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PUBLIC FINANCE

PUBLIC FINANCE. The Role Of Government in the Economy Contents. Main Approaches Designing The Role Of Government In Economy The Reasons of Government Intervention to Economy Public Sector Balance Optimal Production Level of Public Sector. Scarce Sources. Public Economics. Private Economics.

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PUBLIC FINANCE

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  1. PUBLIC FINANCE

  2. The Role Of Government in the EconomyContents • Main Approaches Designing The Role Of Government In Economy • The Reasons of Government Intervention to Economy • Public Sector Balance • Optimal Production Level of Public Sector

  3. Scarce Sources Public Economics Private Economics Market Budgeting Pricing Process Political Process Private needs Social (public) needs Human needs

  4. REASONS FOR INTERVENTION OF GOVERNMENT TO THE ECONOMY • 1. Imperfect Competitive Markets • 2. Public Goods • 3. Externalities • 4. Imperfect Markets • 5. Asymmetric Information • 6. Economic Instability • 7. Redistribution of Income • 8. Resource Allocation

  5. APPROACHES TO DETERMINING THE GOVERNMENT ROLE IN ECONOMY 1. Liberal Approach 2. Economic Rationality Approach 3. Musgrave’sApproach 4. Interventionist (Active) Government Approach

  6. Liberal Approach • Free Market Economy • Limited Government Activity • Limited Public Expenditures • Limited Public Revenues (Taxes) Public Expenditures = Public Revenues Automatic Balance (Budget Balance)

  7. Economic Rationality Approach • Intervening (Active) Government • Positive (Benefit) and Negative (Cost) Externalities

  8. Musgrave’sApproach • Intervening (Active) Government • Economic Functions of Government • Resources Allocation, • Economic Growth and Development, • Economic Stability • Redistribution of Income

  9. Interventionist (Active) Government Approach • Intervening (Active) Government • Increased public expenditures • Increased public revenues (taxes) Public expenditures > Public revenues (Budget Deficit) Economic Balance

  10. Government Tasks Concerning to Some Aims Microeconomic Tasks Macroeconomic Tasks Efficiency in Resource Allocation Equity in Income Distribution: Reallocation of Income Economic Growth and Development Economic Stability: Balance of Total Demand and Total Supply Production of Public Services Intervention to Quasi Fiscal Goods State Economic Enterprises Developed Economies: Balance between of Total Demand and Total Supply Less Developed Economies: Investment/ National Income

  11. PUBLIC SECTOR LIMITS (OPTIMAL PRODUCTION LEVEL)‏ MBp MBs MCp MCs (Private Sector) (Public Sector)‏ =

  12. EQUILIBRIUM at PUBLIC SECTOR S(Social) + T = I(Social) + G EQUILIBRIUM ofPUBLIC SECTOR-PRIVATE SECTOR 1. T > G(Budget Surplus) S(Private) <I (Private)‏ 2. T <G (Budget Deficit) S(Private) > I(Private)‏ 3. T = G (Balanced Budget) S(Private) = I(Private)‏

  13. The role of government in the economy • Public Economy (Public Sector) • Private Economy (Private Sector) • Mixed Economy • Government Intervention to Economy • Limited Government (Classsical Economics) • Active Government (Keynesian Economics) • Functions of Government • Economic Stability Function • Economic Development Function • Redistribution of Income Function

  14. PUBLIC ECONOMY (PUBLIC SECTOR): Thegovernmentusesanddistributesthesources in theeconomythroughitschannelssuch as publicexpendituresandtaxes (publicbudget). This is a politicalprocess. Thegovernmentaimstomeetthesocialneeds. PRIVATE ECONOMY (PRIVATE SECTOR): Market participantsusesourcesindependently in theeconomythroughpricemechanism. This is a free market andtheneedsareprivateneeds, not social. MIXED ECONOMY: Thesources in theeconomyareusedupbyboththegovernmentandthe market participants. Thegovernmentmeetsthesocialneedswhile market participantsactfreelytomeettheirprivateneeds.

  15. GOVERNMENT INTERVENTION TO ECONOMY • LimitedGovernmentIntervention: ClassicalEconomistsarguethatthefunctions of government in theeconomyshould be limited. Bothpublicexpendituresandpublicrevenues (taxes) should be limited. Thegovernmentshouldonlyspend (usepublicexpenditures) tomeetthesocialneedsandthetaxesshouldonly be collectedtocovertheseexpenditures . Publicbudgetshould be balanced, meaningthatpublicexpendituresequalstaxes (balancedbudget). • ActiveGovernmentIntervention: Keynesianeconomistsarguethatthegovernmentshouldactmore in theeconomy. Bothpublicexpendituresandtaxesshould be activelyimplementedtoachivespecificaimssuch as economicstabilisation, economicdevelopment, redistribution of income. Toachivetheseaims, thepublicexpendituresshould be increased, meaningthatpublicexpendituresmayexceedtaxesfortheaim of economicbalance (budgetdeficits)

  16. FUNCTIONS OF GOVERNMENT • EconomicStabilityFunction: Thegovernmentusespublicexpendituresandtaxestoechieveeconomicstability. Economicstability is achievedwhenbothpricestabilityandfullemploymentareprovided. Economicstability is violatedwheninflationordepressiontakeplacewhichwecallinstabilities. Duringinflation, aggregatedemand is higherthanaggregatesupply. So, thegovernment can reducepublicexpendituresand/orincreasetaxratestoreduceexcessdemandandconstitutetheequilibrium. Duringdepression, aggregatedemand is lowerthanaggregatesupply. So, thegovernment can increasepublicexpendituresand/orreducetaxratestoencouragedemandandconstitutetheequilibrium.

  17. Economic Growth and Development Function: The government implements public expenditures such as investment exp., economic transfers to increase the number of investments that help to increase economic growth and development rate. Also taxes are used to increase economic development rate. Tax incentives and tax reductions help to increase private investments which helps to increase economic growth rate. • Redistribution of Income Function: The government intervenes economy through taxes and public expenditures to reduce the inequality between the rich and the poor. Government taxes high income groups and uses these tax revenues in public expenditures in the form of social security payments, welfare payments, medical care payments, etc. In this way the national income is redistributed between the rich and the poor.

  18. THE THEORY OF PUBLIC GOODS

  19. Contents • Main Properties of Public Goods • Production of Public and Private Goods in Economy • Private and Public Goods Demand in Economy • Quasi-Public Goods Demand and Supply in Economy

  20. Characteristics of Public Goods 1. Benefits not marketing / impartible / no pricing 2. Nonexcludable(collective consumption) 3. Nonrival in consumption 4. Production and consumption are indispensable

  21. PRIVATE GOODS XP =X1 + X2 + X3 + .......................... + Xn PUBLIC GOODS XS =X1 = X2 = X3 = ............................. = Xn QUASI PUBLIC GOODS XQ = XP + XS

  22. Production of Public and Private Goods . E4 Public Good . . E1 E2 G . E3 Private Good

  23. Production of Public and Private Goods • There is a production possibility curve which shows the allocation of resourses between production of private and public goods in economy. Each point on this curve (E4 and E2) shows efficient production level and others (E1and E3) inefficient ones. When government spends OG expenditures, there is an efficient production level at point E2.

  24. PRIVATE-PUBLIC-QUASI PUBLIC GOODS (BOX DIAGRAM)‏ 0' P' %100 impartible Pure public (4)‏ Quasi-private partible -MPB>MSB (2)‏ ( Quasi public partible -MSB>MPB (3)‏ (1)‏ P 0 %0 partible- private goods

  25. WHY DOES THE GOVERNMENT PRODUCE PRIVATE GOODS?

  26. Contents • Why Does The Government Produce Public Goods? • Production In Monoply • Production with Decreasing Costs • Production With Zero Marginal Costs • Collective Consumption

  27. DIFFERENCES BETWEEN PUBLIC GOODS AND PRIVATE GOODS 1. In producing public goods, the amount of public expenditures is determined before the amount of public revenues 2. Public goods have economic, social and political features 3. The effects of producing public goods in an economy are much more than the effects of private goods 4. The main purpose of producing private goods is to increase (maximize) the profit of the private firm while the main purpose of producing public goods is to achieve social welfare

  28. Why Does The Government Produce Private Goods? 1. Production under Monopoly 2. Production under decreasing costs 3. Production with zero marginal cost 4. Collective Consumption

  29. Production under Monopoly y AC Price MC Ep P Ps S Es C AR (D)‏ MR x qs Quantity 0 q

  30. Production Under Monopoly • In the figure, without government intervention the equilibrium of the monopolist occurs at point Ep on AR. But the optimal condition occurs at point Es where MC intersects AR. At Es, price reduces from P to Ps and quantity increased from q to qs. This result shows that government production is more efficient than private production and the main purpose is to achieve social welfare.

  31. Production under decreasing costs y Price MC E P C AC . CS ES PS AR(D)‏ x q 0 qS Quantity MR

  32. Production Under Decreasing Costs • In figure optimal production level occurs at point Es where MC intersects AR and qs amount is produced at cost Cs and sold at price Ps. At point E on AR where the monopolist produces the good, quantity is reduced to qs. At this point and as cost increased to Cs, price is also increased to Ps. Production reduces by qqs, cost and price increases by CCs and PPs respectively.

  33. Distortions In Production Under Monopoy and Decreasing Costs • Distortions in the Resource Allocation • Distortions in the Redistribution of Income • Distortions in the Price Stability

  34. Production with zero marginal cost y Price AR (D)‏ MR E P AC Es MC=0 P=0 0 qs Quantity x q

  35. Production with Zero Marginal Cost • If the government produces the good, MC will be equal to price (P) and to zero (MC=P=0) which shows that ever individual in the society benefits from the production of the good. As MC=P=0, AR collides with x-axis and Qs constitutes the optimal production level. • If a private firm produces the good, it will be produced at a private cost, so, it will be priced (P) and MC and P will not equal to zero. At point E, Q amount will be produced at price P and the quantity that was produced will reduce by QQs.

  36. Collective Consumption • Social benefit of the production is higher than private benefit of the production (SB>PB) • Marginal cost of production in public sector is lower than of private sector (MCpublic < MC private) • All individuals benefit because of collectivist characteristic of the private good

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