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Public Finance

Public Finance

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Published by: Alauddin Ahmed Jahan on Mar 28, 2011
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05/04/2011

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P
UBLIC
 
FINANCE
Public finance
is a field of economics concerned with paying for collective or governmental activities, and with the administration and design of those activities. Thefield is often divided into questions of what the government or collective organizationsshould do or are doing, and questions of how to pay for those activities. The broader term,
public economics
, and the narrower term,
government finance
, are also oftenused.The proper role of government provides a starting point for the analysis of public finance.In theory, private markets will allocate goods and services among individuals efficiently(in the sense that no waste occurs and that individual tastes are matching with theeconomy's productive abilities). If private markets were able to provide efficientoutcomes and if the distribution of income were socially acceptable, then there would belittle or no scope for government. In many cases, however, conditions for private marketefficiency are violated. For example, if many people can enjoy the same good at the sametime (non-rival, non-excludable consumption), then private markets may supply too littleof that good. National defense is one example of non-rival consumption, or of apublic good.In economics, a
public good
is agood that isnon-rivalrousandnon-excludable. Non- rivalry means that consumption of the good by one individual does not reduce availabilityof the good for consumption by others; and non-excludability that no one can beeffectively excluded from using the good. In the real world, there may be no such thing asan absolutely non-rivaled and non-excludable good; but economists think that somegoods approximate the concept closely enough for the analysis to be economically useful.For example, if one individual visits a doctor there is one less doctor's visit for everyoneelse, and it is possible to exclude others from visiting the doctor. This makes doctor visitsa rivaled and excludable private good.Conversely, breathing air does not significantly reduce the amount of air available to others, and people cannot be effectively excludedfrom using the air. This makes air a public good, albeit one that is economically trivial,since air is a free good. A less straight-forward example is the exchange of MP3musicfiles on the internet: the use of these files by any one person does not restrict the use byanyone else and there is little effective control over the exchange of these music files andphoto files.Non-rivalness and non-excludability may cause problems for the production of suchgoods. Specifically, some economists, have argued that they may lead to instances of market failure, where uncoordinated marketsdriven by parties working in their own self  interest are unable to provide these goods in desired quantities. These issues are known as
public goods problems
, and there is a good deal of debate and literature on how tomeasure their significance to an economy, and to identify the best remedies. Thesedebates can become important to political arguments about the role of markets in the1
 
economy. More technically, public goods problems are related to the broader issue of externalities.Graphically, non-rivalry means that if each of several individuals has a demand curve for a public good, then the individual demand curves are summed vertically to get theaggregate demand curve for the public good . This is in contrast to the procedure for deriving the aggregate demand for a private good, where individual demands are summedhorizontally.ExcludableNon-excludableRivalries
food, clothing,toys, furniture,cars
(
)fish, huntinggame, water,arterial roads
Non-rivalries
satellite television
Public goods
nationaldefense, free-to-air television,air 
Paul A. Samuelsonis usually credited as the first economist to develop the theory of public goods. In his classic 1954 paper 
The Pure Theory of Public Expenditure
,. hedefined a public good, or as he called it in the paper a "collective consumption good", asfollows:
...
[goods] which all enjoy in common in the sense that each individual's consumption of such agood leads to no subtractions from any other individual's consumption of that good 
...
This is the property that has become known as
. In addition a
pure publicgood 
exhibits a second property called
: that is, it is impossible toexclude any individuals from consuming the good.Ineconomics, a
market failure
occurs when there is aninefficientallocation of goods  and services in amarket. That is, there exists another outcome where market participants' overall gains from the new outcome outweigh their losses (even if some participants loseunder the new arrangement). Market failures can be viewed as scenarios whereindividuals' pursuit of pure self-interest leads to results that are not efficient – that can beimproved upon from the societal point-of-view. The first known use of the term by2
 
economists was in 1958, but the concept has been traced back to the Victorianphilosopher Henry Sidgwick .According to mainstream economic analysis, a market failure (relative toPareto efficiency) can occur for three main reasons.First,agentsin a market can gain market power , allowing them to block other mutually beneficialgains from tradesfrom occurring. This can lead to inefficiency due toimperfect competition,which can take many different forms, such asmonopolies, monopsonies, cartels, or monopolistic competition,if the agent does not implement perfect price discrimination. In a monopoly, the market equilibrium will no longer bePareto optimal The monopoly will use its market power to restrict output below thequantity at which the Marginal social benefit (MSB) is equal to the Marginal social cost(MSC) of the last unit produced, so as to keep prices and profits high An issue for thisanalysis is whether a situation of market power or monopoly is likely to persist if unaddressed by policy, or whether competitive or technological change will undermine itover time.
Second, the actions of  agentscan haveexternalities, which are innate to the methods of production, or other conditions important to the market. For example,when a firm is producing steel, it absorbs labor, capital and other inputs, it mustpay for these in the appropriate markets, and these costs will be reflected in themarket price for steel. If the firm also pollutes the atmosphere when it makessteel, however, and if it is not forced to pay for the use of this resource, then thiscost will be borne not by the firm but by society Hence, the market price for steelwill fail to incorporate the full opportunity cost to society of producing. In thiscase, the market equilibrium in the steel industry will not be optimal More steelwill be produced than would occur were the firm to have to pay for all of its costsof production. Consequently, theMSCof the last unit produced will exceed itsMSB
Finally, some markets can fail due to the nature of certain goods, or the nature of their exchange. For instance, goods can display the attributes of public goods.or common-pool resources, while markets may have significanttransaction costs, agency problems, or informational asymmetry. In general, all of these situations can produce inefficiency, and a resulting market failure. A related issue can be theinability of a seller to exclude non-buyers from using a product anyway, as in thedevelopment of inventions that may spread freely once revealed. This can causeunderinvestment, such as where a researcher cannot capture enough of thebenefits from success to make the research effort worthwhileUnder broad assumptions, government decisions about the efficient scope and level of activities can be efficiently separated from decisions about the design of taxation systems(Diamond-Mirlees separation). In this view,public sector programs should be designed tomaximize social benefits minus costs (cost-benefit analysis), and then revenues needed to 3

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