Functions & Scope of Government in Economics - UPSC MCQ

• A public good is a commodity or a service provided to the Citizen without any intention of making a profit out of it.
• Electricity is not provided free. People pay for the service or the unit of electricity they consume.
• National Defence, Light House, and Public Parks are an example of Public goods as people are not charged for it by the government.

Correct answer is C.
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The Correct Answer is C : Military 

Explanation:
Private goods are characterized by:

• Excludability: Producers can prevent or limit access to the good based on the buyer's ability to pay.
• Rivalry: Consumption of the good by one person reduces its availability for others.

Among the options provided, the following are examples of private goods:

• Clothes: They are excludable and rivalrous - you must pay to purchase them, and once you own them, others cannot use them without your permission.
• Cars: Like clothes, cars are also excludable and rivalrous. You must pay for a car, and once you own it, others cannot use it without your permission.
• Food items: Food is excludable because you must buy it to consume it, and it is rivalrous because once you consume it, others cannot consume the same food item.

However, Military is not a private good because:

• It is non-excludable: The protection provided by the military is available to all citizens within a country, regardless of their ability to pay for it.
• It is non-rivalrous: One person's enjoyment of the protection provided by the military does not reduce the availability of that protection for others.

Therefore, C: Military is the correct answer as it is not an example of a private good.

The correct answer is B: Allocation function.

Allocation function refers to the role of government in providing goods and services that cannot be efficiently or effectively provided by the private market due to various reasons such as market failures, public goods, or externalities. The allocation function is essential for ensuring that resources are distributed in a way that maximizes social welfare and addresses inequalities. Key aspects of the allocation function include:

• Public goods provision: Governments provide public goods like national defense, public infrastructure, and environmental protection that are non-excludable and non-rivalrous in nature. Private markets often fail to provide these goods due to the free-rider problem.
• Addressing externalities: Externalities are costs or benefits that affect third parties who are not directly involved in the production or consumption of a good or service. Governments can intervene through regulation, taxes, or subsidies to correct for negative or positive externalities.
• Redistribution of income: Governments may use taxation and social welfare programs to reduce income inequality and ensure a more equitable distribution of resources within society.
• Regulation: Governments may regulate industries or markets to prevent monopolies, protect consumers, and ensure fair competition.
• Provision of essential services: Governments may also provide essential services such as healthcare, education, and public transportation that may be difficult for private markets to provide efficiently and equitably.

In summary, the allocation function of government deals with the provision and distribution of goods and services that are not efficiently supplied by the private market. This function is critical for addressing market failures, promoting social welfare, and ensuring a more equitable distribution of resources.

The correct answer is A: Distribution function.
Distribution function:
- Refers to the process of distributing resources and wealth among the population.
- Ensures an equitable distribution of resources and reduces income inequality.
- Involves the use of taxation and welfare policies to redistribute wealth from higher-income earners to lower-income earners.
- Examples of distribution policies include progressive tax systems, social security, and unemployment benefits.
- By redistributing resources, the government aims to improve social welfare, reduce poverty, and promote economic stability.

The correct answer is: C: Stabilization
Explanation:
The stabilization function of the government refers to its efforts to maintain a stable economy by addressing various macroeconomic factors. This function is crucial for promoting economic growth and ensuring the well-being of the citizens. The stabilization function encompasses the following main aspects:
Employment:
- Governments aim to achieve full employment, where all individuals who are willing and able to work can find jobs.
- Policies that support job creation, such as public works projects, job training programs, and tax incentives for businesses, can help reduce unemployment rates.
Demand-Supply balance:
- Governments strive to achieve a balance between the aggregate demand and aggregate supply in the economy.
- Fiscal policies, such as government spending and taxation, and monetary policies, such as interest rate adjustments and money supply management, are used to influence the levels of demand and supply.
Inflation:
- Inflation refers to the sustained increase in the general price level of goods and services in an economy over a period of time.
- Governments aim to maintain low and stable inflation rates to preserve the purchasing power of the currency and promote economic growth.
- This can be achieved through various monetary and fiscal policies, including controlling the money supply, adjusting interest rates, and managing government expenditures.
By performing the stabilization function, governments can help create a stable economic environment that allows businesses and individuals to thrive and prosper.

The Government Budget consists of the following main components:
A: Revenue Budget and Capital Budget
1. Revenue Budget
- The revenue budget includes the government's day-to-day operational expenses and revenue generation.
- It consists of:
a. Revenue Receipts: These are the earnings of the government from various sources like taxes, duties, and fines.
b. Revenue Expenditure: These are the expenses incurred by the government in its daily operations, such as salaries, pensions, subsidies, and interest payments on loans.
2. Capital Budget
- The capital budget deals with the government's long-term investments and capital assets.
- It consists of:
a. Capital Receipts: These are the funds raised by the government through loans, borrowings, and the sale of assets.
b. Capital Expenditure: These are the expenses incurred by the government on acquiring or maintaining long-term assets, such as land, buildings, infrastructure, and investments in various sectors.

Both the Revenue Budget and Capital Budget together form the Government Budget, which is a comprehensive financial plan for a specific fiscal year. This budget helps the government allocate resources and prioritize spending to achieve its short-term and long-term goals.

Explanation of Market Borrowings:
Market borrowings refer to the funds raised by a government from the public through the issuance of various debt instruments, such as government bonds, treasury bills, and other securities. These borrowings help the government to finance its budget deficit and fund various development projects.
Key features of market borrowings include:
- Debt instruments: The government issues various debt instruments, such as government bonds, treasury bills, and other securities, to raise funds from the public.
- Interest rates: Market borrowings typically come with interest rates that the government must pay to the investors holding the debt instruments.
- Term of borrowing: The term of the borrowing can vary depending on the debt instrument, ranging from short-term (e.g., treasury bills) to long-term (e.g., government bonds).
- Investors: Investors who buy these debt instruments can be individuals, financial institutions, or foreign investors. They invest in these instruments to earn a fixed income and for the safety of their investments.
- Secondary market: There is usually an active secondary market for government debt instruments, allowing investors to buy and sell these securities before their maturity.
- Credit rating: The credit rating of a government's debt instruments influences the interest rate it has to pay on its market borrowings. A higher credit rating generally results in a lower interest rate.
In summary, market borrowings are loans raised by the government from the public through the issuance of debt instruments. This type of borrowing helps governments finance their budget deficits and fund development projects.

Explanation:
The correct answer is D: Budget deficit.
A budget deficit occurs when a government's expenditures exceed its revenue collection. This imbalance typically results in the need for the government to borrow money to cover the shortfall. Here's a breakdown of the terms mentioned in the question:
- Public deficit: This term is not commonly used in discussions about government spending and revenue imbalances. It could be mistaken as a combination of public and budget deficits but is not a recognized term.
- Market deficit: This term generally refers to a shortfall in the supply of goods or services in the market relative to demand. It is not related to the government's financial situation.
- Government deficit: This term is often used interchangeably with "budget deficit," though it may also refer to a broader range of government financial imbalances. In most cases, however, it is synonymous with a budget deficit.
- Budget deficit: As mentioned earlier, a budget deficit occurs when a government's expenditures exceed its revenue collection. This is the correct term for describing the imbalance resulting from the government spending more than it collects in revenue.

Answer Explanation:
The correct answer is D: John Maynard Keynes. The idea that government's fiscal policy can be used to stabilize the level of output and employment is attributed to John Maynard Keynes.
Keynes was a British economist who developed the Keynesian economic theory during the 1930s in response to the Great Depression. His ideas laid the foundation for modern macroeconomic policy and greatly influenced economic policy-making in the 20th century.
Keynesian Economic Theory:
• Fiscal Policy: Keynes believed that the government should play an active role in managing the economy by using fiscal policy tools such as government spending and taxation to influence aggregate demand and stabilize output and employment levels.
• Government Spending: According to Keynes, during an economic downturn or recession, the government should increase its spending to stimulate demand, create jobs, and boost the economy. This is known as expansionary fiscal policy.
• Taxation: Conversely, during periods of economic growth and high inflation, the government should increase taxes and/or reduce spending to decrease aggregate demand, control inflation, and stabilize the economy. This is known as contractionary fiscal policy.
• Multiplier Effect: Keynes argued that an increase in government spending would have a multiplier effect on the economy. This means that each dollar spent by the government would result in an increase in the overall economic activity that is greater than the initial amount spent.
• Automatic Stabilizers: Keynes also emphasized the importance of automatic stabilizers, which are built-in mechanisms in the economy that help to stabilize output and employment without the need for active government intervention. Examples of automatic stabilizers include progressive taxation and unemployment benefits.

The correct answer is C: Discretionary fiscal policy.
Discretionary fiscal policy refers to the intentional actions taken by the government to influence the economy through changes in taxing and spending policies. It is distinct from automatic stabilizers, which are built into the fiscal system and operate without any additional government intervention. Some key points to consider about discretionary fiscal policy include:
- Purpose: The main goal of discretionary fiscal policy is to stabilize the economy, counteract economic fluctuations, and promote economic growth.
- Tools: Discretionary fiscal policy uses two primary tools - changes in government spending and changes in taxation. These can be adjusted to either increase or decrease aggregate demand, depending on the state of the economy.
- Timing: Discretionary fiscal policy is implemented at the discretion of the government, often in response to specific economic conditions or events. It is not automatic and requires active decision-making by policymakers.
- Examples: Some examples of discretionary fiscal policy include stimulus packages, infrastructure spending, tax cuts, or tax increases aimed at managing inflation.
In contrast, automatic fiscal policy refers to the built-in stabilizers that automatically respond to changes in the economy without any active intervention by the government. These include progressive tax systems and transfer payments, such as unemployment benefits, which help to smooth out economic fluctuations without the need for deliberate government action.

The answer is A: Ricardian theory of equivalence.
Explanation:
The Ricardian theory of equivalence, also known as the Ricardian equivalence theorem, is an economic theory that suggests that the method of financing government spending does not affect the overall demand in the economy. This theory was introduced by the economist David Ricardo and it states that whether the government finances its spending through taxation or through issuing debt, the outcome on the aggregate demand will be the same. Here's a breakdown of the main points:
Assumptions:
- Consumers are rational and forward-looking.
- There is a perfect capital market, meaning that individuals can borrow and lend at the same interest rate.
- The economy is at full employment, so there is no room for fiscal policy to stimulate output.
Key concepts:
- When the government increases spending, it can finance this either through higher taxes or by issuing debt (borrowing).
- If the government raises taxes, consumers will reduce their current consumption to maintain their desired level of future consumption.
- If the government issues debt, consumers will save the additional income they receive from the government and use it to pay future taxes. This is because they anticipate that the government will need to raise taxes in the future to pay off the debt.
- In both cases, the increase in government spending is offset by a decrease in private consumption, leading to no change in aggregate demand.
In conclusion, the Ricardian theory of equivalence suggests that the method of financing government spending does not impact the overall demand in the economy, as consumers adjust their behavior in response to changes in taxes or government debt.

The Fiscal Responsibility and Budget Management Act (FRBMA) was implemented in:
Answer: D. 2003
Explanation:
- The Fiscal Responsibility and Budget Management Act (FRBMA) was enacted by the Parliament of India in 2003.
- The objective of the FRBMA is to ensure fiscal discipline, reduce the fiscal deficit, improve macroeconomic stability, and promote transparency in the management of public finances.
- The Act sets targets and guidelines for the central government to manage its public finances, including targets for the reduction of fiscal deficit and revenue deficit, and limits on government borrowings.
- FRBMA also requires the central government to present a medium-term fiscal policy statement and a fiscal policy strategy statement to the Parliament each year, as part of the annual budget process.
- The Act has been instrumental in bringing about greater fiscal responsibility and transparency in the management of public finances in India.

An open economy refers to a country that engages in international trade, including the exchange of goods, services, and financial assets with other nations. This type of economy is characterized by its openness to global markets and competition, allowing for the movement of resources, products, and investments across borders. In an open economy, businesses and individuals can import and export goods and services, invest in foreign markets, and borrow or lend capital with other countries.

Option 1, which refers to free-market and laissez-faire economics, describes an economic system with minimal government intervention, but it does not necessarily imply that the economy is open to international trade. Option 3, an economy without government intervention, is also not necessarily an open economy, as it does not directly address international trade.

The answer is A: Current account.
Current account
- The current account is a component of a country's balance of payments.
- It records the transactions related to exports and imports of goods and services, as well as transfer payments.
- These transactions include:
- Exports of goods and services: The sale of products or services to foreign countries, which brings money into the domestic economy.
- Imports of goods and services: The purchase of products or services from foreign countries, which takes money out of the domestic economy.
- Transfer payments: These are one-way transactions, such as remittances sent by migrant workers to their home countries or foreign aid provided by one country to another.
- A positive current account balance indicates a surplus, meaning the country is exporting more than it is importing or receiving more transfer payments than it is sending. This can be a sign of a strong economy.
- A negative current account balance indicates a deficit, meaning the country is importing more than it is exporting or sending more transfer payments than it is receiving. This can be a sign of a weak economy or a need for foreign financing.
- The current account is important for understanding a country's trade position and overall economic health. A balanced current account is generally seen as desirable, as it indicates a stable and sustainable level of trade and financial flows.

Nominal Exchange Rate

• The nominal exchange rate is the rate at which one currency can be exchanged for another currency.
• It is expressed as the number of units of one currency needed to buy one unit of another currency.
• Nominal exchange rates are used to determine the relative value of currencies for international trade, investment, and other transactions involving foreign currency.
• These rates can fluctuate due to market demand and supply, economic factors, and political events.
• For example, if the nominal exchange rate between the US Dollar (USD) and the Euro (EUR) is 1.2, it means that 1.2 USD is needed to buy 1 EUR.

The correct answer is: A: Real exchange rate
Explanation:
The real exchange rate is an important concept in international economics and finance. It measures the value of one country's currency in terms of another country's currency, while taking into account the differences in price levels between the two countries. The real exchange rate is a key indicator for comparing international competitiveness and trade balances.
Key points to understand the real exchange rate:
- Nominal exchange rate: The nominal exchange rate is the rate at which one currency can be exchanged for another currency. It is expressed as the number of units of a foreign currency that can be exchanged for one unit of the domestic currency. The nominal exchange rate is the most commonly quoted and used exchange rate in international transactions.
- Price levels: Price levels are the average prices of goods and services in an economy. They are influenced by factors such as inflation, productivity, and supply and demand conditions. Price levels play an important role in determining the real exchange rate since they reflect the purchasing power of a currency within a country.
- Purchasing power parity: Purchasing power parity (PPP) is a theoretical concept that suggests that exchange rates should adjust to equalize the purchasing power of different currencies. In other words, a unit of currency should buy the same amount of goods and services in any country when exchange rates are adjusted for price level differences.
- Real exchange rate formula: The real exchange rate can be calculated using the following formula:
Real Exchange Rate = (Nominal Exchange Rate × Domestic Price Level) / Foreign Price Level
In summary, the real exchange rate is a measure of the relative value of two currencies, adjusted for differences in price levels between the countries. It provides a more accurate picture of international competitiveness and trade balances than the nominal exchange rate alone.

The real effective exchange rate (REER) is the weighted average of a country's currency in relation to an index or basket of other major currencies. The weights are determined by comparing the relative trade balance of a country's currency against each country within the index.

A floating exchange rate is a regime where the currency price of a nation is set by the forex market based on supply and demand relative to other currencies.

The international gold standard emerged in 1871 following its adoption by Germany. By 1900, the majority of the developed nations were linked to the gold standard. Ironically, the U.S. was one of the last countries to join.

The International Monetary Fund (IMF) is an organization of 189 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world.
Created in 1944, the IMF is governed by and accountable to the 189 countries that make up its near-global membership.