Course: Public Finance and Policy (HS30079)

Topics Covered (Pre-Mid Semester, 2019):

1. Introductory Remarks: Three broad aspects – (a) why government in an economy, (b) role and functioning of government and impacts, (c) what should government do

2. Allocation of Resources and Distribution of Goods and Services: (a) Basic notion of Pareto optimality; (b) Pareto optimality in consumption and its marginal conditions,
(c) Pareto optimality in production and its marginal conditions (three aspects – optimum combination of factors of production, optimum degree of specialization, (c)
optimum factor-output combination); (d) Perfect competition and marginal conditions of Pareto optimality; (e) Limitations of marginal conditions and general condition
of Pareto optimality; (f) Perfect competition and general conditions of Pareto optimality; (g) Imperfect competition and conditions of Pareto optimality; (h)
Indeterminacy of Pareto optimality and concept of utility possibility frontier and social welfare function; (i) Pareto improvement (compensation principle); (j) the theory
of second best

3. Market Failures and Role of Government: (a) Public goods and Pareto optimality; (b) Externalities in production and consumption; (c) Market power and welfare; (d)
Information gaps and welfare; (e) Possible role of the government to address market failures (with special emphasis on internalization of externalities, Lindahl’s solution
for public goods and Groves-Clarke Taxation)

4. Incidence of Taxation: (a) Impact of taxation on consumers’ surplus, producers’ surplus, deadweight loss in a perfectly competitive market; (b) Burden of tax on
consumers and producers in a perfectly competitive market; (c) Response of a competitive firm and monopolist to different types of taxes; (d) Impact of income and
commodity taxation on consumers

5. Impact of Macroeconomic Policies: (a) Impact of fiscal policies (in respect of changes in government expenditure, taxation, subsidies, transfer payments, etc.) on
income, employment, price level, private investment, etc.; (b) Fiscal and monetary policy interactions; (c) Relative effectiveness of fiscal policies in simple Keynesian
model, IS-LM model and Complete Keynesian model; (b) Dynamic perspectives of fiscal interventions

Suggested Readings:

Textbooks:

1. Public Finance in Theory and Practice by R. A. Musgrave and P. E. Musgrave

2. Public Finance and Public Choice : An Analytical Perspective by John Cullis and Philip Jones
3. Intermediate Public Economics by Jean Hindriks and Gareth D. Myles

Others:
1. Microeconomic Theory: A Mathematical Approach by James M. Henderson and Richard E. Quandt (Chapter 11: Welfare Economics)
2. Modern Microeconomics by A. Koutsoyiannis (Chapter 23: Welfare Economics)
3. Macroeconomics: Theory and Policy by William H. Branson (Chapter 3-9)
 Conceptual Framework of the Course Public Finance and Policy (HS30079) (Pre Mid-Semester)

Basic Economic Problems Major Economic Decisions Who Should Make Decisions?
 Limited resources with  What to produce?  The market forces?
alternative uses  How to produce?  The government?
Scarcity
 Unlimited wants of  For whom to produce?  Combination of market
diverse nature Objective: Maximization of forces and government?
Social Welfare

Impact of Govt. Interventions:

(a) Macroeconomic Policies
Decisions through Market Mechanisms Interventions of the Governments(s): Change in income, employment,
Notion: Pareto Optimality  Provision of public goods rate of interest, private investment,
Aspects: Pareto optimality in production and  Internationalization of externalises (taxes, subsidies, savings, inequality, etc.
consumption property rights, restrictions on quantity, etc.) (b) Sectoral Policies
Objectives: (a) Optimum allocation of resources; (b)  Production of private goods (public sector enterprises) Sectoral growth, employment
Optimum distribution of goods and services  Distribution (procurement & public distribution system) (c) Impact on Markets
Assumptions: (a) No externality; (b) No public good;  Development of infrastructure (public investment & PPP) Consumers’ surplus, producers’
(c) No market power; (d) No information gap  Dissemination of information surplus, deadweight loss, burden of
Requirements for Pareto Optimality: Perfect  Facilitating Innovations (intellectual property rights) taxes, etc.
competition in product and factor markets  Macroeconomic (fiscal, monetary, trade, investment, etc.) (d) Impact on Firms
and Sectoral Policies (agricultural and industrial) and Changes in price, output, profit
target specific programmes and schemes (e) Impact on Individuals
Three Concerns  Regulation of market forces and individual behaviour Changes in optimum choices,
horizontal and vertical equity

Market Failures in the Presence of: Lack of Uniqueness Pareto Optimality versus
 Externalities in production and - Multiple Pareto optimality solutions Pareto Improvement Possibility of Govt. Failures
consumption Possible Solution: Maximization of  Compensation principle  Inefficiency
 Public goods social welfare subject to the grand  Resource allocation in  Leakages
 Market power utility possibility frontier combination with  Elite captures
 Information gaps Possible Problem: Deriving social redistribution of benefits  Imbalance between growth
Failure of perfect competition to satisfy welfare function due to inconsistent Guiding Principle: Utilitarian and equity
Pareto optimality conditions individual preferences or Rawlsian approach?

What should the govt. do?