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American Economic AssociationThe Peculiar Economics of BureaucracyAuthor(s): William A. NiskanenSource: The American Economic Review, Vol. 58, No. 2, Papers and Proceedings of theEightieth Annual Meeting of the American Economic Association (May, 1968), pp. 293-305Published by: American Economic AssociationStable URL: http://www.jstor.org/stable/1831817 .Accessed: 23/09/2013 16:46Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at ms.jsp.JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range ofcontent in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new formsof scholarship. For more information about JSTOR, please contact support@jstor.org.American Economic Association is collaborating with JSTOR to digitize, preserve and extend access to TheAmerican Economic Review.http://www.jstor.orgThis content downloaded from 128.195.160.103 on Mon, 23 Sep 2013 16:46:04 PMAll use subject to JSTOR Terms and Conditions
NONMARKETDECISION MAKINGTHE PECULIAR ECONOMICS OF BUREAUCRACYBy WILLIAM A. NISKANENInstitutefor DefenseAnalysesI. IntroductionEconomics does not now provide a theory of the maximizing bureaucrat. The currently dominant approach to public administration is toprovide the organizational structure, information system, and analysisto bureaucrats who, for whatever reason, want to be efficient. Thisapproach,however, does not develop, or explicitly recognizeas relevant,the conditions for which the personal objectives of the bureaucrat areconsistent with the efficiencyof the bureaucracy.At present, with a large and increasing proportion of economic activity being conducted in bureaus, economists have made no substantialcontribution to answering the following questions: What are the distinguishing characteristics of bureaucracies? What are the criticalelements of a theory of bureaucracy?Specifically, what do bureaucratsmaximize and under what external conditions? What are the consequences of maximizing behavior under these conditions? For example,what is the equilibriumoutput and budget of a bureaufor given demandand cost conditions? What are the effects of changes in demand andcost conditions? What are the welfare consequences of bureaucraticorganization of economic activity? What changes in organization andthe structure of rewardswould improve the efficiencyof a bureaucracy?This paper presents a simple model of the maximizing bureaucrat and,based on this model, a set of tentative qualitative answers to thesequestions.II. The ModelThe model outlined in this section is based on the following twocritical characteristics of bureaus: (1) Bureaucrats maximize the totalbudget of their bureau, given demand and cost conditions, subject tothe constraint that the budget must be equal to or greater than the minimum total costs at the equilibrium output. (2) Bureaus exchange aspecific output (or combination of outputs) for a specific budget. Forthis paper, thus, bureaus are defined by these two characteristics.Among the several variables that may enter the bureaucrat's utilityfunction are the following: salary, perquisitesof the office,public reputation, power, patronage, ease of managing the bureau, and ease of mak293This content downloaded from 128.195.160.103 on Mon, 23 Sep 2013 16:46:04 PMAll use subject to JSTOR Terms and Conditions
294ECONOMIC ASSOCIATIONAMERICANing changes. All of these variables, I contend, are a positive monotonicfunction of the total budget of the bureau.' Budget maximization shouldbe an adequate proxy even for those bureaucrats with a relatively lowpecuniary motivation and a relatively high motivation for makingchanges in the public interest. It is an interesting observation that themost distinguished public servants of recent years havesubstantiallyincreased the budgets of the bureaus for which they are responsible.The second characteristic-bureaus exchange their output for a totalbudget rather than at a per unit rate-is generally recognized, but theimplications of this characteristicfor the behavior of a bureau are not.This characteristicgives the bureau the same type of "market" poweras a monopoly that presents the market with an all-or-nothing choice.2A bureau, thus, can appropriateall of the consumersurplus. As is shownlater, however, this characteristicleads to significantly different output,budget, and welfare conditions for a bureau than for a monopoly.3The equilibriumconditionsfor a bureau, as definedby these two characteristics, are developed below by consideringa bureau faced by lineardemand and cost conditions. First, consider a bureau that buys factorsin a competitive market and for whichV a-bQandC c 2dQ,4whereV- marginal value to consumersC sminimum marginal cost to bureauandQ--zoutputof bureau.For these conditions, then,B aQ -b2-Q21 This paper develops only the static model of a bureau and does not explore the timedimension of budget maximization.2 I am indebted to Gordon Tullock for this powerful insight.3 This characteristic applies strictly to a "pure" bureau, such as the Department of Defense.Many economic institutions such as the Post Office, most colleges and universities, and mosthospitals sell part of their output at a per unit rate and a substantial proportion of their outputfor a budget.4 The marginal cost function for a bureau that is not a discriminating monopsonist includesthe factor surplus. The average cost function to this bureau and the corresponding marginalcost functions for a monopoly or bureau which is a discriminating monopsonist would beC c dQ.This content downloaded from 128.195.160.103 on Mon, 23 Sep 2013 16:46:04 PMAll use subject to JSTOR Terms and Conditions
NONMARKETDECISIONMAKlNG295andTC cQ dQ2,whereB total budget of bureauandTC minimum total cost to bureau.The equilibriumlevel of Q, for these conditions, is determinedas follows:Maximization of B leads to an upper level of Q a/b. The constraintthat B must be equal to or greater than TC, under some conditions,leads to a lower level of Q 2(a-c)/b 2d.These two levels of Q areequal where a 2bc/b - 2d. For a bureau that buys factors in a competi-tive market, the equilibriumlevel of Q, thus, is where2(a - c)b 2da bfor a for a 2bcb-2d2bcb-2dFigure 1 illustrates these equilibriumlevels of output for representative demand and cost conditions.For the lower demand condition represented by VI, the equilibriumoutput of a bureau will be in the budget-constrainedregion where thearea of the polygon ealki is equal to the area of the rectangle efgi. At theequilibrium level of output, there is no "fat" in this bureau; the totalbudget just covers the minimum total costs, and no cost-effectivenessanalysis will reveal any wasted resources. The output of this bureau,however, is higher than the Pareto-optimal level. The equilibriumlevelof output is in a region where the minimum achievable marginal costsig are substantially higher than the marginal value to consumers ih,offsetting all of the consumer surplus that would be generated by efficient operation at lower budget levels. If minimum marginal costs increase with output as a consequence of increasing per-unit factor costs(rather than diminishing productivity), this bureau will generate asubstantial factor surplus equal to the triangle cfg-larger than wouldbe generated at the lower, Pareto-optimal output. Legislatures predominantly representing factor interests understandably prefer theprovision of public services through bureaus.For the higher demand conditions representedby V2, the equilibriumoutput of a bureau will be in the demand-constrainedregion where themarginal value of output is zero. In this case the total budget will beThis content downloaded from 128.195.160.103 on Mon, 23 Sep 2013 16:46:04 PMAll use subject to JSTOR Terms and Conditions
AMERICAN296ECONOMIC ASSOCIATIONa2af2(aI-c)b 2da2bFI&GuRE1EQUILIBRIUMOUTPUT or BUREAUequal to the triangle ea2land will be largerthan the minimum total costsequal to the rectangle ejkl. At the equilibrium level of output, there is"fat" in this bureau. A careful analysis would indicate that the sameoutput could be achieved at a lower budget, but the analyst shouldexpect no cooperation from the bureau since it has no incentive to eitherknow or reveal its minimum cost function. In this region, the equilibriumlevel of output is dependent only on demand conditions. The output ofthis bureau is also higher than the Pareto-optimal level, operating at anoutput level where the minimum marginal costs are equal to Ik and themarginal value to consumers is zero, again offsetting all of the consumersurplus. The factor surplus generated by this bureau, of course, is alsosubstantially larger than would be generated by a lower, Pareto-optimaloutput level.III. Comparisonof OrganizationalFormsA better understanding of the consequences of bureaucratic organization of economic activity can be gained by comparison with theconsequences of other forms of economic organization facing the sameThis content downloaded from 128.195.160.103 on Mon, 23 Sep 2013 16:46:04 PMAll use subject to JSTOR Terms and Conditions
297NONMARKET DECISION MAKINGdemand and cost conditions. Table 1 presents the equilibrium levels ofoutput and related variables for a private monopoly which buys factorson a competitive market, a private monopoly which discriminatesamong factor suppliers, a competitive industry, a bureau which buysfactors on a competitive market, and a bureau that discriminatesamongfactor suppliers. Each form of organization faces the same followingdemand and cost conditions:V200 -1.00 QC 75 .25 Q.5TABLE 1EQUILIBRIUMCONDITIONSFOR ALTERNATIVEFORMS OF ECONOMICORGANIZATIONFACING SAME DEMAND AND COST CONDITIONSFactor MarketCompetitiveBureauCompetitiveMonopolyProduct uresOutput .Revenue:Total.Average .Marginal .Costs:Total .Average .Marginal .Profits .Consumer surplus.Factor surplus . . 93,472.21,543.3010,00010010005,0001 , ,37587.5100.03,1251,250312.5The traditional concern about private monopolies is that they produce too little output. Operating in an output region where marginalvalue is greater than marginal cost, they do not generate as muchsurplus value as would a competitive industry. For the demand andcost conditions shown in Table 1, a private monopoly would generatea sum of profit plus consumerand factor surplus around 75 percent thatof a competitive industry.For these demand and cost conditions, a bureau that buys factors ona competitive market will have an equilibriumoutput around two-thirdsmore than the competitive industry. This bureau will generate no profitsor consumersurplusbut will generate a factor surplusaround 55 percentof the total surplus from a competitive industry. For these conditions,I This is the average cost function to a monopoly or bureau that is not a discriminatingmonopolist, the marginal cost function to a discriminating monopsonist, and the supply function to a competitive industry.This content downloaded from 128.195.160.103 on Mon, 23 Sep 2013 16:46:04 PMAll use subject to JSTOR Terms and Conditions
298AMERICANECONOMIC ASSOCIATIONa bureau that discriminates among factor suppliers will have an equilibrium output twice that of a competitive industry and will generateno profits or surplus value.A comparison of the supply and cost conditions is also helpful. Amonopoly has no supply function; it will set an output such that marginal revenue equals marginal cost, with the output sold at a uniformprice. A bureau also has no supply function; it will exchange incrementsof output at the demand price for each increment to an output levelsuch that the budget equals the minimum achievable costs or the marginal value of the increment is zero. In a sense, a bureau also has no separate marginal cost function. The incremental resource withdrawal for abudget-maximizingbureau will be equal to the demand value, as thedifference between this value and the minimum incremental cost willbe financed from the consumer surplus appropriated at lower outputlevels. Only if a bureau is efficient at lower output levels, for whateverreason, would the incremental resource withdrawal be equal to theminimum incremental cost. One implication of this condition is that ananalyst may not be able to identify a demand-constrained bureau'sminimum cost function from budget and output behavior. All this mayyield is the bureau's estimate of its demand function; in the static case,all bureaus will appear to have declining marginal costs and in a sensethey do. An estimate of a demand-constrainedbureau'sminimum marginal cost function must be constructed from detailed estimates of theproduction function and factor costs-creating an extraordinary demand for analysis.For different reasons, in summary, both private monopolies andbureaus operate in output regions that are inherently nonoptimal. Thesubstitution of a bureau for a monopoly to provide some product orservice, however, solves no problems; this substitution will reduce theaggregate surplus value and serve only the interests of the owners ofspecific factors.IV. Effects of Changesin Demand and Cost ConditionsThe model outlined in Section II may also be used to estimate abureau'sresponse to changes in demand and cost conditions.Demand Shifts. Figure 2 illustrates the changes in a bureau's equilibrium output and budget, for given cost conditions, in response toshifts in demand.In the budget-constrainedoutput region, the output of a bureau willgrow by more than the amount of a demand shift, even when faced byincreasing marginal costs. A bureau producing an output at constantmarginal costs will grow at twice the rate of a competitive industryunder the same conditions. In this region, the budget per unit outputThis content downloaded from 128.195.160.103 on Mon, 23 Sep 2013 16:46:04 PMAll use subject to JSTOR Terms and Conditions
NONMARKETDECISION40080, 000300a - variableb 1C 75d 0.2560,000/BQ E 2EFFECTS OF DEMAND SHIIFTwill increase only by the amount of the increase in the minimum unitcosts.In the demand-constrainedoutput region, the output of a bureau willgrow by the same amount as the demand shift, regardlessof the slope ofthe minimum marginal cost function. The slower rate of growth of abureau in this region is still higher than the rate of growth of a competitive industry facing increasingmarginalcosts. In this region, the budgetper unit output increases rapidly, by an amount proportionate to thedemand shift, regardless of the slope of the minimum marginal costfunction.A bureau, like a private monopoly, will often find it rewardingto tryto shift its demand function. The incremental budget that would resultfrom a demand shift will be particularlyhigh in the demand-constrainedoutput region. One would expect, therefore, that bureaucrats wouldspend a significant part of their time on various promotional activities,supported by the owners of specific factors.Changesin the Demand Slope. Figure 3 illustrates the changes in aThis content downloaded from 128.195.160.103 on Mon, 23 Sep 2013 16:46:04 PMAll use subject to JSTOR Terms and Conditions
300AMERICANECONOMIC ASSOCIATIONbureau's equilibrium output and budget, for given cost conditions, inresponseto changes in the slope of the demand function. The indicatedchanges in the intercept and slope are such that the output of a competitive industry, given the same cost conditions, would be constant ata level of 100 for each combination.32, 000170160*:15028, 00024, 000Q 14020,0004*.130120/a - variableb - variable16,OOOC 75d O0.25L112.5 150 200 250 300aIIL I I.125 .50 1.0 1.52.040012,000500I13.04.0bFIGURE 3EFFECTS OF CHANGES IN THE DEMAND SLOPEIn the budget-constrainedoutput region, the equilibriumoutput of abureau will increase with increasing (negative) demand slopes; in thedemand-constrainedregion, output will decline with increasing demandslopes. A bureau faced by a nearly horizontal demand function willproduce an output at a budget per unit output only slightly higher thanthat of a competitive industry, but the total budget and the budgetper unit output will increase monotonically with higher demand slopes.This suggests that a bureau may find it rewardingto try to increase theslope of the demand function for its output by promotional activitiesciting public "need" or military "requirement"to be fulfilled regardlessof cost. A more important suggestion is that a bureau operating in ahighly competitive output market would be relatively efficient. However, the present environment of bureaucracy-with severe constraintsThis content downloaded from 128.195.160.103 on Mon, 23 Sep 2013 16:46:04 PMAll use subject to JSTOR Terms and Conditions
NONMARKETDECISION301MAKINGon the creation of new bureaus or new outputs by existing bureaus, andthe passion of reformersto consolidate bureaus with similar outputseems diabolically designed to reduce the competition among bureausand increase the inefficiency (and, not incidentally, the budget) of thebureaucracy.CostShifts. Figure 4 illustrates the changes in a bureau's equilibriumoutput and budget, for given demand conditions, in response to shiftsin the minimum marginal cost function.20, 000200.044150Q15,000\Q10,0001ooBca 200550 b 1c variabled 0.2500*5, 000j255075-I0100 125 150 175 200FIGURE 4EFFECTS OF COST SHIFTSIn the budget-constrained output region, a downward shift of theminimum marginal cost function will increase the equilibriumoutput ofa bureau at a rapid rate. A bureau producing an output at constantminimum marginal cost will grow at twice the rate of a competitiveindustry for the same downward cost shift. The bureau's budget willgrow rapidly with the initial cost reductions and then very slowly asoutput approaches the demand-constrainedoutput level. In the higheroutput region, further reductions in cost will not increase either theequilibrium output or budget.These effects suggest that new bureaus or those facing exogenousThis content downloaded from 128.195.160.103 on Mon, 23 Sep 2013 16:46:04 PMAll use subject to JSTOR Terms and Conditions
302AMERICANECONOMIC ASSOCIATIONincreasesin costs will be very cost conscious. Such bureaus will have anincentive to determine their minimum marginal cost function and totry to reduce the level of this function. Older bureaus or those facing arapid increase in demand couldn't care less on either count. Tullock hasbeen intrigued by the observation that bureaus both attempt to reducecosts and manifestly waste huge amounts of resources. This model20020,9000B.0175Q17,500a200b 1c - variabled - varible1500B12, 50012510015,000I251.0'.755010,0075 100 125 150 175 200.50 .250-.25-.50-.75-1.0dFIGURE 5EFFECTS OF CHANGESIN THE COST SLOPEsuggests that, in equilibrium, a single-product bureau will be in one orthe other of these conditions. A multiproduct bureau, such as Department of Defense, should be expected to attempt to reduce costs on thebudget-constrained outputs and to assure that costs are sufficientlyhigh to exhaust the obtainable budget on the demand-constrainedoutputs.Changesin the Slope of the Minimum Unit Cost Function. Figure 5illustrates the changes in a bureau's equilibrium output and budget,for given demand conditions, in response to changes in the slope of theminimummarginalcost function. The indicated changes in the interceptand slope are such that the output of a competitive industry, given theThis content downloaded from 128.195.160.103 on Mon, 23 Sep 2013 16:46:04 PMAll use subjec
American Economic Association The Peculiar Economics of Bureaucracy Author(s): William A. Niskanen Source: The American Economic Review, Vol. 58, No. 2, Papers and Proceedings of the Eightieth Annual Meeting of the American Economic Association (May, 1968), pp. 293-305 Published by: American Economic Association
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American Economic Association U.S. Economic Growth since 1870: One Big Wave? Author(s): Robert J. Gordon Reviewed work(s): Source: The American Economic Review, Vol. 89, No. 2, Papers and Proceedings of the One Hundred Eleventh Annual Meeting of the American Economic Association (May, 1999), pp. 123-128 Published by: American Economic Association
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