CFI 313: Public Finance;
Introduction
Learning focus areas
1. Definition of public finance
2. Main role of government under public finance
3. Scope of Public Finance
4. Alternatives views of government
5. Types of economic systems
6. Measuring the size of the public sector
7. Reasons for government participation in the economic activities
8. Welfare economics
9. Distinction between public and private finance
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 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 condition 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.
2.1.4 Adjustments in the reduction of income
Income disparity and social values may require adjustments in the distribution of incomes and wealth.
It’s the government objectives to provide employment and ensure stability in prices of goods and
services. To achieve high employment and stable price the must intervene through budgetary
allocations, fiscal policies and also monetary policies.
2.1.5 Determine proportions of national resources to be devoted for producing consumer goods and
investment goods.
In the case of public goods a certain quantity is consumed by everyone. Therefore the demand for any
quantity of that public good is the sum of prices that each individual consumer is willing to pay for that
quantity. Each demand curve implies the marginal benefit that the consumer gets from consuming every
level of production. The optimum level of production of a public good is determined by equating the
sum of the marginal benefits to the marginal cost of production i.e. the optimum quantity is that
quantity for which the marginal cost of the last unit consumed is equal to the sum of prices that all
consumers are willing to pay for that unit.
2.2 Distribution function
Whereas allocation functions deals with provision of social goods due to market failure, distribution
function concern itself with the efficient use of the resources compared to the given the level of income
and consumption patterns of the citizens. Distribution function seeks to bring equity and equality among
all citizens and in different regions of the country e.g. Equal pay for women, Disability fund, HELP for
higher education funding, Minimum wage. Uwezo fund etc.
Introduction
Learning focus areas
1. Definition of public finance
2. Main role of government under public finance
3. Scope of Public Finance
4. Alternatives views of government
5. Types of economic systems
6. Measuring the size of the public sector
7. Reasons for government participation in the economic activities
8. Welfare economics
9. Distinction between public and private finance
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 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 condition 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.
2.1.4 Adjustments in the reduction of income
Income disparity and social values may require adjustments in the distribution of incomes and wealth.
It’s the government objectives to provide employment and ensure stability in prices of goods and
services. To achieve high employment and stable price the must intervene through budgetary
allocations, fiscal policies and also monetary policies.
2.1.5 Determine proportions of national resources to be devoted for producing consumer goods and
investment goods.
In the case of public goods a certain quantity is consumed by everyone. Therefore the demand for any
quantity of that public good is the sum of prices that each individual consumer is willing to pay for that
quantity. Each demand curve implies the marginal benefit that the consumer gets from consuming every
level of production. The optimum level of production of a public good is determined by equating the
sum of the marginal benefits to the marginal cost of production i.e. the optimum quantity is that
quantity for which the marginal cost of the last unit consumed is equal to the sum of prices that all
consumers are willing to pay for that unit.
2.2 Distribution function
Whereas allocation functions deals with provision of social goods due to market failure, distribution
function concern itself with the efficient use of the resources compared to the given the level of income
and consumption patterns of the citizens. Distribution function seeks to bring equity and equality among
all citizens and in different regions of the country e.g. Equal pay for women, Disability fund, HELP for
higher education funding, Minimum wage. Uwezo fund etc.
