by Public finance deals with the question how the Government raises its resources to meet its ever-rising expenditure. As Dalton puts it,” public finance is “concerned with the income and expenditure of public authorities and with the adjustment of one to the other.”
Accordingly, effects of taxation, Government expenditure, public borrowing and deficit financing on the economy constitutes the subject matter of public finance. Thus, Prof. Otto Eckstein writes “Public Finance is the study of the effects of budgets on the economy, particularly the effect on the achievement of the major economic objects growth, stability, equity and efficiency.”
Further, it also deals with fiscal policies which ought to be adopted to achieve certain objectives such as price stability, economic growth, more equal distribution of income. Economic thinking about the role that public finance is expected to play has changed from time to time according to the changes in economic situation.
Before the Great Depression that gripped the Western industrialised countries during the thirties, the role of public finance was considered to be raising sufficient resources for carrying out the Government functions of civil administration and defence from foreign countries. During this period, the classical economists considered it prudent to keep expenditure to the minimum so that taxing of the people is avoided as far as possible.
Further, it was thought that Government budget must be balanced. Public borrowing was recommended mainly for production purposes. During a war, of course, public borrowing was considered legitimate but it was thought that the Government should repay or reduce the debt as soon as possible.
Economists have a strict definition of a public good, and it does not necessarily include all goods financed through taxes. To understand the defining characteristics of a public good, first consider an ordinary private good, like a piece of pizza. A piece of pizza can be bought and sold fairly easily because it is a separate and identifiable item. However, public goods are not separate and identifiable in this way.
Even though new technology typically creates positive externalities through which one-third to one-half of the social benefit of new inventions spills over to others, the inventor still receives some private return. But what about a situation where the positive externalities are so extensive that private firms could not expect to receive any of the social benefit? This kind of good is called a public good.
Instead, public goods have two defining characteristics: they are nonexcludable and nonrivalrous. The first characteristic, that a public good is nonexcludable, means that it is costly or impossible to exclude someone from using the good. If Larry buys a private good like a piece of pizza, then he can exclude others, like Lorna, from eating that pizza. However, if national defense is being provided, then it includes everyone. Even if you strongly disagree with America’s defense policies or with the level of defense spending, the national defense still protects you. You cannot choose to be unprotected, and national defense cannot protect everyone else and exclude you.
The second main characteristic of a public good that it is nonrivalrous means that when one person uses the public good, another can also use it. With a private good like pizza, if Max is eating the pizza, then Michelle cannot also eat it it the two people are rivals in consumption. With a public good like national defense, Max’s consumption of national defense does not reduce the amount left for Michelle, so they are nonrivalrous in this area.
A number of government services are examples of public goods. For instance, it would not be easy to provide fire and police service so that some people in a neighborhood would be protected from the burning and burglary of their property, while others would not be protected at all. Protecting some necessarily means protecting others, too.
Positive externalities and public goods are closely related concepts. Public goods have positive externalities, like police protection or public health funding. Not all goods and services with positive externalities, however, are public goods. Investments in education have huge positive spillovers but can be provided by a private company. Private companies can invest in new inventions such as the Apple iPad and reap profits that may not capture all of the social benefits.
Key Character
- A public good has two key characteristics: it is nonexcludable and nonrivalrous. These characteristics make it difficult for market producers to sell the good to individual consumers.
- Nonexcludable means that it is costly or impossible for one user to exclude others from using a good.
- Nonrivalrous means that when one person uses a good, it does not prevent others from using it.
It is apparent that public goods will not be adequately supplied by the private sector. The reason is plain: because people can’t be excluded from using public goods, they can’t be charged money for using them, so a private supplier can’t make money from providing them. … Because public goods are generally not adequately supplied by the private sector, they have to be supplied by the public sector.
Economists have often jumped from the observation that public goods are susceptible to underproduction to the conclusion that the government should tax people and use the revenues to provide public goods.
Public goods are regularly supplied by private actors without government coercion. For example:
- Having one’s downtown be free of impoverished beggars is a benefit that is both non-rivalrous and non-excludable, yet privately funded homeless shelters and soup kitchens are common.
- A beautiful, well-kept garden provides a vista that multiple users can enjoy without depletion (non-rivalrous) and from which passersby cannot easily be barred (non-excludable), yet many homeowners in populated areas expend significant sums, not to mention hours of hard labor, tending their yards.
- A highly educated citizenry tends to make better political decisions and to generate a richer cultural environment—both benefits that are non-rivalrous and largely non-excludable—yet people routinely spend great sums educating their children.
- Private groups regularly clean up roadsides, even though the benefit they are creating is not depleted as more drivers use the road (non-rivalrous) and cannot be limited to people who contribute to the clean-up (non-excludable).
- Millions of people make donations on “crowd-funding” websites like Kickstarter to finance projects like community theatre spaces, thereby creating the non-excludable, non-rivalrous benefit of more cultured communities.
Overcoming the Free-Rider
Direct provision of a public good by the government can help to overcome the free-rider problem which leads to market failure
- The non-rival nature of consumption provides a strong case for the government rather than the market to provide and pay for public goods.
- Many public goods are provided more or less free at the point of use and then paid for out of general taxation or another general form of charge such as a license fee.
- State provision may help to prevent the under-provision and under-consumption of public goods so that social welfare is improved.
- If the government provides public goods, they may be able to do so more efficiently because of economies of scale.
Public goods an example of market failure
- Pure public goods are not normally provided by the private sector because they would be unable to supply them for a profit.
- It is up to the government to decide what output of public goods is appropriate for society.
- To do this, it must estimate the social benefits from making public goods available.
Free Rider Problem
- Because public goods are non-excludable it is difficult to charge people for benefitting form a good or service once it is provided
- The free rider problem leads to under-provision of a good and thus causes market failure
Quasi-Public Goods
A quasi-public good is a near-public good i.e. it has many but not all the characteristics of a public good. Quasi-public goods are:
- Semi-non-rival: up to a point, extra consumers using a park, beach or road do not reduce the space available for others. Eventually beaches become crowded as do parks and other leisure facilities. Open access Wi-Fi networks become crowded
- Semi-non-excludable: it is possible but often difficult or expensive to exclude non-paying consumers. E.g. fencing a park or beach and charging an entrance fee; building toll booths to charge for road usage on congested routes
- The air waves – a public good or quasi public good?
- The airwaves used by mobile phone companies, radio stations and television companies are owned by the government.
- Do they count as a pure public good? One person’s use of the airwaves rarely limits how other people can benefit from utilising them.
- At peak times, the airwaves become crowded
