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(1621788764) Chapter 2 Unit 1 PDF

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14 views3 pages

(1621788764) Chapter 2 Unit 1 PDF

Uploaded by

ruhamahpopson111
Copyright
© © All Rights Reserved
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1

CHAPTER 2 : PUBLIC FINANCE

UNIT 1 :FISCAL FUNCTIONS: AN OVERVIEW

ROLE OF GOVERNMENT IN AN ECONOMIC SYSTEM

The functions of government are separated into three:


a) Resources allocation (efficiency)
b) Income distribution (fairness)
c) Macroeconomic stabilization

The allocation and distribution function are microeconomic function and stabilization is
macroeconomic function.

The allocation function aims to correct the sources of inefficiency in the economic system
while the distribution role ensures that the distribution of wealth and income is fair.
Monetary and fiscal policy, the problems of macroeconomic stability, maintenance of high
levels of employment and price stability etc fall under the stabilization function.

ALLOCATION FUNCTION

Meaning

Resource allocation refers to allocation of factors of production to the various uses. It aims for
the optimal and efficient allocation of available resources so that resources are put to their
best use and no wastages are there.

Reason

Resources of a society are limited, while human wants are unlimited. Allocation of resources is
based on demand and supply in market. In the absence of govt. intervention, market failure
may occur. It means resources are misallocated by too much production of certain goods and
too little production of certain other goods. The main purpose of allocation function is
maximizing social welfare.

NITHYAN SETHUMADHAVAN SWASTHIK ACADEMY


2

Reasons for market failure in proper allocation

1. Imperfect competition and presence of monopoly in the market which reduce welfare of
consumers
2. Failure of market to provide collective goods which is consumed commonly by all the
people.
3. Externalities exist
4. Factor immobility which causes unemployment and inefficiency
5. Imperfect information
6. Inequalities in the distribution of income and wealth.
7. Free rider problem causing over use and exhaustion of public goods.

Instruments for allocation function

There are many instruments by which government can perform its allocation function some of
which are as follows:

1. Government can directly produce goods


2. Government may influence private allocation through incentives and disincentives
3. Regulatory activities such as licensing, control, minimum wages, and directives on location
of industry
4. Government sets legal and administrative frameworks.

REDISTRIBUTION FUNCTION

Meaning

The outcomes of the economic progress and growth have not spread evenly across the
households. Distribution function is concerned with the distribution of income and wealth so
as to ensure distributive justice, equity and wealth. When there is high inequality in
distribution of income and wealth, government intervene for distributive justice and wealth.

Objectives

1. Achieve an equitable distribution of social output among household


2. Advancing the well-being of those member of the society who suffer from deprivations of
different type
3. Providing equality in income, wealth and opportunities
4. Provide security for people who had hardship
5. Ensuring that everyone enjoy a minimal standard living

NITHYAN SETHUMADHAVAN SWASTHIK ACADEMY


3

Instruments

1) Taxation policies
2) Financing public services for the benefits of low income households
3) Employment reservation and preferences to protect certain segments of the population
4) Regulation of the manufacture and sale of certain products to ensure the health and
wellbeing of consumers
5) Special schemes for backwards regions etc.

STABILIZATION FUNCTION

Meaning

Instability in economy mainly arises due to business cycle. The market mechanism is limited in
its capacity to prevent or to resolve the disruptions caused by the fluctuations in economic
activity. In the absence of appropriate corrective intervention by the government, the
instabilities that occur in the economy in the form of recessions, inflation etc. may be
prolonged for longer periods causing enormous hardships to people especially the poorer
sections of society.

It is also possible that a situation of stagflation (a state of affairs in which inflation and
unemployment exist side by side) may set in and make the high problem. The stabilization
issue also becomes more complex as the increased international interdependence causes
forces of instability to get easily transmitted from one country to other countries this is also
known as “contagion effect”.

The stabilization function is one of the key functions of fiscal policy and aims at eliminating
macroeconomic fluctuations arising from suboptimal allocation.

Implementation of stabilization function

Stabilization function implemented through Monetary policy & Fiscal policy.

Monetary policy: Increase or decrease in money supply or interest rate to affect inflation,
output,consumption, investment etc.
(discussed in detail in chap 3)

Fiscal policy: Government expenditure policy and taxation policy to affect economic activities
like production, investment, saving, inflation, income, demand etc. Expansionary fiscal policy is
adopted to end recession and Contractionary fiscal policy is resorted to for controlling
inflation.

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NITHYAN SETHUMADHAVAN SWASTHIK ACADEMY

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