The George Washington University

Department of Economics
Economics 2167 - Economics of Crime
A. Yezer Third Problem Set Answers Spring 2018

1a. Individuals who have careers in sports or entertainment often engage in gambling or
high risk investing that results in substantial losses. How might an economist explain this
association? These are all high risk activities in the sense that it is possible to earn substantial
sums but also possible to earn very little or even lose everything. Indeed in gambling the
expected return is negative and the variance high. Risk seekers are attracted to all these
activities.

1b. Claire has a job as a loan officer working in the Bank of Kansas where she earns
$100,000 per year. However, she chose to supplement her income by taking $80,000 in bribes to
originate a number of fraudulent loans. If she is caught, she will lose her job and the $80,000 will
be sized by the bank in a civil judgement. Given that the probability of such behavior by a bank
employee resulting in conviction is 0.5, what can you conclude about Claire’s level of risk aversion?
Claire can earn $100,000 risk free at the Bank of Kansas if she is careful in approving
loans. Her expected return if she approves fraudulent loans is E(y) = 0.5 (0) + 0.5(180,000)=
$90,000. So Claire engages in approval of fraudulent loans when the expected return to fraud
of $90,000 is less than the certain income of $100,000. She must be a risk seeker.

2. In some parts of the US, alligators are allowed to roam freely. Indeed some people have
pet alligators on their unfenced property. There are no criminal penalties for having alligator pets or
for allowing them to occupy an unfenced yard. Any damage done by the alligator can be the object
of civil action. In other parts of the country, allowing an alligator to roam freely in on unfenced land
could result criminal penalties even if the animal did not damage anyone or any property. As an
economist, how might you rationalize the difference in treatment of alligator pets?
As an economist, you would conclude that, where there a no criminal penalties for allowing an
alligator to wander, the externality must be small. But criminal penalties are invoked when
externalities are large. Why might externalities be small? Perhaps in areas that have lots of
alligators wandering about naturally might provide a situation where one alligator more or
less has little incremental effect on externalities. But appearance of an alligator in an area
where none are expected could be alarming to the general public.

3a. Campaign finance reform is changing. Consider a politician who is faced with the need
for funds to be reelected. There are two strategies to take, ethical and unethical (E and U
respectively). The politician can allocate fund raising time, T, between t E and tU. Assume that an
hour spent raising funds ethically raises only half as much as an hour spent raising funds
unethically. Further assume that the current system provides for discovery in terms of investigative
reporting and sanctions in the form of bad publicity. Assume that the sanction for unethical
fundraising is that the politician, has to give back ALL of the funds raised illegally. Further assume
that the probability of sanction = p (you can make up an initial value of p if you wish. Set up
a model of the current system using a state preference model diagram (you can substitute specific
values for T, and the amount of funds raised legally (then illegal funds are just twice as large) as
well as p. Identify the factors that determine the allocation of political effort to tU.
Given the material that we have covered, there are two ways
to set up this model. The most straightforward application of theory is to treat this as
a state preference model in which the politician maximizes expected utility of campaign funds.
Simply adapt the Ehrlich model so that total time T = tE + tU and fund raising is an increasing
function of time spent on each activity so that total ethical funds is fE = FE(tE) and similarly for
unethical funds we have fU = FU(tU). Now plot the Funds Possibility Frontier on the diagram.
Total funds if completely ethical are: f0+FE(T)
Total funds raised if completely unethical and not discovered are given by:
fN = f0 + FU(T).
Total funds raised if completely unethical and discovered are given by:
fD = f0 + FU(T) - S(T) and, given that FU(tU) = S(tU), this means that: fD = f0
This is all that is needed to plot the Funds Possibility Frontier and analyze political
choice using the standard Ehrlich state preference model of crime diagram shown below. Plot
the FPF (funds possibility frontier) beginning with the point in which an indifference curve
based on expected utility given above is tangent to a utility possibility frontier based on the
tradeoff between fD and fM shown above.

Funds if not Discovered

f0+FU(T) Optimal Time Allocated

Funds Possibility
Frontier

f0 + FE(T)

f0 = f0+FU(T)-S(tU) f0+FE(T) Funds if Discovered

The diagram shows a risk averse politician and assumes a level of enforcement so that the
probability of conviction, pc, is low, making the indifference curve slope at the certainty line,
−pc/(1−pc) rather flat. Given this low probability of conviction and the slope if the FPF, it
appears that there will be lots of time spend raising unethical funds.
 3b. What types of "election finance reform" might change the system? What if we give candidates
funds automatically? How does the model change? What if they can earn these funds though expenditure of
a certain amount of time? Consider your own alternative.
Public funding of candidates raises f0 in the equations above. This does not necessarily
reduce unethical fund raising in an Ehrlich model. THIS IS VERY IMPORTANT AND
COUNTERINTUITIVE TO MOST PEOPLE. Giving candidates $ that they don't have to
raise, shifts the frontier out parallel to the old frontier. This does not necessarily lower the
level of unethical behavior just as raising wealth does not necessarily lower criminal behavior
generally! Note how easy it is to use the model to analyze the policy of giving election funds.

To lower tU and raise tE, policies need to flatten the Funds Possibility Frontier. Note
how the model shows you the possible solutions. There are two ways to flatten the FPF.
1.Raise the return to time spend raising funds ethically. This could be done by
matching ethical funds with public funds. This would raise FE(T) and rotate the FPF
couinterclockwise around the upper point where tU = T. The problem with this approach is
that it must be possible to identify funds raised ethically.
2.Raise sanctions S(tU) which rotates the FPF counterclockwise around the certainty
line and flattens its slope. The problem with raising sanctions is that the government is being
asked to enforce laws against politicians but politicians control the government. It might even
be possible for one group of incumbent politicians to raise false sanctions against those out of
power who are trying to raise funds.

4. Assume that you are working for the government or a private non-profit organization. You are
asked to devise a plan to reduce the number of burglaries in a given area at modes cost. Set up the market for
crime diagram with an initial equilibrium level of burglary. Then indicate what strategy you would
recommend and using the diagram, indicate the effect of your strategy on (1) the number of burglaries, (2) the
gross of sanctions returns to burglary, (3) the net of sanctions return to burglary. The point is to use the
market for crime diagram to establish the effects of your recommendation.
Return to burglary

S+pcs

π
π* S

π−pcs
π*−pcs
D* D

B* B burglaries per week

The initial setup generates the starting conditions for the market. Supply of effort is
given by S, supply gross of sanctions is S+pcs, and demand is D. Equilibrium where supply
gross of sanctions cuts demand from below occurs when burglary effort = B, and gross of
sanction return is π while net of sanction return is π−pcs.

My proposed policy change (you could, of course, choose another approach but mine is
very inexpensive) is to subsidize the sales price of burglar alarms. It is likely that the most
vulnerable would be induced to purchase these alarms and that would shift demand down but
also rotate it because the downward shift would be most pronounced near the vertical axis
where the most attractive targets are. This is shown by the D* demand curve. Note that
subsidizing crime prevention is virtually never considered as part of public or even non-profit
approaches to crime prevention. The result is a fall in burglary to B*, and the gross of
sanction and net of sanction returns both fall also.

It is curious that public policy subsidizes (sometimes even gives away) smoke and fire
alarms in spite of the fact that the benefits of installing these are private but there are no
policies to lower the cost of alarms, bars, deadbolt locks, etc. This shows the difference in
economic and muggle thinking about public policy toward crime.