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Economic Rationale for Government

Economic Rationale of the Modern State . Why do governments provide the specific types of goods and services that they do?

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Economic Rationale for Government

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    1. Economic Rationale for Government Presented by: Amanda Fitschen University of Cape Town School of Economics First Semester 2007

    2. Economic Rationale of the Modern State Why do governments provide the specific types of goods and services that they do?   Is there anything particular about these goods and services such that they be allocated via the public sector’s budget rather than through the market mechanism? There is no single economic explanation for the rationale of government – different problems, different roles

    3. Economic Rationale of the Modern State “Undisputed” 1.  Defense 2.  Internal law and order   Market failure provides the basis for public sector involvement in the economy   5 forms of market failure

    4. Imperfect competition -Monopolies What can G do? Do nothing and wait for profits to attract other participants Impose price control to prevent unduly high prices Tax the profits in full – but tax shifting Regulate by using competition policy Decreasing cost industries or natural monopolies - require different approach - Government regulates or produces because capital expenditure or scale of production so great –EOS e.g. SAA, Eskom, Rand Water

    5. Public goods (vs private goods) Characteristics: Non-excludability – pricing infeasible (lighthouse) Free riding encouraged Non-rivalry – benefits shared by large number of consumers BUT may be non-rival until congested, then user charges become applicable (Parks)  

    6. Externalities Arises when production or consumption of one party affects production or utility of another party Ř Negative (regulate or tax/fine) e.g. Pollution To avoid over-production of the good associated with the diseconomy G can sell property rights and use funds to repair damage ŘPositive (G can subsidise or provide) e.g. Inoculation against disease To maximise consumption Not all externalities require G intervention – negotiated settlement

    7. Income inequality Ř   Transfer payments Ř   Tax policy

    8. Economic instability Ř   Macroeconomic policy (GEAR) Ř   Monetary and fiscal policy

    9. Government’s role ALLOCATION (Reducing the tragedy of the commons) REGULATION (Legislation – to avoid irrationality, selfishness) DISTRIBUTION (Public health, education, social security) STABILISATION (To affect the aggregate performance of the economy ito employment, K utilisation, output, income, price levels, BOP, growth) Coordinate activities

    10. Government Fails Too G intervention results in changes that are unpredictable Difficult to state ends of public policy Implementation failure Costs of provision (public service) Rent-seeking behaviour of politicians (election business cycle, corruption)  MUST BE AWARE OF THE LIMITATIONS OF GOVERNMENT INTERVENTION

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