NCERT Class 12 Economics The Government Functions and Scope

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In a mixed economy, apart from the private sector, there is the government which plays a very important role. In this chapter, we shall not deal with the myriad ways in which it influences economic life but limit ourselves to three distinct functions that operate through the revenue and expenditure measures of the government budget. First, certain goods, referred to as public goods (such as national defence, roads, government administration), as distinct from private goods (like clothes, cars, food items), cannot be provided through the market mechanism, i.e. by transactions between individual consumers and producers and must be provided by the government. This is the allocation function. Second, through its tax and expenditure policy, the government attempts to bring about a distribution of income that is considered ‘fair’ by society. The government affects the personal
disposable income of households by making transfer payments and collecting taxes and, therefore, can alter the income distribution. This is the distribution function. Third, the economy tends to be subject to substantial
fluctuations and may suffer from prolonged periods of unemployment or inflation. The overall level of employment and prices in the economy depends upon the level of aggregate demand  hich is a function of the spending decisions of millions of private economic agents apart from the government. These decisions, in turn, depend on many factors such as income and credit availability. In any period, the level of expenditures may not be sufficient for full utilisation of labour and other resources of the conomy. Since wages and prices are generally rigid downwards (they do not fall below a level), employment cannot be restored automatically. Hence, policy measures are needed to raise aggregate demand. On the other hand, there may be times when expenditures exceed the available output under conditions of high employment and thus may cause inflation. In such situations, restrictive conditions are needed to reduce demand. These constitute the stabilisation requirements of the domestic economy. To understand the need for governmental provision of public goods, we must consider what distinguishes them from private goods. There are two major differences. One, the benefits of public goods are not limited to one particular consumer, as in the case of private goods, but become available to all. For instance, if a person consumes a chocolate or wears a shirt, these will not be available to other individuals. This person’s consumption stands in a rival relationship to the consumption of others.

However, if we consider a public park or measures to reduce air pollution, the benefits will be available to all. The consumption of such products by several individuals is not ‘rivalrous’ in the sense that a person can enjoy the benefits without reducing their availablity to others. Two, in case of private goods anyone who does not pay for the good can be excluded from enjoying its benefits. If you do not buy a ticket, you are excluded from watching a film at a local theatre. However, in case of public goods, there is no feasible way of excluding anyone from enjoying the benefits of the good (they are non-excludable). Since non-paying users usually cannot be excluded, it becomes difficult or impossible to collect fees for the public good. This is what is called the ‘free-rider’ problem. Consumers will not voluntarily pay for what they can get for free and for which there is no exclusive title to the property being enjoyed. The link between the producer and the consumer is broken and the government must step in to provide for such goods. Public provision, however, is not the same as public production. Public provision means that they are financed through the budget and made available free of any direct payment. These goods may be produced directly under government management or by the private sector.
Excercise

1. Explain why public goods must be provided by the government.
2. Distinguish between revenue expenditure and capital expenditure.
3. ‘The fiscal deficit gives the borrowing requirement of the government’. Elucidate.
4. Give the relationship between the revenue deficit and the fiscal deficit.
5. Suppose that for a particular economy, investment is equal to 200, government purchases are 150, net taxes (that is lump-sum taxes minus transfers) is 100 and consumption is given by C = 100 + 0.75Y (a) What is the level of equilibrium income? (b) Calculate the value of the government expenditure multiplier and the tax multiplier. (c) If government expenditure increases by 200, find the change in equilibrium income.

7. In the above question, calculate the effect on output of a 10 per cent increase in transfers, and a 10 per cent increase in lump-sum taxes. Compare the effects of the two.
8. We suppose that C = 70 + 0.70Y D, I = 90, G = 100, T = 0.10Y (a) Find the equilibrium income. (b) What are tax revenues at equilibrium income? Does the government have a balanced budget?
9. Suppose marginal propensity to consume is 0.75 and there is a 20 per cent proportional income tax. Find the change in equilibrium income for the following (a) Government purchases increase by 20 (b) Transfers decrease by 20.
10. Explain why the tax multiplier is smaller in absolute value than the government expenditure multiplier.
11. Explain the relation between government deficit and government debt.
12. Does public debt impose a burden? Explain.
13. Are fiscal deficits necessarily inflationary?
14. Discuss the issue of deficit reduction.


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