Unit-1.[Public Economic Theory].
A)Fiscal functions :an overview.
There is three fiscal functions, they are in given below.
1. Allocation function:
Meaning
Resource allocation refers of factors of production to various uses. It is optimal and
efficient allocation of available resources so that resources are put to their best use and
no wastages are there.
Reason
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 little too production of certain other goods. The
main purpose of allocation function is maximizing social welfare.
Reasons for market failure.
1. Imperfect composition 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.
REDISTRIBUTION FUCTION.
Meaning.
Distribution function is concerned with the distribution of income and wealth so as to
ensure distribution justice, equity, and wealth. When there is high inequality in
distribution of income and wealth, government intervenes for distribution justice and
wealth.
OBJECTIVES.
1. Achieve an equitable distribution o social output among household.
2. Advancing the wellbeing of those members of the society who suffer from
deprivations of different type.
3. Providing eqaulity in income, wealth, and opportunities.
4. Provide security for people who hardship.
5. Ensuring that everyone enjoy a minimal standard living.
STABILIZATION FUNCTION.
Instability in economy mainly arises due to business cycle. The market mechanism is
limited in its capacity to prevent or to resolve the disruption 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 period causing enormous hardships to people
especially the poorer sections of society. It also possible that a situation of stagflation
( a state to 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 accuses forces of instability to get easily
transmitted from one country to other countries this is also know as contagion effect”.
The stabilization function is one of the key functions of fiscal policy and aims at
eliminating macroeconomics fluctuation is one of the key function of fiscal policy and
aims at eliminating to get macroeconomics fluctuations arising from suboptimal
allocation. Areas covered in stabilization function. The stabilization function is
concerned with the performance of the aggregate economy in terms of:
1. Labor employment and capital utilization
2. Overall output and income
3. General price level.
4. Balance of international payments.
5. The rate of economic growth.
IMPLEMENTATION OF STABILIZATION FUNCTION.
STABILIZATION FUNCTION
Stabilization function implements through monetary policy or fiscal policy.
MONETARY POLICY.
Increase or decrease in money supply or interest rate to affect inflation, output,
consumption, investment etc.
INSHORT FISCAL POLICY.
Government expenditure policy and taxation policy to affect economics 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.
• PUBLIC GOODS- commodity or service that is made available to all members of
a society, typically administered by government and paid for collectively through
taxation.
*What are public goods?
Ans:Public goods are those goods which can be used by people with or without
payment. These goods include parks, bridges, roads, etc. It is the responsibility of
government to make the public goods available.
Public has two key characteristics, that is non excludability and non-rival consumption.
• Models of efficient allocation.
1)Cost Benefit Analysis: this method involves comparing the total expected benefits of
a public good against its total costs. The goal is to ensure that the benefits outweigh the
costs, thus supporting efficient allocation. This approach helps in prioritizing projects
and making decisions about the provision and level of public goods.
2)Weighted voting Models: in some models, different stakeholders have varying
weights in decision-making processes regarding the allocation of public goods. These
weights can be based on factors like their contribution or the benefits they receive. The
aim is to reflect the reference the impacts across different groups, aiming for an
efficient and fair distribution.
3)Lindahl Pricing: This model proposes a pricing mechanism where individuals pay a
price for a public goods proportional to their marginal benefits from it. In theory, this
leads to an efficient provision of the public goods as each person’s contribution
matches their valiation of the goods. However, implementing Lindahl pricing in practice
is challenging due to difficulties in determining individual valuations and collecting
payments.
4) samulson Rule; this rule provides a criterion for the efficient provision of public
goods. It states that the sum of individual’s marginal rates of substitution( the rate at
which they are willing to trade one good for another) should equal the marginal cost of
providing the public good. Essentially, the total value that society places on the public
good should equal the cost of producing it.
5) Pareto Efficiency: this principle states that resources are allocated in a way where no
individual can be made better off without making someone else wore of. In the context
of public goods, achieving Pareto efficiency means finding a level of provision where
further improvements can be made in terms of social welfare.
6) Public Choice Theory: this theory explores how decisions regarding public goods are
made through the political process. It examines the behavior of voters, politicians, and
bureaucrats, suggesting that incentives and personal interests can affect the allocation
of resources. Efficient outcomes are often complicated by these non-market factors,
and the theory emphasizes the importance of designing institutional mechanisms that
align individual incentives with social welfare.
*Pure and Impure Public Goods.
Pure public goods: Goods that are perfectly non-rival in consumption and are non-
excludable
Non-rival in consumption: One individual’s consumption of a good does Not affect
another’s opportunity to consume the good.
Non-excludable: Individuals cannot deny each other the opportunity to Consume a
good.
Impure public goods: Goods that satisfy the two public good conditions
(non-rival in consumption and non-excludable) to some extent, but not fully.
*Pure and Impure Public Goods
Impure Goods.
• Besides the polar cases of pure goods- that is pure public and pure private-
there are also some other type of public goods. The other typpe of goods
under rubric of “impure goods”
• “Club goods”. “common-pool goods” and “merit/demerit goods’ are the main
types of impure public goods.
Pure public Good.
• A pure public good has some other characteristics that a pure private goods
usually has non. These are:
• Externality,
• Free rider problem.
• Forced rider.
• Free riding-
1)What is free riding?
Ans: A free rider is a person who benefits from something without expending effort or
paying for it. In the other words, free riders are those who utilize goods without paying
for their use.
2) The Free Rider Problem?
Ans: The free rider problem is an economic concept of a market failure that occurs
when people are benefiting from resources, goods, or services that they do not pay for
it. If there are too many free riders, the resources, goods, or services may be
overprovided. Therefore, this would be create a free rider problem. The problem is
commonly seen with public goods (goods with non-excludable benefits.)
Another answer.
Ans: When a person enjoys that benefit of goods and services without paying the price,
he/she is called a free rider.
• The burden on a shared resource that is created by its use or overuse by
people who aren’t paying their fair share.
Examples of the free Rider Problem
Here are two type of examples of the free rider problem:
Example 1
John builds a lighthouse on the coast to serve as a navigational aid. As a result, all
sailors are now able to benefit from the lighthouse even if they are not paying toward its
unkeep. There is no profit incentive for John to maintain the lighthouse, as he is the only
person contributing to its unkeep.
Example 2
Wikipedia, a free encyclopedia, faces a free rider problem. Hundreds of million of
people use Wikipedia every month but only a tiny fraction of users pay to use it. A large
majority of Wikipedia users do not pay to use the site but are able to benefit from the
information provided by the website.
3) Public Goods and Free Rider Problem.
Ans: Public goods commonly face a free rider problem due to the two characteristics of
public goods:
1. Non-rival: Consumption of the goods or service by one individual does not
reduce the availability of the goods to others.
2. Non- excludable: It is impossible to prevent other consumers from consuming
the goods or service.
Examples of public goods include:
• National defense.
• Fresh air.
• Lighthouses.
• Street lighting.
Possible Solutions to the problem.
There are several possible solutions to the free rider problem:
1) Taxes.
2) Making a public good private.
3) Soliciting Donations.
4)When the free rider problem arises?
Ans: The free rider problem as an economics issue only occurs under certain
conditions:
• When everyone can consume a resource in unlimited amounts;
• When no one can limit anyone else’s consumption; and
• When someone has to produce and maintain the resource.
