Summary Deck Flashcards
What is the main reason for government intervention in an economy?
Government intervention is primarily aimed at correcting market failures, ensuring efficient resource allocation, stabilizing the economy, and promoting social welfare. Market failures occur due to externalities, public goods, monopoly power, and information asymmetry. By intervening, the government ensures fair competition, provides essential services, and reduces economic disparities.
What is market failure and what are its dimensions?
Market failure occurs when the allocation of goods and services by a free market is inefficient, leading to a net loss of economic value. The dimensions of market failure include externalities (costs or benefits affecting third parties), public goods (non-excludable and non-rival goods like national defense), market power (monopolies restricting output and raising prices), information asymmetry (buyers or sellers having more information than the other), and income inequality (large disparities in wealth distribution).
What are the two conditions for government intervention in the economy?
The first condition is the existence of market failure, meaning the free market alone cannot efficiently allocate resources. The second condition is that government intervention must improve economic efficiency or social welfare, meaning the benefits of intervention should outweigh the costs.
How would you describe government intervention in an economy?
Government intervention refers to regulatory measures, policies, and actions taken by the government to influence economic activity. This can include taxation, subsidies, provision of public goods, price controls, and regulatory oversight to correct inefficiencies, redistribute income, and stabilize economic fluctuations.
What are the means through which governments intervene in an economy?
Governments intervene through taxation (raising revenue and discouraging harmful activities), subsidies (supporting essential industries), public goods provision (funding education, healthcare, infrastructure), regulations (setting standards for labor, environment, and business), property rights enforcement (protecting ownership and contracts), and direct restrictions (such as bans on harmful goods).
Why do governments engage in direct provision of public goods, and how is this funded?
Governments directly provide public goods because they are non-excludable and non-rival, meaning private markets may not supply them adequately. Examples include national defense, public parks, and street lighting. These services are primarily funded through taxation, ensuring that all citizens contribute to and benefit from their provision.
Define public investment.
Public investment refers to government spending on projects and infrastructure that enhance long-term economic productivity. This includes investments in transportation systems, education, healthcare, and technological research, which contribute to economic growth, job creation, and improved public welfare.
What are the criteria for public investment?
Public investment is assessed based on several criteria: economic viability (cost-benefit analysis to ensure high returns), social impact (benefits to disadvantaged populations), environmental sustainability (ensuring projects do not harm ecosystems), technological innovation (supporting research and development), and financial sustainability (ensuring investments are fiscally responsible and do not lead to excessive debt).
What is fiscal stabilization?
Fiscal stabilization refers to government policies aimed at reducing economic volatility and maintaining stable growth. This includes adjusting government spending and taxation to control inflation, reduce unemployment, and promote steady economic expansion.
Distinguish between Expansionary and Contractionary Fiscal Policy.
Expansionary fiscal policy involves increasing government spending or reducing taxes to stimulate economic growth, typically used during recessions. Contractionary fiscal policy, on the other hand, involves decreasing government spending or increasing taxes to reduce inflation and prevent economic overheating.
What is a Fiscal Multiplier?
The fiscal multiplier measures the impact of changes in government spending or taxation on overall economic output. A multiplier greater than one indicates that an increase in government spending leads to a proportionally larger increase in GDP, while a multiplier less than one suggests a weaker impact on the economy.
What is public money creation?
Public money creation refers to the process by which a government or central bank increases the money supply, typically through printing new money or using monetary policies like open market operations to influence liquidity.
What is the goal of public money creation?
The primary goal of public money creation is to ensure adequate liquidity in the economy, facilitate economic growth, and stabilize financial markets while preventing excessive inflation.
Present a positive argument in support of public money creation.
Public money creation can be a useful tool for stimulating economic growth without increasing tax burdens. When used strategically, it can finance critical infrastructure projects, provide liquidity during financial crises, and support economic recovery without immediately increasing public debt.
Discuss the various reasons why governments borrow.
Governments borrow to finance budget deficits, fund long-term infrastructure projects, stabilize the economy during downturns, and manage unforeseen expenses such as natural disasters or financial crises. Borrowing is often necessary when tax revenues are insufficient to cover expenditures.
Identify and explain the steps that constitute the framework for public debt management.
Effective public debt management involves defining debt objectives (ensuring sustainability), risk assessment (evaluating interest rate and currency risks), refinancing strategies (planning repayments efficiently), and maintaining a liquid government securities market (ensuring demand for government bonds).
What should a government consider when deciding whether to tax or borrow?
- The benefits received principle: If project will benefit future generation, then having them pay for it via loan finance is appropriate.
- Intergenerational equity: If future generation is expected to be richer than the present one, it is fair to have them bear the burden.
- Efficiency consideration: comparison of excess tax burdens and debt finance. If there is no crowding out debt finance is less burdensome since series of small tax measures generate lesser excess burden than a large tax incerease. However, if there’s risk of crowding out, financing through tax will be more efficient.
- Economic conditions (inflation, growth, unemployment)
- Public acceptance (political and social factors),
- long-term fiscal policy objectives (balancing revenue sources and expenditures).
Explain the concept of externalities.
Externalities refer to costs or benefits arising from an economic transaction that affect third parties who are not directly involved. Negative externalities (e.g., pollution) impose costs on society, while positive externalities (e.g., vaccinations) create benefits beyond the individual consumer or producer.
Graphically discuss different types of positive externalities.
Positive externalities occur when the social benefits of an activity exceed private benefits. Examples include education (leading to a more skilled workforce), healthcare (reducing disease transmission), and public transportation (reducing congestion and pollution). These externalities can be represented graphically with social benefit curves exceeding private benefit curves.
Discuss negative externalities as they relate to production and consumption.
Negative externalities arise when production or consumption imposes unintended costs on society. Examples include pollution from factories (harmful to public health) and cigarette smoking (leading to higher healthcare costs). In such cases, government intervention through taxation or regulation is often necessary to correct the inefficiencies.
What are the three main requirements in any approach to setting user charges/tariffs?
Effective pricing of public services requires financial sustainability (ensuring revenue covers costs), economic efficiency (setting prices to reflect true costs and demand), and social equity (ensuring affordability for low-income populations).
Identify and explain the common goals in setting charges/tariffs.
Goals include affordability (ensuring essential services are accessible), revenue generation (covering operational costs), cost recovery (ensuring financial sustainability), efficiency (promoting responsible consumption), and fairness (charging according to usage and ability to pay).
Discuss the need for a competition policy.
A competition policy is necessary to prevent monopolies, promote fair market practices, encourage innovation, and protect consumer interests by ensuring competitive pricing and quality services.
Itemize and briefly explain elements of the competition policy.
Key elements include anti-competitive agreements (preventing collusion), abuse of market power (preventing price manipulation), merger control (regulating corporate takeovers), market liberalization (opening industries to competition), and competition advocacy (promoting fair business practices).
What do you understand by the concept of privatization?
Privatization refers to the transfer of government-owned enterprises to private ownership to enhance efficiency, attract investment, and reduce the fiscal burden on the government.
What are the benefits of privatizing public enterprises?
Benefits include increased efficiency, improved service delivery, reduced government financial burdens, greater innovation, and enhanced competition.
Discuss the rationale for social ownership.
Social ownership aims to ensure equitable distribution of resources, prevent exploitation, and provide essential services to all citizens regardless of income levels.
What is government failure?
Government failure occurs when government interventions lead to inefficiencies, unintended negative outcomes, or excessive bureaucracy, making economic conditions worse rather than better.
Identify the sources of government failure.
Sources include regulatory capture (favoring special interests), policy inconsistency (frequent changes in laws), corruption (misuse of public funds), and high administrative costs (inefficient allocation of resources).
What do you understand as public choice-making?
Public choice-making is the application of economic principles to political decision-making. It studies how individuals, politicians, and bureaucrats make decisions in a non-market setting. Public choice theorists assume that political agents, like economic agents, act in their self-interest rather than purely for the public good
What are the various collective decision-making rules that exist?
Collective decision-making rules include simple majority voting (where a decision is made if more than 50% agree), plurality voting (where the option with the most votes wins, even if not a majority), Borda count (where rankings are assigned to choices), and point voting (where voters distribute points among different options)
What is Arrow’s (Im)possibility Theorem?
Arrow’s theorem states that no collective decision-making rule can satisfy all fairness criteria while consistently translating individual preferences into a collective outcome. The theorem highlights the inherent challenges in designing a perfect voting system.
What is logrolling, and how does it affect political outcomes?
Logrolling is the trading of votes among legislators to pass policies that may not have broad public support. It allows voters or politicians to prioritize certain issues, but it can also lead to inefficient government spending on special interests
Identify the sources of government failure.
Government failure can arise from imperfect information (where policymakers lack sufficient data), policy myopia (short-term focus instead of long-term planning), special interest influence (where politicians favor certain groups in exchange for support), and regulatory capture (where government agencies serve industry interests instead of the public)
Explain the crowding-out effect.
The crowding-out effect occurs when increased government borrowing raises interest rates, making it more expensive for the private sector to invest, potentially reducing private-sector economic activity.
What is the Pigouvian tax?
A Pigouvian tax is a corrective tax imposed on activities that generate negative externalities. It raises the cost of the activity to reflect its true societal cost, reducing overproduction and aligning private incentives with social welfare.
What are the methods of redemption of public debt?
Governments redeem public debt through: (i) Repudiation (cancellation), (ii) Refunding (issuing new bonds), (iii) Conversion (changing debt terms), (iv) Sinking funds (gradual repayment), and (v) Surplus budgeting
What is taxation?
Taxation is the compulsory levy imposed by governments on individuals and businesses to generate revenue for public expenditure, redistribute income, and regulate economic activities.
Differentiate between horizontal and vertical equity in tax administration.
Horizontal equity means individuals with similar income levels should pay similar taxes, while vertical equity suggests those with higher incomes should pay more, ensuring a fair tax burden
What are three broad classifications of taxes?
(i) Direct taxes (income tax, corporate tax), (ii) Indirect taxes (VAT, sales tax), and (iii) Trade taxes (import/export duties)
Explain the Benefit and Ability-to-Pay theories of taxation.
The Benefit Theory states that individuals should pay taxes based on the benefits they receive from government services, while the Ability-to-Pay Theory suggests tax burdens should be based on an individual’s economic capacity.
What are subsidies, and why do governments use them?
Subsidies are financial assistance provided by governments to encourage the production or consumption of certain goods and services. They help support essential industries, correct market failures, and promote social welfare.
What are the merits and demerits of direct and indirect taxation?
Direct taxes provide stability and equity but may discourage work effort, while indirect taxes are easier to administer but can be regressive
What is fiscal policy?
Fiscal policy refers to the use of government spending and taxation to influence economic activity. It aims to stabilize the economy, promote growth, and control inflation
Discuss the criteria for a good tax system.
Equitable (Fair distribution of tax burden across income groups).
Efficient (Minimizes distortions in economic behavior).
Certain (Predictable and stable for taxpayers).
Convenient (Easy to comply with and administer).
Administratively simple (Low collection and enforcement costs)
