Public Finance  
      Introduction to Public Finance:  
      Before we begin with the public finance, we would like to point out the major functions of 
      a modern government:  
         (a) Improving economic efficiency  
         (b) Making the distribution of income less unequal  
         (c) Stabilising the economy through macro-economic policies  
         (d) Representing the country internationally  
      It is duty of the government to bring economic and social justice in the country.  And this 
      can only be done by properly utilising the funds raised through taxes and other sources 
      of public finance.  
      The famous American Economist J.M. Keynes has revolutionised and changed the 
      meaning of public finance.  According to Keynes, public finance should be used as an 
      instrument for achievement of certain economic and social objectives.  Before Keynes, 
      the concept of public finance was to raise sufficient revenues for meeting public 
      expenditure.  In other words, before Keynes, public finance was concerned with the 
      raising of financial resources for the State.  But Keynes made a fundamental change in 
      the nature and scope of public finance.  Keynes and his followers emphasised that 
      public finance is to help in the achievement of certain social and economic objectives 
      and finance some essential economic activities.  
      Keynes underlines the fact that the taxation and public expenditure policy of the State 
      vitally affects the level of income and employment in the country.  Keynes showed that 
      during depression, how a government could reduce the depression from the economy 
      by increasing its public expenditure and raise the level of employment.  When the 
      government increases its investment expenditure on public works, then the level of 
      income and employment in the country increases more than the ratio of increase in 
      initial investment.  This is Keynes' Income Multiplier.  
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      Generally, the level of full employment in the economy is impossible.  This is so 
      because whenever there is lack of effective demand, the production remains unsold 
      which ultimately leads the entrepreneur to loss.  Thus investor will reduce the level of 
      investment resulting more unemployment and a situation of depression in the economy.  
      In depression, the purpose of budgetary policy is to provide investment opportunities 
      and increase employment level in the economy.  The government should increase 
      public expenditure during depression more than the public revenue.  The deficit can be 
      covered by deficit financing, i.e., by creating money.  The result of deficit financing is 
      that the purchasing power with the people increases and aggregate demand for goods 
      and services increases.  Owing to increase in aggregate demand and the operation of 
      multiplier, the depression will tend to disappear and the economy will move towards full 
      employment.  
      On the contrary, whenever, there is a higher effective demand and when the money 
      supply is increased, there will be a generation of inflation in the economy.  In such a 
      situation, the purpose of fiscal policy to reduce money supply in the economy so as to 
      reduce the inflationary pressure and so people can save more and consume less.  
      When there is inflation in the economy and the prices are soaring higher and higher, the 
      government should levy heavy taxes and in this way withdraw purchasing power from 
      the people and should also reduce its own expenditure.  The demand having been 
      reduced in this way, prices would tend to come down.  It is clear that to fight inflation, 
      the government should frame a 'surplus budget'.  A surplus budget means that the 
      government should collect more money from the public by imposing more taxes but 
      keep its expenditure less than the revenue raised.  The result will be that less 
      purchasing power will be left with the people and the aggregate demand for goods will 
      be reduced.  Consequently, the prices will have a tendency to fall.  
      The above situation is mostly existed in economically advanced and rich countries.  The 
      less developed countries, like Pakistan, Bangladesh, India, China, Myanmar, etc. are 
      caught up in the vicious circle of poverty and their main problem is to break this circle 
      and move towards economic development so that poverty is removed and the living 
      standard of the people is raised.  The objectives of public finance in less developed 
      countries are to give a fill up to capital formation, encourage industrialisation, encourage 
      productive investment, and foster economic growth.  Thus the objectives of public 
      finance in less developed countries are different from those in the developed countries.  
      Whereas in developed countries, the function of public finance is to accelerate 
      economic growth so that the widespread unemployment and poverty prevailing in the 
      country are removed.  
      Causes of Market Failure / Reasons of Government's Intervention in 
      Market Economy: 
      The market economic system operates under Price Mechanism.  Consumers show their 
      will or desire to buy a commodity at a given price in order to maximise their utility.  On 
      the other hand, the producers are aimed at maximising their profit for what they 
      produce.  In market economy, there is no justification for state intervention but there are 
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      some reasons that necessitate the government's intervention in the economy as 
      discussed below:  
      (a) To avoid Monopoly: Monopoly is a situation in which one seller rules over the 
      whole industry.  The buyers are compelled to purchase commodity at the price fixed by 
      the monopolist.  Therefore, the government interferes for the benefits of the consumers.  
      The government interferes in pricing of the commodity, and/or encourages new firms to 
      enter into the market/industry.  
      (b) To maintain Price Mechanism: There may be possibilities of prevailing an 
      unjustified price mechanism even in the presence of perfect competition in the market.  
      The government can monitor the prices fixed by the market and protect the consumers 
      from the burden of unjustified prices.  
      (c) To meet Externalities: Externalities represents those activities that affect others for 
      better or worse, without those others paying or being compensated for the activity.  
      Externalities exist when private costs or benefits do not equal social costs or benefits.  
      There are two major species, i.e., external economy and external diseconomy.  In such 
      situation, government intervene the market with its different policies.  
      (d) Increasing Social Welfare and Benefits: Another strong reason of government's 
      intervention in the market economy is the social welfare and benefit.  It is one of the 
      duties of an elected government to work for the common welfare of the nation; to 
      provide social goods and services, like hospitals, education facilities, parks, museums, 
      water and sewerage, electricity, old age benefits, scholarships, etc; and the protect the 
      people from the evils of a laissez faire economy.  
      (e) To meet Modern Macro-Economic Issues: It is the duty of the government to 
      ensure that the country is in a right direction of economic development.  Government 
      must ensure controlled inflation, greater employment opportunities, rapid technological 
      advancement, adequate capital formation, and higher economic growth rate.  
      Governmental Activities / Actions taken by the Government: 
      Intervention of government in the economy takes a number of forms.  The government 
      may undertake the conduct of production, or may influence private economic activity by 
      subsidies or taxes, or they may exercise direct control over behaviour on the private 
      sector.  Finally, governments may transfer purchasing power from some persons to 
      others.  The government activities can be broadly classified into four groups:  
      (a) Allocative Activities: These activities alter the overall mix of gross national product.  
      The allocative activities arise out of the failure of the market mechanism to adjust the 
      outputs of various goods in accordance with the preferences of society.  The ultimate 
      goal of the government is to maximise per capita income.  
      (b) Efficiency in Resource Utilisation: Maximum efficiency in the use of resources 
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      requires the attainment of three conditions:  
         (i) Attainment of least cost combinations  
         (ii) Operation of the firms at the lowest long-run average cost  
      (iii) Provision of maximum incentive for developing and introducing new techniques.  
      While the private sector is presumed to be less deficient, on the whole, in attaining 
      optimal efficiency than in attaining optimal allocation of resources, nevertheless in 
      several situations governments may be more effective.  
      (c) Stabilisation and Growth Activities: are those activities reducing economic 
      instability and unemployment and increasing the potential and actual rates of economic 
      growth.  
      (d) Distributional Activities: are those activities altering the pattern of distribution of 
      real income.  
      Approaches of Government Actions: 
      Following are the approaches or tools of government action plan against the 
      malfunctions of market economy:  
      (a) Governmental Conduct of Production: The public goods such as defence, law 
      enforcement, etc are supplied by the government, since their inherent character they 
      cannot be produced and sold on a profit-making basis by private enterprise.  
      Government may also undertake education.  In order to adapt the nature and quality of 
      education to meet community goals, governments produce the services directly, 
      although allowing private enterprise to provide them as well for persons who prefer the 
      private product.  
      Government conduct of production may also be undertaken for efficiency reasons - to 
      avoid collection costs, to obtain advantages of longer-term investments, or to attain 
      economies of scale.  
      (b) The Subsidy Approach: An alternative to governmental production is subsidisation 
      of private producers to induce them to increase output or to undertake investments that 
      they would not otherwise make.  Thus private schools could be subsidised to provide 
      additional education at prices less than those equal to marginal cost.  Subsidies might 
      also be used to increase investment to lessen unemployment or to lower output when 
      carried beyond the optimal figure.  
      (c) The Control Approach: For some purposes, direct control of private sector activity, 
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      with no governmental production except the limited amount involved in administration of 
      the regulatory rules, is a satisfactory solution.  Activity that gives rise to significant 
      external costs, such as pollution, may be subjected to controls, such as requirements 
      for adequate waste disposal.  Monopoly may be broken up by antitrust laws or 
      monopoly firms may be subjected to detailed regulation of rates and services.  This form 
      of regulation creates a continuous clash of interest between government and the firms.  
      (d) Aggregate Spending: Prevention of unemployment and attainment of the potential 
      rate of economic growth or prevention of inflation may require fiscal and monetary