The Demand and Supply of Fines and Corruption

supply-and-demandA comment on the last piece prompts this tiny lesson in microeconomics.

“Corruption is one big pain point in the economic growth of a country. I have this funny idea but would like your inputs from an economists perspective. If things get costly it reduces its demand. Can corruption be made costly? This may increase compliance. Just to illustrate. If we raise fine for a fault, say traffic violation, which suppose today is Rs 500 to Rs 5000. Today the violator gets away by paying Rs 100 to traffic police. This is 20% of legal cost. If the penalty is 5000 and assuming traffic police acts rationally thereby asking for bigger bribe…won’t that deter future violations by the offender? Here I presume that traffic police will act smart knowing fully well that offender isn’t going to pay 5000 but at the same time he himself won’t settle for just Rs 100 and may raise ‘price’ to Rs 200 or 300. This is effective 100-200%% jump in bribe money that may pinch offender at some point in time. Pls throw some light.”

To start off, let’s examine the statement “If things get costly it reduces its demand.” In lay terms, that is true but economically speaking, prices don’t affect the demand or the supply of a product. To understand why not, we have to clearly understand what economists mean by “demand” or “supply” and distinguish them from “the quantity demanded” and “the quantity supplied.”

Demand and Supply

Demand is the relationship between prices on the one hand and the quantities bought (or demanded) on the other hand. At higher prices, the quantities demanded are low, and at lower prices the quantities demanded are high. That is, there is an inverse relationship between prices and the quantities demanded. Graphed with prices on the vertical axis, and quantities on the horizontal axis, the line representing demand is therefore downward sloping. Demand — the relationship between prices and quantities — does not change with change in prices: what happens is that when prices rise, the quantity bought falls, and vice versa.

Supply is similarly defined as a relationship between prices and quantities supplied. When prices go up, quantities supplied go up, and vice versa.

What we are distinguishing is the difference between a change in the quantity bought and supplied when prices change, from the relationship between prices and quantities that is invariant to change in prices. When the prices change (everything else being the same), the quantity demanded or supplied changes, not the demand or the supply relationships.

Demand and supply, of course, do change. These happen with changes in technology, the prices of factors of production, and changes in preferences. If sugar is reported to be harmful, the demand for sugar will decrease. Meaning, at the same price as before, the quantity of sugar bought will be lower because of changed preferences.

Supply will increase when something gets cheaper to produce. At the same price, lower costs of production (due to cheaper factors or better technology) lead to higher quantities supplied at the same price.

Finally, higher incomes will change demand because at the same price as before, higher quantity would be bought. This is called the “income effect” that changes demand.

Traffic Violations

When the “price” of an act goes up, the “quantity demanded” of that act falls. Thus when the price of a traffic violation goes up, the quantity of traffic violations goes down. So far so good. But what is the effect of the higher price of the traffic violation on corruption? Basic intuition says that the instances of violations will likely go down. Economics informs us that the quantity of bribes could go up, down or remain the same.

The amount extracted in bribes per violation would certainly go up when the fine is set at a higher amount, as the commenter says. But will the total amount extracted in bribes go up or go down? It depends. Suppose the higher fine reduces violations to zero (an extreme), then the total amount of bribes will also go to zero. But if the number of violations (which will be lower) go down only a small bit, but the extra bribes are significantly higher than before, then the end result could well be that the total amount of bribes goes up. It depends on a parameter called “elasticity” of demand and supply, which is determined only empirically — meaning, you have to find out how people actually respond to the change in price.

The main lesson here is that people respond to incentives. The motorist takes more care to avoid violations when fines go up, but when he does get caught, both the motorist and the police have a greater incentive to settle the matter “amicably” on the spot instead.

Reducing Corruption

Bribery and corruption are probably as ineradicable as the common cold. At best it can be managed and mechanisms designed to reduce the incidence and intensity of the problem.

One simple method is change the rules to so that two conditions are met. First, make sure that the penalty for an offense is reasonable. For minor offenses, the penalty should not be an arm and a leg. That would incentivize the offender to pay the fine instead of trying to avoid it.

Second, punish the bribe-taker, and reward the bribe-giver to report the incident of bribery by providing a financial prize and an amnesty. The official is deterred from demanding a bribe knowing that the offender will get a reward by reporting the incident.

Talking of traffic fines, I think that traffic fines should be “equitable”. That is, a rich guy should pay a higher monetary fine than a poor guy. If a movie star runs a red light, he should pay a much, much higher fine than an office worker. The idea is to deter the behavior. Finland, I believe, has that sort of rule. One internet millionaire was fined $90,000 for speeding.

But there’s a problem of ascertaining incomes and wealth. The simple solution to that is to base the fine on the value of the vehicle. The driver of a Maserati should be fined proportionally more than the driver of a Maruti 800.

Don’t you think so?

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