Public Finance

Chapter 2

Introduction to Public Finance

1
 Public Finance: Definition
niymn½yénhirBaØvtßúsaFarNH
 Public Finance is concerned with the income
and expenditure of public authorities.
-hirBaØvtßúsaFarNHsikSaBak;B½næCamYycMNUl nig
cMNayrbs;GaC£aFrsaFarNH.
 Public Finance analyzes the implication of such
income and expenditure activities on the allocation of
resources and distribution of income as well as overall
stability of the economy.
-hirBaØvtßúsaFarNHvaviPaKelITMnak;TMTgéncMNUl
nigskmµPaBcMNay elIkarkarEbgEck
RbPBFnFan nig
karEbgEckcMNUlKWeFVIya:gNaeGayesdækic©manesß
rPaB.

2
Public Finance: Subject Matters
 Public Finance deals with the taxing and spending activities of various governmental units.

-hirBaØvtßúsaFarNHvabgðajelIkarRbmUlBnæ nig
skmµPaBcMNayénkrNIepSg²Kñarbs;rdæaPi)alelIGVImYy.
 However, the resources for all government expenditures ultimately come from the private sector.
-eTaHbICacMNayya:gNak¾eday
ral;RbPBénral;rdæaPi)alcMNayKW)anmkBIvis½yÉkCnTaMgGs
;.
 So, public sector decisions impact private sector decisions in many ways both large and small.
-dUecñH
karsMerccitþrbs;vis½ysaFarNHvaman\TæiBlelIkarsMerccitþrbs;
vis½yÉkCnkñúgpøÚvCaeRcInkñúgenaHman
CMerIsBIrKW eFVIFM nig eFVItUcelIkarvinieyaK.
 The overall impact of public sector decisions must be examined in the context of their impact on
private sector behavior.
- ral;\TæiBlénkareFVIesckþIsMerccitþrbs;vis½ysaFarNHRtUvEtk
MNt;kñúgbribTEdlvaman\TæiBlelI\riyabfrbs;
vis½yÉkCn

3
Public Finance: Subject Matters
 Public Finance is the area of economics or economic theory devoted to the study of how
government policy -- tax and expenditure policy-- effects microeconomic behavior as well as
aggregate economic activity.
hirBaØvtßúsaFarNHKWCaEpñkmYyénesdækic© rW
RTwsþIesdækic©ya:gsMxan;sMrab;sikSafaetIeKalneya)ayRbmUl
Bnæ
nig eKalneya)aycMNay vaman\TæiBlelI\riyabfmIRkUesdækic©
dUcCaskmµPaBesdækic©dulya:gdUcemþc?
 Public finance does not concentrate on financial arrangements of government but on the
economic consequences of public policy on
• Resource allocation: Allocation
• Income distribution: Distribution
• Level of economic activity: Stabilization
hirBaØvtßúsaFarNHminsikSasgát;F¶n;elIkarerobcMhirBaØvtß
úrbs;rdæaPi)alenaHeT b:uEnþvasikSaelIesdækic©CasMxan;
rW
vi)ak énneya)aysaFarNH dUcCa
+karEbgEckRbPBFnFan
+ karEbgEckcMNUl nig
+ kMriténskmµPaBesdækic© eFVIya:gNaeGaymanesßrPaB
4
Public Finance: Ideological Division

The study of public finance not only deals with the expenditure and
revenue, but often, indulge in the study of what the government should and
shouldn’t do. The experts are deeply divided into largely two camps.

 Organic View of the Government:

• Individuals are valued only by their contribution to the
realization of social goals. These goals are determined
by the government.
 Mechanistic View of the Government:
• The primary goal of Government is to further facilitate
the achievement of individual’s objectives. The
government should also try to resolve conflicting
individual goals in a ‘socially acceptable’ manner such
that social benefit is maximized.

5
The Role of Government
 Rationale
• Though it can be argued that Market, under certain
conditions, leads of efficient allocation of resources. Such
efficient allocation (often refer to as Pareto efficiency)
occurs when no person can be made better off without
making another person worse off.
• However, society may prefer an inefficient allocation on the
basis of equity or some other criterion. This requires
government intervention in the operation of free market.
• We can divide the basic argument for governments
intervention in free market into two categories
• Market Failure
• Concern for Equity

6
The Role of Government (cont)
• Market Failure
• First, there are public goods which are non-rival (if
some consume them, it does not affect the rest of
the supply) and non-excludable (users cannot be
prevented from consuming them) like national
defense, street lamps, etc. making impossible to
charge consumers for their use. This causes
market failure which the state can attempt to
overcome.

7
The Role of Government (cont)
• Market Failure (Cont.)
• Second, consumption or production of some goods
may generate positive or negative external effects
for the society not reflected in their price. Without
government intervention, the market would
overproduce or under-produce those goods,
depending on whether the externalities were good
or bad.

8
The Role of Government (cont)
• Market Failure (Cont.)
• third, immobility of productive resources, specially
labor, can help to prevent the attainment of efficient
resource allocation.
• Fourth, imperfect and asymmetric information may
lead to erroneous valuation of goods and services,
and therefore inadequate supply or demand.
• Finally, market failures are also related to problems
of adverse selection and moral hazard when buyers
or sellers act exclusively on the basis of benefit.

9
The Role of Government (cont)
• Concern for Equity
• Worldwide awareness of the need to combat
poverty more vigorously
• Empirical results around the world generally
suggest that improvements in equity contribute to
higher economic growth, faster development and
less poverty.

10
The Role of Government (cont)
• Concern for Equity
• Inequality often results in insecurity and crime,
negative externalities which affect growth and
social justice, nationally and globally.
• Role of the private sector and need for
partnerships: opportunities, empowerment and
protection

11
The Role of Government (cont)
• Concern for Equity (cont.)
• The concern for equity does not mean that only the
state should/could contribute to reduce poverty. The
task associated with providing- opportunities,
empowerment and protection-, the three main
dimensions of poverty do not belong exclusively to the
public sector.
• The private sector can play an active role creating
economic opportunities (employment creation, credit),
promoting inclusion of all members of the civil society
(associations of private sector producers, workers etc.)
and contributing to reducing inequalities through its
association with government activities and its
participation in social sectors (public hospitals and
schools with private sector financing/delivery).

12
The Role of Government-Types
 Provider Role
• Natural monopolies in certain sector like energy,
mining, etc. are now questioned in light of recent
technologies
• The state should provide public goods:
macroeconomic stability, justice, clean environment,
resolution of conflicts, protection, defense of human
rights and social stability. However, Not all these
functions require the state as a provider of goods or
services, many of which can be facilitated by
regulations and creation of an appropriate framework.

13
The Role of Government-Types
(Cont.)

 Partnership Role
• It is widely recognized that neither the state nor the
private sector can function properly without both
functioning well. Today more than ever the state needs
to be in the forefront as regulator of the market and the
facilitator of an institutional and regulatory environment
conducive to private sector development.
• Government can partner with the private sector by
• Providing Regulations
• Building basic infrastructure
• Protecting from risk and losses (providing air
insurance, etc.)

14