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Questions and Answers
What is a budget deficit?
What is a budget deficit?
Budget deficit is the excess of government expenditure over government revenue.
How can deficits be reduced?
How can deficits be reduced?
Government debt is also known as national debt.
Government debt is also known as national debt.
True
______ debt is owed to lenders within the country.
______ debt is owed to lenders within the country.
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Match the following debt classification with their descriptions:
Match the following debt classification with their descriptions:
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What is the main concern with deficits in political and economic discussions?
What is the main concern with deficits in political and economic discussions?
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What are goods and services produced to satisfy collective wants known as?
What are goods and services produced to satisfy collective wants known as?
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Which principle associated with private goods is not applicable to public goods?
Which principle associated with private goods is not applicable to public goods?
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Public goods are consumed distributively, just like private goods.
Public goods are consumed distributively, just like private goods.
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Individuals and Governments rely upon borrowings when current incomes become insufficient to meet current __________.
Individuals and Governments rely upon borrowings when current incomes become insufficient to meet current __________.
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Match the following characteristics with either private finance or public finance:
Match the following characteristics with either private finance or public finance:
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What is the main argument forwarded by proponents of laissez-faire in supporting minimal government intervention in the economy?
What is the main argument forwarded by proponents of laissez-faire in supporting minimal government intervention in the economy?
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What is a common social and economic goal of public expenditures?
What is a common social and economic goal of public expenditures?
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Define public revenue in public finance.
Define public revenue in public finance.
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Taxation is the most significant source of revenue for the government.
Taxation is the most significant source of revenue for the government.
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Fee is a compulsory payment made by citizens who receive special benefits from the services rendered by the ______.
Fee is a compulsory payment made by citizens who receive special benefits from the services rendered by the ______.
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Match the components of public finance with their descriptions:
Match the components of public finance with their descriptions:
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What is market failure?
What is market failure?
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What are the five specific sources of market failure mentioned in the text?
What are the five specific sources of market failure mentioned in the text?
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Externalities can be positive or negative.
Externalities can be positive or negative.
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A natural monopoly is nonrival but ________.
A natural monopoly is nonrival but ________.
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Match the correct approach to correct externalities with its description:
Match the correct approach to correct externalities with its description:
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What are the two ways governments intervene to offset unequal income distribution?
What are the two ways governments intervene to offset unequal income distribution?
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What is a transfer payment?
What is a transfer payment?
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Taxation is the most common method of financing government activities.
Taxation is the most common method of financing government activities.
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Tax imposes a personal obligation on the tax______ers to _ _ _ _ it.
Tax imposes a personal obligation on the tax______ers to _ _ _ _ it.
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What is tax evasion?
What is tax evasion?
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How do accountants refer to tax avoidance?
How do accountants refer to tax avoidance?
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Tax avoidance violates the letter of the law.
Tax avoidance violates the letter of the law.
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Define tax delinquency.
Define tax delinquency.
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What is the basic purpose of taxation?
What is the basic purpose of taxation?
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Which principle of taxation emphasizes that the tax burden should be more on the rich than on the poor?
Which principle of taxation emphasizes that the tax burden should be more on the rich than on the poor?
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Taxation can be used to prevent harmful consumption.
Taxation can be used to prevent harmful consumption.
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Another important canon of taxation advocated by Adam Smith is __________.
Another important canon of taxation advocated by Adam Smith is __________.
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Match each taxation principle with its description:
Match each taxation principle with its description:
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What type of tax is a tax on income earned by individuals?
What type of tax is a tax on income earned by individuals?
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Direct taxes are taxes that can be shifted to another person or thing.
Direct taxes are taxes that can be shifted to another person or thing.
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Define 'Vertical Equity' in terms of taxation.
Define 'Vertical Equity' in terms of taxation.
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_____ taxes are based on the percentage of individuals' income.
_____ taxes are based on the percentage of individuals' income.
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Match the tax type with its description:
Match the tax type with its description:
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Which type of tax requires the taxpayer to adhere to legal formalities such as submission of income returns and disclosing sources of income?
Which type of tax requires the taxpayer to adhere to legal formalities such as submission of income returns and disclosing sources of income?
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Direct taxes are paid by all individuals, regardless of their income level.
Direct taxes are paid by all individuals, regardless of their income level.
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What is the main disadvantage of direct taxes in terms of encouraging work, saving, and investment?
What is the main disadvantage of direct taxes in terms of encouraging work, saving, and investment?
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Under direct taxes, each taxpayer is separately assessed, making the ________ of tax collection more expensive.
Under direct taxes, each taxpayer is separately assessed, making the ________ of tax collection more expensive.
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Match the following advantages with the type of tax they belong to:
- Convenient to taxpayers
- Wide scope
- Revenue can be increased
- Discourages consumption of harmful items
Options:
A. Direct taxes
B. Indirect taxes
Match the following advantages with the type of tax they belong to:
- Convenient to taxpayers
- Wide scope
- Revenue can be increased
- Discourages consumption of harmful items
Options: A. Direct taxes B. Indirect taxes
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Study Notes
Basics of Public Finance
- Public finance is the study of the provision, custody, and disbursement of resources needed for the conduct of public or governmental functions.
- It deals with the budgeting of revenues and expenditures of a public sector entity, usually government, and its effects on economic and social systems.
Meaning of Public Finance
- Financing of government is a universal concern, requiring adequate revenue to provide social amenities like education, health, and sanitation facilities, and public utilities.
- Public finance is sometimes crudely defined as the study of states, but this definition is vague and unhelpful.
- Public finance is also referred to as public sector economics or simply public economics.
Scope of Public Finance
- The scope of public finance includes:
- Public expenditure
- Public revenue
- Public debt
- Financial administration
- Federal finance
Public Expenditure
- Public expenditure refers to spending by the public sector during a given period of time.
- It includes fiscal spending, plus all spending by fiscal and semifiscal firms with autonomous administration from the central government.
- Public spending is used for goods for public consumption or capital goods, public investment.
- Governments undertake expenditures to pursue a variety of economic, social, and political goals, such as poverty alleviation and creating an enabling environment for the private sector.
Public Revenue
- Public revenue refers to the various sources of government income, including taxation, fees, sale of goods and services, fines, gifts, and grants, and government properties.
- Taxation is the most important source of revenue for the government.
- A tax is a compulsory contribution from the person to the government to defray the expenses incurred in the common interests of all, without reference to special benefits conferred.
Public Debt
- Public debt is the money or credit owed by any level of government, including central, state, and local governments.
- Budget deficit is the excess of government expenditure over government revenue, and can be reduced by cutting spending or increasing revenue.
- Governments usually borrow by issuing securities such as government bonds and treasury bills.
Financing Budget Deficit
- Budget deficit can be financed in four basic ways:
- Printing money
- Running down foreign exchange reserves
- Borrowing abroad
- Borrowing domestically
Effects of Public Debt
- Each of the above mechanisms could lead to at least one potential problem:
- Printing money acts like a tax, but the associated inflation exacts a heavy toll on social cohesion
- Drawing foreign exchange reserves could lead to a balance-of-payment crisis
- Borrowing abroad could precipitate a foreign debt crisis
- Domestic borrowing might crowd-out private investment by raising interest rates
Economic Functions of Modern Government
- The economic functions of modern government include:
- Allocation function: providing public goods and services to maximize social welfare
- Distribution function: redistributing income and wealth to reduce inequality and promote social welfare### Fiscal Operations
- Fiscal operations aim to reduce income and wealth inequality by:
- Implementing progressive taxation to reduce the income and wealth of the rich
- Using the collected revenue to increase the income and standard of living of the lower-income group through public expenditure
- This approach has been commonly used in many countries to address income and wealth inequality
Stabilization Function
- Fiscal operations help to moderate fluctuations in the economy, such as:
- Business booms and inflations
- Business recessions and depressions
- To achieve this, fiscal operations may:
- Increase taxation to control business booms and inflations
- Increase public expenditure to stimulate economic growth during recessions
Private vs. Public Goods
Private Goods
- Are goods and services that are consumed by individuals to satisfy their personal wants or needs
- Examples: food, clothing, shelter, recreation, transportation, communication
- Characteristics:
- Are priced in the market based on cost of production and demand
- Can be divided among individuals based on their willingness to pay
- Are subject to the principle of exclusion (those who don't pay can't consume)
- May be affected by externalities (favorable or unfavorable effects on third parties)
Public Goods
- Are goods and services that are produced and supplied to meet collective wants
- Examples: defense, education, public health, infrastructure facilities
- Characteristics:
- Cannot be divided among individuals
- Are collectively consumed by all members of society
- Are not priced in the market
- Are not subject to the principle of exclusion (everyone benefits, regardless of payment)
Public Finance vs. Private Finance
Similarities
- Both aim to satisfy human wants
- Both involve balancing income and expenditure
- Both aim for maximum satisfaction
- Both involve borrowing to finance expenditure
- Both face the problem of economic choice (limited resources, unlimited wants)
Dissimilarities
- Income and expenditure adjustment:
- Private finance: adjusts income to expenditure
- Public finance: adjusts expenditure to income
- Nature of benefits:
- Private finance: individual benefits
- Public finance: collective benefits
- Other differences:
- Postponement of expenditure
- Allocation of resources
- Motive of expenditure
- Influence on expenditure
- Nature of perspective
- Nature of budget
- Nature of resources
- Coercion
- Publicity
- Audit
Role of the State in a Market Economy
- Ongoing debate about the role of the state in a market economy
- Different perspectives:
- Laissez-faire: minimal government intervention
- Industrial policy advocates: active government role in a market economy
- Arguments for government intervention:
- Market irrationalities
- Need for efficient markets
- Challenges that cannot be settled through voluntary transactions
- Most economies today are mixed economies, with both government and private sector involvement
Market Failure and the Need for Government Intervention
- Market failure: a situation where markets are not able to provide enough of a particular socially desirable good
- Sources of market failure:
- Public goods
- Externalities
- Market power (monopoly)
- Equity considerations
- Inadequate information
- Classification of goods and resources:
- Excludable vs. non-excludable
- Rival vs. non-rival
- Private goods
- Public goods
- Common resources
- Natural monopolies
- Public goods and the free-rider problem: since no one can be excluded from consuming a public good, public goods create a free-rider problem, and private firms will not provide them.### Public Goods and Externalities
- Private firms cannot provide public goods because they are non-rivalrous and non-excludable, leading to free riders who consume the good without paying for it.
- Government intervention is necessary to provide public goods.
Externalities
- An externality is a valued impact (cost or benefit) resulting from an action that affects someone who did not fully consent to it.
- Externalities can be positive (benefit) or negative (cost).
- Social costs are the full resource costs of an economic activity, including externalities.
- Private costs are the costs of an economic activity directly borne by the immediate producer or consumer (excluding externalities).
- External costs are the difference between social and private costs.
Market vs. Social Demand
- Market demand expresses only the anticipated private benefits of consumption.
- Social demand includes private benefits and accounts for externalities.
- If there is a negative externality, market demand exceeds social demand, leading to overproduction.
- If there is a positive externality, social demand exceeds market demand, leading to underproduction.
Correcting Externalities
- Approaches to correct externalities include:
- Bargaining (Coase Theorem)
- Legal System
- Tax
- Regulation
- Subsidy
- Market for Externality Rights
Market Power (Monopoly)
- Market power is the ability of a firm to alter the market price of a good or service.
- Government intervention is necessary to prevent or dismantle concentrations of market power.
Equity
- Equity concerns the distribution of goods and services generated by the free market.
- Government intervention may be needed to redistribute income if the market fails to reflect our notions of fairness.
Inadequate Information
- Inadequate information can lead to market failure.
- Government intervention is necessary to prevent information failures, such as:
- Moral hazard
- Adverse selection
Government Revenue Raising Mechanisms
- Government revenue raising mechanisms include:
- Sale of goods or services
- Borrowing
- Printing paper money
- Taxation
Taxation
- A tax is a compulsory charge imposed by the government without any expectation of direct return in benefit.
- Characteristics of taxation:
- Compulsory contribution
- Benefit is not the basic condition
- Personal obligation
- Common interest
- Legal collection
- Element of sacrifice
- Regular and periodical payment
- No discrimination
- Wide scope
Structure of Taxation
- Taxation structures can be centralized or decentralized.
Objectives of Taxation
- Tax objectives are goals that are expected to be achieved through the taxation system.
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Description
This quiz covers the basics of public finance, including the meaning and scope of public finance, government financing, and public projects. Test your knowledge of public finance fundamentals.
