© Oxford Fajar Sdn. Bhd. (008974-T), 2013 13 - 1: Principles of Economics

PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved
© Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 1

TOPIC 4
ROLE OF GOVERNMENT

ECONOMIC FUNCTION OF
GOVERNMENT
IMPORTANT FUNCTIONS OF GOVERNMENT
Adjust the allocation of resources
Assist private sector to ensure economic stabilization
Create a business environment
Redistribute income and wealth among the

population
Provide a legal and social framework for the

effective operation of an economy

TYPES OF BUDGET
1. BALANCED 2. SURPLUS 3. DEFICIT

BUDGET BUDGET BUDGET
The government’s The government’s The government’s
total expenditure total expenditure total expenditure
is equal to its is less than its is more than its
total revenue. total expenditure. total revenue.

GOVERNMENT’S REVENUE
TAX REVENUE NON-TAX REVENUE
SOURCES OF
REVENUE
NON-REVENUE RECEIPTS

GOVERNMENT REVENUE
 Tax Revenue
-compulsory contribution by an individual or a firm to the
government
-eg: direct tax, indirect tax
 Non-tax revenue
-revenues which arise from other sources than tax
-eg: licenses, permits, petroleum royalty, return on investment,
fees
 Non-revenue receipts
-refunds of expenditure and receipts from government
agencies
-eg: financial aids from government of other countries
GOVERNMENT REVENUE
(cont.)
OBJECTIVES OF TAXATION
SOURCE OF INCOME
EQUITABLE DISTRIBUTION OF INCOME
REDUCTION OF HARMFUL CONSUMPTION
REGULATION OF FOREIGN TRADE
CONSERVATION OF RESOURCES

TYPES OF TAXES
DIRECT TAXES
• Tax paid by the person on whom it is levied which
cannot be passed on to another person.
• Example: Income Tax, Corporate Tax
TYPES OF TAXES
INDIRECT TAXES
• Burden of tax can be passed on to another person.
• Example: Sales Tax, Service Tax

TYPES OF TAX STRUCTURE
PROPORTIONAL TAX
Tax which is imposed
at the same rate for all
income levels.
Tax Rate
Income 500 1000 1500 2000

Total Taxes 25 50 75 125
Tax Rate 5% 5% 5% 5%
(Total
Tax/Income)
Income

(cont.)
PROGRESSIVE TAX Tax which is imposed
at the increasing rate
Tax Rate for all income levels.
Income 500 1000 1500 2000

Tax Rate 5% 8% 10% 12%
(Total
Tax/Income)
Income

(cont.)
REGRESSIVE TAX
Tax which is imposed
at the decreasing rate
Tax Rate for all income levels.
Income 500 1000 1500 2000
Tax Rate 10% 8% 6% 4%

(Total
Tax/Income)
Income

GOVERNMENT EXPENDITURE
Pensions and Debts Service charges Subsidies

gratuities
GOVERNMENT OPERATING
EXPENDITURE
Expenditure allocated to cover the
expense of operating government departments
GOVERNMENT DEVELOPMENT
EXPENDITURE
Expenditure for investment purposes
to improve facilities and infrastructure
General Social Defense and

Economic
administration services security
services

PUBLIC DEBT
The debt which a government

owes to its nationals
of other countries.
INTERNAL SOURCES EXTERNAL

SOURCES OF SOURCES
PUBLIC
DEBT

INTERNAL AND EXTERNAL
SOURCES
 INTERNAL
1. Borrowing from citizen
- sale of securities, bonds and savings certificates
2. Borrowing from financial institutions
- insurance companies purchase gov. securities
3. Loans from the central bank
- central bank purchases gov. securities, bonds and
debentures
4. Loans from commercial bank
- commercial banks invest their deposits in gov. bonds to fulfill
liquidity requirement
INTERNAL AND EXTERNAL
SOURCES
 EXTERNAL
1. International money market
- foreign exchange banks lend to governments
2. Currency loans from foreign government
- loans to get the supply of goods
3. Loans from international financial institutions
-International Monetary Fund (IMF) gives short-term loans
to it members
- World Bank gives long-term loans for development
purposes

FISCAL POLICY
 Refers to the use of government taxation and

expenditure
 Influence country’s spending, employment and
price levels.
 Government expenditure, tax income and public
debt are important factors that influence
aggregate output, employment and prices.

Securing efficient Attaining and
allocation of maintaining full
economic resources employment
OBJECTIVE
OF FISCAL
POLICY
Controlling the Accelerating

equitable distribution the rate of
of income and wealth economic growth

EXPANSIONARY FISCAL POLICY
TYPES OF FISCAL POLICY
CONTRACTIONARY
FISCAL POLICY

Types of fiscal policy
 Expansionary Fiscal Policy

- to overcome unemployment or recession
- recession leads to unemployment, fall in income and shrink in
economic activity
- government will increase spending by undertaking public
work programs
- government will reduce taxes to increase disposable income
 Contractionary Fiscal Policy

- to overcome inflationary problems
- during inflation, government must create budget surplus to
reduce aggregate spending
- government will reduce spending and increase taxes
INSTRUMENTS OF FISCAL
POLICY
DISCRETIONARY AUTOMATIC
FISCAL POLICY FISCAL POLICY
Changes in gov expenditure

Government controls
and taxes
taxes and spending
which occur automatically
1. Government expenditure 1. Transfer payments

2. Taxes 2. Taxes


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PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved