CFI 313: PUBLIC FINANCE
LECTURES ONE & TWO – INTRODUCTION
1.0 Definition of public finance
Public finance is the study of the role of government in the economy and the relationship between the
individual and the state. Public finance is also known as public sector economics or just public economics
2.0 The Main roles of Government under public finance
According to Richard A. Musgrave (the father of modern public finance) there are three main
government functions under public finance :-
2.1 Allocation function
Under the allocation function the government seeks to provide social or public goods which cannot be
effectively provided through the market system of supply and demand. Since the price mechanism does
not work in some cases the government role is to influence resource allocation. This the government
does by carrying out the following:-
2.1.1 Securing conditions that ensures price mechanism work
The claim that the market mechanism leads to efficient resources use (i.e. produces what consumers
want most and does so in the cheapest way) is based on the condition of competitive factor and product
market. Thus there must be no obstacle to free entry in the market and consumers and producers must
have full market knowledge. Government regulation or other measures may be needed to secure these
conditions.
2.1.2 Provide a legal structure
The contractual arrangements and exchanges needed for market operation cannot exist without the
protection and enforcement of a governmentally provided legal structure.
2.1.3 Provision of public goods
The problem of externalities arises in production of certain goods leading to market failure and
therefore the government must intervene and provide these goods thorough normal budgetary
provisions, subsidies or tax penalties. Externalities refer to social costs and benefits that are not fully
accounted for in the market system e.g. provision of national defense, reduction of air pollution, street
lights, providing law and order e.t.c.
LECTURES ONE & TWO – INTRODUCTION
1.0 Definition of public finance
Public finance is the study of the role of government in the economy and the relationship between the
individual and the state. Public finance is also known as public sector economics or just public economics
2.0 The Main roles of Government under public finance
According to Richard A. Musgrave (the father of modern public finance) there are three main
government functions under public finance :-
2.1 Allocation function
Under the allocation function the government seeks to provide social or public goods which cannot be
effectively provided through the market system of supply and demand. Since the price mechanism does
not work in some cases the government role is to influence resource allocation. This the government
does by carrying out the following:-
2.1.1 Securing conditions that ensures price mechanism work
The claim that the market mechanism leads to efficient resources use (i.e. produces what consumers
want most and does so in the cheapest way) is based on the condition of competitive factor and product
market. Thus there must be no obstacle to free entry in the market and consumers and producers must
have full market knowledge. Government regulation or other measures may be needed to secure these
conditions.
2.1.2 Provide a legal structure
The contractual arrangements and exchanges needed for market operation cannot exist without the
protection and enforcement of a governmentally provided legal structure.
2.1.3 Provision of public goods
The problem of externalities arises in production of certain goods leading to market failure and
therefore the government must intervene and provide these goods thorough normal budgetary
provisions, subsidies or tax penalties. Externalities refer to social costs and benefits that are not fully
accounted for in the market system e.g. provision of national defense, reduction of air pollution, street
lights, providing law and order e.t.c.
