics. People
differ, for example, in preferences regarding public spending on public goods and about

ECONOMICS Paper 7: Theory of Public Finance

Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem
____________________________________________________________________________________________________

who should pay taxes that finance the public spending. They may be affected differently
by externalities – or may be the sources of externalities. If the vote is on income
redistribution, voters are usually influenced by whether they personally gain or lose from
an income-redistribution proposal. They may also be influenced by whether low-income
people gain or lose. The Condorcet jury theorem, which is based on a single objective
common to all voters, provides no answers about voting outcomes when people have
different objectives”, this theorem shows that in the presence of information limitations,
the collective decisions of democracy are preferable to dictatorship – and also to
randomly selecting someone to make decisions on behalf of society – and this is so even
if the dictator or randomly selected decision maker seeks an objective on which everyone
agrees.
As it is clear that determination of budget is more of a political process than market
process, let us now examine the political process more closely. We will broadly talk
about
 Direct Democracy
 Representative Democracy; and
 Leviathan Hypothesis

4. Direct Democracy

Direct democracy is a system in which referendum among the voters determines the final
outcome on fiscal decisions. Whatever decision is reached by voting is considered to be
binding on the voters. Given the non-excludability of a social good and large number of
voters, a rational voter is aware of the fact that his or her individual vote has very less
probability of affecting the final outcome. Still if he or she chooses to vote, it is because
of their sense of responsibility. In this context Musgrave and Musgrave (1973) observe,
“...such action may not reflect a narrowly defined act of ‘rational behaviour’ but happily,
human action is not limited to that premise.

ECONOMICS Paper 7: Theory of Public Finance

Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem
____________________________________________________________________________________________________

Under direct democracy, there can be alternative voting rules. Majority rule is one where
each individual has one vote and majority wins.

In context of majority voting, median voter theorem emphasizes that such a majority
voting will ultimately lead to an outcome which will be the one most preferred by
the median voter.

To explain the concept, we can take example of a hypothetical country or economy where
three voters X, Y and Z have to make a choice about public spending.
Let X opts for a spending decision of 1000 Rs, Y for 2000 Rs and Z for 4000 Rs. In this
example Y can be called as the median voter ( because he is in middle of X and Z).Each
individual will opt for a public spending decision which is closer to their preferred
spending amount, to those that are farther from it. We can easily conclude that Y, being
the median voter Will always casts his vote for the policy that is adopted and his
preferred policy decision will defeat any other.
The median voter theorem explains many intricacies of majority voting viz.
 The decision of politicians to opt for similar campaigns (more towards middle
ground, rather than having extremist views) so that the median voter can be
lured;
 This theorem also provides convincing explanation to the fact that in a majority
voting system generally two major political parties who will co-opt the platforms
of the minor parties in order to secure more votes.

5. Representative Democracy

This approach is strongly influenced by the concept of ‘Self Interest’ given by Adam
Smith. Both politicians and voters will be guided by self interest in their behaviour. The
politicians will seek to maximise the votes in order to stay in power and secure re-
election. The objective of the voter is to maximise the net benefits from any fiscal
activity. Here, by net benefit voters will imply the difference between benefit from public
ECONOMICS Paper 7: Theory of Public Finance
Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem
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expenditure and cost of taxes to finance this expenditure. In such a situation, the voters
will seek to elect those who will best represent their interests and the politicians will offer
promises and programmes that best satisfy the voters.
In representative democracy, role of coalitions also becomes very important. Some
policies may not be supported by voters if they are considered in isolation, but the same
may win acceptance if are considered in coalition.

6. Leviathan Hypothesis

The Leviathan model of government was given by Brennan and Buchanan (1980).
Leviathan is a sea monster referenced in the Testament, the first section of the Christian
Bible. Brennan and Buchanan (1980) assumed government to act as a monopolist that
maximizes tax revenues. Such representation is given under the assumptions of (1)
rational ignorance (2) fiscal illusion and (3) outright collusion among elected officials
which ultimately deprive voters (who are the taxpayers too) of any control they may have
over government. According to this hypothesis, monopolization of government activity
leads to an ability to extract revenue from citizens. The more decentralized the fiscal
relations between levels of government, the less monopoly power can be exerted in tax
collection.

7. Arrow’s Impossibility Theorem

The theorem was given by Kenneth Arrow in 1950. He showed that there is no
constitutional rule that will satisfy the list of reasonable ‘conditions’ of correspondence.
He enlists five conditions of correspondence, viz.,
 Collective nationality i.e., convexity and transitivity must be there. Convexity
means that the outcomes must be comparable. Transitivity means if X is preferred
to Y, Y is preferred to Z, then X must be always preferred to Z.
ECONOMICS Paper 7: Theory of Public Finance
Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem
____________________________________________________________________________________________________

 Pareto Principle i.e., if all members of a community prefer X to Y, then the

collective choice that emerges from a constitutional rule must also indicate that X
is preferred to Y.
 Independence of irrelevant alternatives i.e., if the choice has to be made between
two alternatives X and Y, this choice should not be influenced by the ranking of
either X or Y with other alternatives such as Z or A.
 Non-dictatorship
 Unrestricted domain i.e., no individual should be excluded from contributing to
the establishment of a collective choice, provided that the individual has a
transitive order of preferences.

The Arrow Impossibility theorem shows that no constitutional rule will comply with
all these conditions. This can be explained by the forthcoming example given in
Cullis and Jones (1998).
Table 1 : The Arrow Impossibility theorem (Majority Voting)
Options
Voters X Y Z
A 3 2 1
B 1 3 2
C 2 1 3

Table 2: Outcome dependency on agenda setting

Vote between Vote between Outcome
Y v. X X v. Z Z
X v. Z Z v. Y Y
Z v. Y Y v. X X

ECONOMICS Paper 7: Theory of Public Finance

Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem
____________________________________________________________________________________________________

In table 1, three individuals (voters A, B and C) choose between three alternatives, X, Y

and Z. The rankings of the individuals are shown as 3, 2, 1 (in order of preference, 3
being the most preferred).It is clear that the each voter has a transitive preference order.
(Transitivity means if X is preferred to Y, Y is preferred to Z, and then X must be always
preferred to Z).
If a collective decision was required as between X and Y, majority would choose X (
voters A and C); between Y and Z, a majority would opt for Y( voters A and B).As a
consequence, to satisfy the condition of collective rationality, majority voting should lead
to a preference for X rather than Z. However, in the example voters B and C constitute a
majority in favour of Z rather than X. In this way, the simple majority voting fails the
Arrow test.
The final winner is dependent on which vote is taken first. The sequence of votes given in
table 2, indicate alternative winners.

ECONOMICS Paper 7: Theory of Public Finance

Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem
____________________________________________________________________________________________________

8. Summary
Let us now summarize what we have learnt in this module:

 Voting represents collective decisions.

 It is misleading to conclude that the social goods can be provided by market
mechanism of demand and supply. As social goods are typically non-rival in
consumption, exclusion is not possible and hence the consumers will not reveal
their preferences voluntarily.
 In this type of dilemma, through political process, preferences can be revealed and
government can decide for the provision of public good i.e., which public good
people really want
 Furthermore, as provision cost will be involved, political process can further
suggest the course of revenue generation for the provision.
 Another option can be that instead of democratically choosing to make the
collective decisions on public policy and finance through voting (mainly on what
to provide and how to finance the provision), we can randomly select a person
from the society and he/she will be expected to make collective decisions on
behalf of everyone. Will such a randomly selected representative person make
better decisions as compared to the collective decision of voters? Or is democracy
more desirable? Answer to this type of dilemma can be found in Condorcet jury
theorem. The Condorcet jury theorem presupposes that all voters have the same
objectives and the only question concerns how an agreed common objective can
best be achieved.

 Direct democracy is a system in which referendum among the voters determines

the final outcome on fiscal decisions. Whatever decision is reached by voting is
considered to be binding on the voters. Under direct democracy, there can be

ECONOMICS Paper 7: Theory of Public Finance

Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem
____________________________________________________________________________________________________

alternative voting rules. Majority rule is one where each individual has one vote
and majority wins.
 Representative Democracy is strongly influenced by the concept of ‘Self Interest’
given by Adam Smith. Both politicians and voters will be guided by self interest
in their behaviour. In representative democracy, role of coalitions also becomes
very important. Some policies may not be supported by voters if they are
considered in isolation, but the same may win acceptance if are considered in
coalition.
 The Leviathan model of government assumes government to act as a monopolist
that maximizes tax revenues. According to this hypothesis, monopolization of
government activity leads to an ability to extract revenue from citizens. The more
decentralized the fiscal relations between levels of government, the less monopoly
power can be exerted in tax collection.
 Arrow’s impossibility theorem shows that there is no constitutional rule that will
satisfy the list of reasonable ‘conditions’ of correspondence.

ECONOMICS Paper 7: Theory of Public Finance

Module 14: Voting Systems; revealing social preferences through majority
voting-Arrow impossibility theorem